D2D China - Domesticization Picks Up Steam

The view from China's WFE sector shows clear momentum as companies adapt to overcome US sanctions

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In which we explore emerging signs of a Spring thaw in China’s chip industry, albeit with continued pressure of fabless companies there; growing adaption in PRC companies specialization in response to the US sanctions; and the emerging asset class of trading semis in Shenzhen’s Huaqing North Road.

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We will be in China for much of July. If you would like to meet up or if there are companies you recommend we meet while we are there, please drop us a line.

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Noteworthy Items

Semis and Deep Tech

China’s chip imports were up 22% in the first quarter of the year, cue celebration as this is a sign the economy is improving. China’s chip exports were up 28% in the same period, cue concers about a deepening of the trade war.

Two big fundraising news items. China’s Big IC fund has reportedly allocated $47 billion for its next fund, and flagship chip designer Unisoc raised $552 million in funding. We actually read these as positive for the US government’s chip restrictions. The Big IC Fund did not deliver the results the government intended, leading to the jailing of several of its executives. The fund’s new direction seems to be invdesting more in the biggest chip companies. Unisoc has had much government support over the years, and that has not made it particularly successful. It is not clear how more money is going to solve any of these entities’ problems.

In small business circles in the US, there is a lot of talk about the transfer of wealth underway as Baby Boomers retire and sell the companies they built. There is a similar phenomenon taking place in China’s semiconductor circles. In the 1980’s many people left their rural hometowns to strike it rich in Shenzhen, and an industry grew up around semiconductor distribution. As those entrepreneurs started to retire, Covid-related shortages led first to a huge boom in business and then an ensuing crash. Now there are signs that the ‘second generation’ of distributors are returning to their parents’ businesses. An interesting read for what it says about the state of the industry but also for a deeper look at some of the people working inside it.

One of the implications of the article above is the extent to which semiconductors are an investible asset class, at least within the narrow confines of Shenzhen’s Huaqiang North Road electronics malls. We have spent a lot of time in this area over the years and so we are not surprised that fortunes have been made buying low and selling high in what is a fairly inefficient market. The hot product of the moment is the latest Broadcom Tomahawk ethernet switch chip, which seems to be in even higher demand than Nvidia GPUs (which admittedly are very hard to find in China, publicly). And just like investors in equity markets search for proxies, prices for domestic Ethernet chips are up considerably as well this year.

There are growing signs of a recovery in Chiaa’s semis markets. We have seen this in the results of Western companies who compete in some of these end markets - industrial, IoT, MCUs, etc.. In China we are now seeing some companies start to raise prices, so far this is fairly limited to packaging, testing and materials companies, but it is an encouraging sign, maybe. The optimistic take on this is that the market is bottoming. The pessimistic take is that these companies have no choice but to pass on inflation-related cost increases, which will just end up further squeezing the profitability of the fabless companies.

China’s semis analysts seem to spend a lot of time thinking about US-based ADI. Many of the best PRC chip companies compete with ADI, or at least compete in some of ADI’s markets and aspire to compete with them. (For some reason, Texas Instruments, does not garner as much attention.) So analysts in China have been heartened by ADI’s results seeming to bottom out cyclically, as that hopefully implies recovery for the company’s nascent peers in China.

An academic team from China, with European collaboration published a paper about building “micron-sized” robots for use in healthcare. The article explicitly mentioned the 1966 film “Fantastic Voyage”.

We have been covering the travail of many semis companies as they transition from dependence on venture funding to dependence on local government funding. Of cousre this was always going to have consequences. One analyst recounts the story of a company that sold its headquarters building to raise money, this sparked fears of the company leaving town, alarming its local government backers. The conclusion is that the industry may be turning around soon and companies need to do whatever they can to survive.

One unsurprising consequence of the US chip sanctions has been to encourage PRC semis companies to specialize in areas where they have solid domestic customers. One area where that has worked out well is solar systems - China leads the world in these and they require a fair amount of microcontrollers (MCUs). This is an interesting case study in how PRC companies are adapting and in a very limited scope out-developing foreign competitors.

A sobering critique of the US CHIPS Act. Some of this is what you would expect from a PRC analyst. While there is definitely some spin in the piece, much of it is also a legitimate critique of unintended consequences and unexpected bottlenecks. Whlie we are on the subject of unintended consequences, half of Japan’s semicap equipment exports now go to China.

Reading offical output from PRC government sources can be a chore, with a lot of very formal, vague language that is deliberately hard to for outsiders to parse. This speech by a leading China computer science professor to China’s legislature is refreshingly clear. Much of it is a history of compute and a rough summary of the changes brought about by “AI”. But read to the end and his specific policy calls are worth noting. His take is that China needs to build both ‘open’ (general usage) and ‘closed’ (government and military) AI systems, He also makes familiar claims that “data is a national strategic asset”, the country needs entities to build “large AI models”, and the country needs an “integrated computing power network”. The first two are common refrains heard from every government. The third one strikes us as very PRC-specific.

A tutorial on how to sell chips to foreigners - buy our manual for RMB 188 now RMB 88, then sign up for our online seminar. This could have been any self-help course anywhere on the Internet, but this one focused on how to read spec sheets for clues on what customer are thinking, be fast and efficient, recognize that your company probably lacks sufficient sales channels, but know that all this is worth the effort.

Huawei

Like all the big tech companies, Huawei is reportedly rolling out its AI platform later this month. Huawei “Project 1” will combine its Pangu large langauge model with integration into its Harmony mobile operating system. Worth keeping an eye on this. We hope they call it HI - Huawei Intelligence.

Huawei’s Harmony OS is now reportedly the second most widely used mobile OS in China, after Android and ahead of Apple’s iOS. This is in terms of new adds, the iOS installed base in China is still much larger. That being said, Huawei is doing very well with its new phones.

Automotive, Industrial and Macro-Economic

Car maker Nio is opening a new manufacutring plant that almost doubles its capacity. This is worth reading less for the news, which is just one of many simmilar stories in the press lately, and more for the way in which the company bends over backwards to prove that this factory is not “excess capacity”, and is only there to fill existing demand for its products. The PRC government and companies are very aware of global criticism of China’s capacity glut flooding export markets.

Diversions

Over the years, we have met many eccentric foreigners living China, but no one is this crazy. American Derek Sandhaus is looking to popularize China’s baijiu liquor outside of China. Having had more baijiu than we would like to (or can) remember, we can attest to the very high level of difficulty he has set for himself. That being said, Ming River Sichuan Baijiu, does look tempting. We will buy the next paid subscriber to this newsletter a bottle.

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For Paid Subscribers below we dig into the domesticization (or lack thereof) of China’s wafer fabrication equipment (WFE) market.