In the current era, national development is indispensable to the fast-growing technology sector. In the high-tech domain, intelligent chips facilitate the most critical technologies applied in all walks of life.
● SMIC's operating income followed an upward trend in the first half of 2020. While most of its revenue is from high-nanometer nodes, the foundry kept expanding its capex at sub-14 nm.
● Various catalysts, including the government subsidies, resolved internal conflicts and the growing consumption market in China, will exert a positive effect on SMIC's future performance.
● The US sanctions will further suppress SMIC's development, widening the gap between the mainland foundry and TSMC and impeding its cooperation with other suppliers.
● Once SMIC solves its supply problems, it will be back on track in its quest to catch up with other top players in the area for the next five years.
As the US Ministry of National Defense announced on December 3, 2020, Shanghai-based semiconductor manufacturer SMIC (HKSE:SMIC) has become the country's second gargantuan high-tech firm to suffer US trade restrictions. Those prevent SMIC from making products by using American components. Moreover, there was an internal conflict that happened right after the restrictions were launched. SMIC's CEO, Mengsong Liang, was rumored to be set to unexpectedly resign from the company. Will SMIC successfully handle this situation as it faces major hurdles in both internal and external environments?
After over 20 years of development, SMIC has become a tier-one foundry in China, distinguished by its large industrial size and advanced technology. Moreover, in 2018, it was ranked in the top four contract semiconductor manufacturers globally, occupying up to 6% of the market. It was ranked in the top five by operating income in the global foundry market by the end of 3Q 2020.
Financial performance and business outlook
Over half of SMIC's operating income comes from chips made at 0.18 µm and 55/65 nm.
In terms of the company's revenue, in the first half of 2020, its year-over-year increase rate was 32.6%, with USD 1.08 billion. The proportion of 14/28 nm hit 14.6%. However, compared with Samsung and TSMC, SMIC profitability is minuscule. Specifically, SMIC's average operating income has been around 9.6% of TSMC's since 2016 of 2020.
From 2018 to the end of 2020, SMIC's capital expenditure increased by around 32.6%; this was connected to SMIC's intentional expansion in 2020. According to the firm's announcement, in March 2020, it purchased LAM, applied materials and electronic equipment from Tokyo Electron limited for USD 0.6 billion, 0.54 billion and 0.55 billion respectively. SMIC has been reportedly stockpiling critical devices since the global tech standoff first emerged.
Although SMIC is facing problems these days, it still has at least three development engines. The first factor is government policy. On January 9, 2021, the Ministry of Commerce announced a plan for 'Blocking Foreign Laws and Methods's, aiming at firms outside of the US. Given the negative impact of US blacklisting policy, some firms, including TSMC and Samsung, which utilize American technologies, will not be capable of cooperating with Huawei and SMIC. Under this situation, this new policy will suppress the firms standing by the US. This leads to their limited opportunities to collaborate with Chinese high-tech firms, thereby losing a significant chunk of financial gains. Moreover, China is encouraging in-house product design and manufacturing these days, making more efforts to support firms like SMIC.
The second factor relates to the resolved internal conflict. According to SMIC's recent announcement, on January 10, 2021, Mengsong Liang still remains in the CEO position. Earlier, he has achieved many accomplishments and contributed outstandingly to SMIC. His previous track record was impressive. Prior to SMIC, Mr. Liang worked at TSMC, which he helped to beat IBM in some critical fields. Furthermore, he assisted Samsung in realizing the production of 14 nm chips and improved SMIC's core capabilities from 28 nm to 7 nm in 2015.
The ever-expanding domestic downstream is the third positive factor here. Even though the US restriction policy on blocking China's chip technology essentially projects a negative impact, China has the largest semiconductor devices market. In detail, from 2011 to 2019, China occupied the highest market shares with around half of the global figure. Furthermore, with the increasing sales of the semiconductor industry worldwide, China's microelectronics supply also presents a rising trend, and is expected to reach USD 539 billion by 2030. For foundry sales, even if the US is still accounting for over half of global shares by 2020, there is a dramatic increase of about 340% for China from 2010 to 2020. This implies enormous potential for China to catch up with the top American players in the foundry industry.
Risks to watch
There are two main risk categories facing SMIC's business. To begin with, SMIC has a decreasing competitiveness. As Bloomberg mentioned, SMIC relied on the US to enhance its technological skills. The recent sanctions will impede the firm's R&D on 7 nm chips, which might let TSMC dominate the market further. To be more precise, TSMC occupied 49% of the global foundry's market shares by the second quarter of 2019, while SMIC held only 5%. Also, TSMC accounted for 61% of China's foundry market in 2019, 45% higher than SMIC. If the Biden administration keeps cracking down on SMIC, its position will be in danger.
Secondly, SMIC lacks core technology. China's largest semiconductor firms do not have sufficient advantages in core chips or advanced technology. For one, China has been importing lithography machines. SMIC ordered a EUV lithography machine from ASML for about USD 0.15 billion three years ago; the elephantine device has not been shipped yet, due to the US sanctions.
SMIC has suffered several issues in the short term, including the US sanctions and the firm's lags in technology. Nevertheless, in the long run, as SMIC takes its advantages and strengthens its collaboration with other suppliers, this foundry can surpass other top players in the next five years. For instance, once ASML gets permission from the Dutch government, ASML will arguably be glad to offer SMIC an EUV lithography machine, helping the foundry continue into 5 nm chips production. Thus, as Bloomberg earlier forecasted, SMIC is likely to surpass GlobalFoundries and UMC's by 2025 by the global market share.