Chips, Chips, Chips: Early-Stage Investment Landscape in Semiconductor Industry
EqualOcean has crunched data to spot the prominent young chipmakers that global venture capital titans are betting big on in 2019.
With the specter of the next technological revolution looming, venture capital (VC) is becoming a more challenging business. One reason is that it is way harder to predict where a new qualitative shift will originate from. However, it is safe to say that the oft-cited ‘global connectivity’ will continue to be one of the key growth drivers in the next phase of the zeitgeist.
Zeros and ones
Since the last decade, countless international think tanks, well-respected consulting firms, investment and research organizations have repeatedly been pointing out that data collection, transmission and processing – or, to be more precise, the design, speed and accuracy of these processes as enabled by frontline chipmakers – are likely to shape the competitive landscape across a handful of industries.
Several hot technologies are widely projected to become game-changing soon. While mutually interconnected, three of them are linked directly to each of the triad of processes mentioned above.
The upcoming fifth generation of wireless technology, known as 5G, will facilitate a major upgrade in data transmission.
Artificial Intelligence (AI) is based on iterative data processing and (indeed, not by coincidence) is used to make this process quicker, smarter, more accurate and, eventually, automatized and self-sustainable.
Internet of Things (IoT), a phenomenon described by another buzzword in the tech and investment circles, being a ‘smart’ combination of interconnected devices, has all the chances to accelerate the data collection process in sophisticated quasi-physical ecosystems.
All these miraculous pieces of evidence for human civilization’s technological progress have a common point. Though it’s been a long way since low-capacity computers occupying several rooms and creaking just to multiply four-digit numbers (till today’s super-productive handsets and autonomous robots) the nature of data hasn’t changed. People still interpret their lives via zeros and ones, whether they know about it or not. And, as is commonly known, there is a tiny on-off switch for every binary signal – a transistor.
Transistors are clustered together, making up a computer chip. Chips, in turn, are parts of integrated circuits (IC), which are ‘in charge’ of distinct functions in every single electronic device around the world. And, finally, devices generate, interpret, preserve information of all types, which makes them the core element of modern digitalized systems and, at the same time, the main lever to compete on the global technology scene.
A classic example of a value chain, it shows the atomic structure of what is called ‘tech’ in a broad sense. And this is arguably enough to explain the pivotal role of semiconductor companies in this data-driven world of today – or the even-more-data-driven world of tomorrow, as they are not only the creators of all the ‘micro’, ‘nano’, ‘pico’ and so on but also the guides that walk the ‘tech’ through the thorny path from transistors to IC.
And these ‘tech sherpas’ are, of course, invested in, albeit not as lavishly as most of rockstar software and Internet companies that often go public with sky-high P/Es. One reason is that chipmakers’ projected return numbers are, in most cases, quite far from private investment firms’ hurdle rates for early-stage startups.
This, obviously, has something to do with relatively high capex and R&D costs. Even some big players in the sector struggle to turn toward sustained profitability. Foundries, which badly depend on a handful of external issues, including macroeconomic shifts and business cycles, are the extreme case.
For example, China’s second-largest foundry HeJian Technology (和舰芯片), which, according to EqualOcean, holds a 2.32% market share domestically, recorded almost CNY 14.4 billion (USD 2.04 billion) in direct costs attributable to the core production, known as Cost of Goods Sold (COGS), over the past three years.
Although the firm has been in top gear, producing on average 19% more wafers than the target amount stated on the official website, its recent sales results are meager, with operating income numbers having a hard time keeping up with the booming capex.
The lackluster financial performance turned out to be one of the factors that triggered HeJian to withdraw its IPO application on the Shanghai Stock Exchange Star Market (read more about the new tech venue on the Shanghai bourse in the latest EqualOcean report -- download) this July.
Secondary markets, filled with ruthless, utterly practical investors, aren’t the only hindrance for semiconductor companies. Most of chipmakers normally don’t get so far, facing barriers at the private equity stage.
