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China’s chip executives brace for winter

On a recent Wednesday afternoon in Shanghai, the founder of a semiconductor start-up spotted the head of a well-known chip venture capital firm near the elevator at an industry event – and grabbed the chance for a 60-second “elevator pitch”. The venture executive walked away and the entrepreneur was left with a sense of foreboding.

“I’ll run out of money soon if there’s no new investment,” said the founder, who declined to be named because of the sensitivity of the topic. “It is not as easy as two years ago, when [former US president Donald] Trump first started to impose sanctions on the industry and largely hyped up the semiconductor investment circle in China,” he told the South China Morning Post.

The start-up founder is just one of many Chinese chip entrepreneurs trying to find shelter from the storm that has hit the country’s chip industry. The galvanisation of the industry that came in the face of earlier US sanctions has turned to desperation after Washington ratcheted up restrictions. Now, all Chinese chip companies are bracing for a tough year ahead.

In 2020, when Washington blacklisted dozens of Chinese tech companies, including Semiconductor Manufacturing International Corp (SMIC) and Hikvision, it helped trigger a boom in China’s chip manufacturing and design sector as firms pushed to meet Beijing’s call for technological self-reliance. Biren Technology, a chip design firm benefited from this drive, raised 4.7 billion yuan (US$648.5 million) in the first 18 months of its incorporation.

Last year alone, China added 592 chip design firms, or about 11 new start-ups per week. Chinese semiconductor-focused cities like Shanghai, Beijing, Shenzhen, Wuxi and Nanjing had a total of 2,810 such firms by the end of the year.

The situation has since changed drastically. During an event at this month’s Semicon China summit, four out of five executives from Chinese chip firms predicted that 2023 would be worse than this year, adding that they are “preparing for winter”.

“Next year will be relatively sluggish, whether from the global or domestic perspective, so we have to improve our product,” said Liu Erzhuang, CEO of Productive Technologies. In addition to partially blaming geopolitics, he also attributed the downturn to the pandemic, interest rate hikes in the US, and a global chip glut.

Zhang Guoming, president of Shanghai-listed semiconductor equipment manufacturer Hwatsing Technology, said chip companies in China have predicted and prepared for a decline next year, which has been anticipated by the global industry after the recent chip shortage reversed into a glut.

Zhang’s comments echoed those from an executive at Nanjing-based Atomic Nano-Materials and Equipment, which produces raw materials for semiconductors, who said the downturn was predicted “as early as March” this year.

In July, Gartner projected that the semiconductor industry would face declining revenues in 2023 amid rising inflation and weakening consumer spending, which would mark an abrupt end to one of the industry’s biggest boom cycles. The research firm lowered expectations for this year’s revenue growth by 6.2 per cent.

“Although chip shortages are abating, the global semiconductor market is entering a period of weakness, which will persist through 2023 when semiconductor revenue is projected to decline 2.5 per cent,” Richard Gordon, practice vice-president at Gartner, wrote in a report in July.

In May, Malcolm Penn, chief executive of Future Horizons, warned of a 22 per cent global slump in integrated circuits amid “a collapsing chip market combined with a global economic downturn”.

As warning signs for the industry piled up, fresh US export controls imposed in October dealt another unexpected blow.

On October 7, the US Bureau of Industry and Security, an agency under the Department of Commerce, implemented a new round of export controls aiming to curb China’s ability to obtain advanced chips, develop and maintain supercomputers, and manufacture advanced semiconductors for military applications, including weapons of mass destruction.

The sanctions, viewed as the most comprehensive and destructive to date targeting China’s semiconductor industry, followed the enactment of the US Chips and Science Act to bolster domestic chip making, and the Commerce Department’s move to restrict Nvidia and Advanced Micro Devices (AMD) from selling their most advanced artificial intelligence (AI) chips to China.

“[The latest export controls] may make it difficult for us to invest in advanced manufacturing process nodes in the future,” said Zhang. “In preparation for the winter, we have to do more research and development.”4

The impact was immediate. Biren, which boasted of having the ability to design chips more powerful than Nvidia’s, was forced to reduce the performance of its chip to avoid the export controls, according to a report by the Financial Times. Biren did not respond to a request for comment.

