► Chinese chipmakers are distressed by the system-wide crisis; the effect will be alleviated by supply chain localization and the semiconductor cycle, which is peaking in 2020.
► Extensive stock accumulated before the Lunar New Year is helping the local industry players to operate – below full capacity though.
► Foundries, which are typically running on long-term contracts, will gain significant revenues in the first half of 2020; the economic downturn will creep up on them in the following quarters.
Having imported more than half the computer chips sold globally over the last decade, China is famously concerned about its domestic semiconductor area. Nowadays, tremendous amounts of capital are being allocated to a sector that is yet to catch up with the world-leading corporations. The mainland’s chipmakers are lagging behind in three key respects – the scale, the scope and the core technology.
The country’s attempts to leapfrog over its competitors, which are often a subject for international disputes, have caused some serious Intellectual Property (IP) objections originating from the western hemisphere, with these feeding into actual or potential trade wars.
It seems obvious to all that China’s preeminence in some areas is only a matter of time. However, in spite of how the state is dealing with the present challenges, there is something that can wipe out all the interim achievements in a wink. Namely, black swan events.
And we are facing one now.
The COVID-19 pandemic appeared to be destructive for the key downstream segment of the chipmaking industry – Information and Communications Technology sector, or ICT, a five-trillion-large colossus. The electronics market, a vital source of demand for chips, is being shaken by the rapidly changing shopping patterns: people are spending less on new gadgets these days, with the consumer confidence index dropping continuously.
The regional supply chain is being hugely affected too. The prolonged holiday break period and further movement restrictions in China have stirred the labor shortage, which was apparent in February. In the first quarter of 2020, the ‘World’s Factory’ is operating way below capacity, per many industry forecasts.
A temporary logistics network disarray seems to be a minor problem though. In essence, the tailing off of the semiconductor cycle signaled a recovery in the fourth quarter of 2019: chip shipments started growing in the region, making the inventory levels decline rapidly. Hence, chip manufacturers can possibly afford themselves a quarter-long stock accumulation.
One way or another, the temporary equilibrium will, almost certainly, turn south-west this time. The client-side factors are likely to eat out more of the potential demand for chips, a short-term oversupply thereby seems to be inevitable. Here below, we go through several pandemic-related narratives affecting the microelectronic devices market in China, trying to identify new opportunities for the country’s chipmakers.
The consumer electronics market slump
It is no secret that the world’s major semiconductor enterprises have a keen sense of the pulse of its principal sales area – the consumer electronics industry. Another commonplace is that this domain has been hit heavily by the outbreak. One example is the quarterly smartphone production forecasts that have already been cut several times, and are currently showing deep two-digit dips.
Other products that run on chips will also be hurt by the expected worldwide economic downturn. TrendForce, a market intelligence provider, estimated in February that one of the fastest-growing classes of wearables – smartwatches – will plunge significantly in the first quarter of 2020. The company made changes in its January forecast, downgrading the figures for notebooks, smart speakers and video game consoles by 12.3%, 12.1% and 10.1% respectively.
As the future of the epidemic is uncertain, it is relatively hard to project the consumer demand in the second quarter of 2020. Nonetheless, we can look back at history. The SARS outbreak of 2002-2003, the last healthcare system crisis in Asia of comparable size (but, indeed, differences abound between the two), happened in the middle of the global smartphone craze, when intelligent gadgets were on the rise.
At the time, the leading wireless chip providers’ sales were shaken by the sliding demand. However, the market rebounded in less than three months after the epidemic was finally handled and then kept on a solid uptrend. That was the time when Finnish giant Nokia was on the top of the planetwide ‘handset pyramid,’ followed by other old household names, such as Sony Ericsson and Motorola.
The game has been flipped over since then. Chinese companies have entered the market, occupying a vast share of it. Huawei, Xiaomi (1810:HKEX) and OPPO accounted for over 35% of the global sales in 2019, for instance. And the same is true for other types of omnipresent technological marvels.
For the local semiconductor players, it means that the industry is getting closer to the sufficient degree of supply chain localization, making the entire path from raw materials to consumption quicker and more resilient. During this turbulent period of time, the Chinese Original Equipment Manufacturers’ (OEMs’) traditional chip-making partners – large Japanese and South Korean corporations – may have difficulties in logistics and delivery operations, allowing the mainland-based firms to win contracts with their compatriots.
An upcoming rollout of the fifth generation of wireless technology, known as 5G, was expected to propel both the global smartphone market – which has been shrinking since 2016 – and Chinese chipset producers’ revenues (a well-known fact is that the country is at the forefront of 5G revolution). Now, the mainstream deployment of the new network protocol is posed to be postponed locally, as the state’s money is limited and being moved to reach urgent goals.
As the disease is spreading out into other regions and is being basically handled locally, the Middle Kingdom’s 5G hardware developers are getting extra time for their endeavors, aiming to beat the likes of Verizon eventually. Besides, this period, in some respects, might be cherished by those relentless futurists that are currently working on 6G.
Apart from consumer electronics, pandemic-spurred upswings in healthcare, remote working platforms and some other areas are creating a healthy demand for data center services. Servers are projected to become one of a few direct memory applications to grow in 2020. For DRAM producers, like Hefei-based state-backed startup Changxin Memory Technologies (CXMT), this is a major driver.
Going back to the semiconductor cycle that is verging to a close, here is another bellwether: foundries will be barely touched by the global emergency in the following months. According to TrendForce’s estimation, TSMC, the indisputable champion within the segment, will gain 43.7% more this year, compared to 2019. The mainland’s leader SMIC will increase its revenue by 26.8%. It is worth mentioning that fabs usually are working on contracts signed a few seasons ago. The gloomy reality of the consumption slump will conceivably reverberate in their financial results in late 2020-early 2021.
Meanwhile, fabless startups that intend to develop hardware solutions for emerging technological concepts, such as Beijing-based embedded AI pioneer Horizon Robotics and cloud server processor builder Cambricon, look quite robust against the backdrop of a looming recession.
More traditional semiconductor businesses are also trying to jump on the bandwagon. Flash memory maker GigaDevice (603986:SH), for example, has been accelerating (in Chinese) production of chips for infrared temperature guns. Many others have launched new product lines, manufacturing protective equipment for their employees, partners and beyond. A strategic industry, chipmaking is prioritized by the Chinese state. Headquartered in Wuhan, the current outbreak epicenter, 3D NAND developer YMTC has reportedly been operating 24/7 with no breaks since the Lunar New Year holidays.
There are a plethora of interconnected factors that must be considered when answering the questions of when and to what extent the world will take control of the epidemic. No matter which scenario plays out, China’s diverse nascent microelectronics industry will have something to say under the new world order. And it is likely to start from the local market, ousting foreign rivals experiencing supply chain trouble. An open question is whether there will be sufficient demand from OEMs and other downstream actors.