Having a longer horizon for generating profit, they typically receive capital from four types of organizations: state-backed funds and corporations that choose them as a certain country’s ‘strategic pick,’ large multinational semiconductor firms or (potential) downstream partners (either vertical or horizontal investment), vast global asset management companies and small private funds specializing in semiconductors.
Only a small number of such entities can afford themselves half-blind long-term equity investments in young enterprises – or, in other words, early-stage funding. Therefore, it is of great interest who throws and who bags money in this important sector of the big high-tech game.
Among other findings, the ultragiant, USD 600 million-large investment round carried out by Horizon Robotics can’t go unnoticed. South Korean semiconductor behemoth SK Hynix (000660:KS) led the event, throwing heaps of capital at the Beijing-based embedded AI upstart. A bunch of Chinese VC firms, including Linear Ventures, Hillhouse Capital Group, V Fund Management and Morningside Venture Capital, joined as well.
That was not only the greatest private capital injection in the sector this year but also the third biggest funding round in history. Its compatriot Semiconductor Manufacturing International Corporation (SMIC, 0981:HK) – a Shanghai-based flagship of Chinese microelectronics fleet – grabbed over USD 1 billion from a long list of investors such as Goldman Sachs, Vertex Ventures and SIIC Investment back in 2001. Two years later, the foundry confirmed its ‘royal’ status by nabbing another USD 630 million brought to the table by more than a dozen of omnigenous entities.
The sun never sets on Zion
Israel, a country with the highest R&D-spending-to-GDP ratio worldwide (over 4.5% in 2017, as reported by OECD), is also a major startup generator: nearly 150 companies founded within the past five years in the country have received over USD 10 million in VC to date; at the same time, eighteen of them have obtained more than USD 50 million. Innoviz Technologies, an AI startup providing solutions for the autonomous vehicle industry, leads the list, with a quarter-billion dollars in known private equity (PE) financing.
While other recent big deals in Israel were made mostly in the booming fields of Internet and software, chips are also in good standing among local investors. However, the number of firms that pump capital into semiconductor rookies is pretty low. And the PE/VC market seems to be overconcentrated.
For one thing, each of the biggest rounds of early-stage investment in chipmakers recorded this year in the country saw participation from Tel Aviv based fund, Grove Ventures. Holding a ‘deep-tech portfolio’ of at least 10 companies that strive to build miscellaneous blocks for smart algorithm-based ecosystems, the asset manager is directly involved in the process of shaping digital tomorrow for Israel.
A proportion of seed investment in the industry tumbled in 2019. As of October 15, only 17 of 42, or 40%, events of this type took place this year so far. By comparison, seed funding accounted for more than half (25/48) of all the financing rounds recorded in the same period in 2018.
Possible explanations for this lie in the international macro environment, which is seemingly deteriorating this year. The ‘Capital winter’ that was declared in China to describe the country’s worsening startup investment scene is now a suitable term for other markets as well. As the number of Series A and B rounds changed insignificantly compared with 2018, it is clear that capital management companies became more sensitive to immature businesses.
Another interesting shift is observed in the major active investors structure. While we saw the likes of Softbank and Sequoia Capital on the crest of the wave last year, nowadays, corporate investment is taking the lead. SK Hynix, Amazon (AMZN:NASDAQ), Qualcomm (QCOM:NASDAQ), Samsung (005930:KS) and other technology heavyweights are making more bets in 2019. In a nutshell, money movers keep their capital out of the sector, while industry leviathans try to pervade distant corners of their respective supply chains.
For market segments with homogenous goods like silicon wafers, chips and IC, the only feasible way to differentiate one’s products is a continuous technological upgrade as prices are rather determined by the stiff competition existing in the industry. Besides, the ‘game of margins’ won’t last long, as it is quickly turning into the ‘game of capacity and scale.’
This ‘economic certainty’ is a huge thundercloud brooding above the semiconductor businesses, which are doomed to build their market strategies into the narrow brackets shaped by the cruel combination of a half-monopolized industry landscape and ever-changing technology, unless mighty state-backed institutions come up with money and protectionist measures. But, as China’s experience shows, even in this case, it is a bumpy road to ride on.