Maintaining overseas supply chains is critical for Chinese chip design firms, as they rely on the more advanced fabrication plants operated by the likes of Taiwan Semiconductor Manufacturing Co (TSMC). HiSilicon, the in-house chip unit of Huawei Technologies, quickly rejected a media report this month saying that it would be able to produce Huawei’s advanced Kirin smartphone chip in 2023.

Wafer fabs and chip-making equipment firms, especially those focusing on advanced nodes, are also dealing with the impact of the restrictions.

Xing Xiao, partner and CEO at Shanghai Haiwang Fund Management, said one of the equipment companies in which it invested has seen orders “directly reduced by 20 per cent”.

Wafer fabs may also be facing a reduction in production capacity, as the export controls have slowed the pace of expansion and new plant construction, Xing added.

The impact in many different areas may soon add up. Slashed orders, reduced revenue and a lack of investment could force some into bankruptcy.

A record number of chip-related companies have already gone out of business this year. As many as 3,470 companies that include the Chinese word for “chip” in their name or business scope deregistered between January and August, surpassing the 3,420 such firms that closed in 2021, according to statistics from business database platform Qichacha.

“China’s semiconductor industry is currently in the recession stage of a business cycle,” said Wang Chikun, a researcher at the Beijing-based research institute Kandong. “Existing enterprises are faced with reduced input-output ratios, declining sales, shrinking business scale, as well as lower gross profit.”

Not even the biggest companies in the industry are immune to the downturn.

“The inevitable political factors and the pandemic this year have caused some short-term fluctuations,” Sun Bin, executive vice-president of ChangXin Memory Technologies (CXMT), said in a keynote speech at Semicon China. “We need to live through the stage of supply and demand imbalance.”

CXMT is one of China’s top two memory chip makers, along with Yangtze Memory Technologies (YMTC). Both are believed to be primary targets of the latest US export controls, which restrict China’s access to dynamic random-access memory (DRAM) chips using the 18-nanometre half-pitch node or smaller, and to NAND flash memory chips with 128 layers or more.

“Large companies are also facing a dilemma when their R&D spending is reduced and the speed of new product launches has slowed down,” said Xing.

Chip venture capital firms, which have invested tens of billions of dollars annually into the domestic industry over the past few years amid a broader move to boost China’s semiconductor self-sufficiency, are also feeling the chilling effects of US restrictions, according to a panel discussion at Semicon China.

Sun Yuwang, president of China Fortune-Tech Capital, a venture capital firm incorporated by SMIC in 2014, said the number of investment projects approved by the company per week has nearly halved compared with four months ago. He attributed this to the “lack of projects with momentum in the semiconductor industry after many years of high-intensity investment”.

Sun said the company planned to slow down investment as it prepares for an industry downturn, in addition to raising the standards for new investments and being “especially cautious” with high-value projects.

Investment decisions are also being impacted in other ways. Su Renhong, founding partner at Shanghai Hushan Investment Management, said his company now takes into consideration the nationalities of company executives.

This stems in part from concerns over how US citizens may be impacted by Washington’s new rules, which “restrict the ability of US persons to support the development or production” of chips at “certain China-located semiconductor fabrication ‘facilities’ without a licence”.
Many executives who have been critical to the development of the domestic industry studied and worked in the US and hold US passports.

“When winter is coming, the first thing entrepreneurs need to do is prepare at least 18 months of cash flow,” said Mi Lei, founding partner and co-CEO of venture capital firm CASSTAR, which focuses on hard tech in China and holds a portfolio of more than 150 chip companies.

“It is likely that a start-up will be unable to get follow-on funding in a year or so under an economic downturn or a crisis, so 18 months of cash reserves would be safe for a company to get through such a period,” Mi said.

However, some are holding out hope that the downturn will not last more than a year as they seek a chance to take off once investment bubbles pop.

Mi, who has witnessed the evolution of China’s chip industry over the past eight years, said the downturn could be helpful to investors as companies return to “rational” market valuations.

While he believes China’s semiconductor market is likely to rebound in 2024, he also thinks the industry’s future lies in technologies beyond smaller process nodes. Photonic chips, for example, can offer greater performance in AI-related scenarios by using photons, or light particles, instead of the electron-based approach used in traditional integrated circuits, he said.

Unisoc, China’s largest fabless chip company in the mobile phone processor market, also sees a bright future for its 5G chips amid increasing demand for such smartphones over the next three years, despite overall weakening demand for electronic products, the company’s chairman Wu Shengwu said. South China Morning Post

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