Technology Author:Dixuan Lu , Ivan Platonov Editor:Luke Sheehan Sep 07, 2020 06:29 PM (GMT+8)

SMIC's H-shares and A-shares plunged by 23% and 11% on the first trading day after it was reported that the US government is considering blacklisting the foundry – most other mainland chipmakers were trading lower as well.

Image credit: Louis Reed/Unsplash

The global tech and economic tussles are entering a new stage: the United States has reportedly launched an internal conversation on whether Shanghai-based Semiconductor Manufacturing International Corporation (00981:HK, 688981:SH) or SMIC, should be banned from using American technologies. The largest contract chipmaker in China's mainland was reportedly accused of working for the country's military sector.

Currently dominating the technology market worldwide, the US aims to impose hurdles in the path of the fast-growing challenger – China.

There are many examples of the world's second-largest economy's national champions that have become more than significant on a global scale. Huawei, for example, possesses plenty of advantages in the wireless sphere, so it shouldn't have been a surprise that the company has lately become the focus of the US government's suppression. SMIC is the fifth-largest foundry globally, with 4.8% of market share. It is also the largest fab with the most advanced processes – i.e. working at a 14nm-scale – among Chinese mainland chipmakers. 

In addition, SMIC has won a large number of funds from the National Integrated Circuit Industry Investment Fund (dubbed the Big Fund), with the country's government has launched a set of policies supporting the development of the semiconductor domain. Apart from that, China has added the 'third-generation semiconductors' into its fourteenth five-year plan.

While those policies and plans show the Chinese government's ambitions of developing local semiconductor companies, they have been deemed too 'aggressive' by the US, which is clearly afraid of the new challenger achieving global technological supremacy.

From the first to the third generation semiconductor, the global industry chain has become mature with American technology flooding the whole chain. For instance, about 7% of TSMC's 7nm techniques originated in the United States. ASML's ratio is even larger. (TSMC is the world's largest semiconductor fab with over half of the global foundry market; ASML is the biggest photolithography system supplier planetwide.)

During the recent meeting with investors, SMIC's executives said (in Chinese) that the company would not be able to produce 14nm chips for Huawei, which means that the product lines of SMIC contain American technology.

Regardless of the purpose of the US government adding SMIC to the blacklist, the performance of the foundry's stock price has shown that the investors are mainly bearish on it. There are a few reasons:

• In the case of getting blacklisted by the US government, SMIC's business growth will become harder. In the high-tech space, the most cost-effective way is to follow the experienced predecessors' methods (and China has been doing this exceptionally well over the past few years). TSMC is currently serving clients at the 7nm and 5nm nodes, which was achieved by combining its own developments with American technologies. If SMIC is blacklisted, it will need to invent a different way, which means higher costs and a longer R&D period.

• SMIC's process techniques are lagging behind those of TSMC. TSMC is reportedly delivering 5nm chips while SMIC only started the mass-production of its 14nm devices at the end of 2019. Although 14nm is an important node in the contemporary digital system, the 5nm is necessary for the 5G rollout. Driven by the new generation of wireless, the market share of TSMC will increase.

• The valuations of Chinese high technology companies are currently overheated, which is widely known by the local retail investors: the semiconductor chip stocks have recently been sliding down. 

While SMIC's possible ties with the Chinese military are under scrutiny, it is at risk of becoming a significant target in the long-lasting Huawei saga. Seems like it's not willing to take on this profile: the company said on September 5 that it has no relationship with the country's army forces and that its chips and services are designed "solely" for civilian and commercial uses.

The semiconductor industry is the foundation of the global technology ecosystem and, thus, an important future battleground. China and the United States are not likely to give up opportunities created by 5G and the progress across multiple industries. The mounting of massive tensions is just getting started.