China Semiconductors Narrowing the Gap – China’S Great Chip Challenge
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EQUITY RESEARCH REPORT TELECOMS, MEDIA & TECHNOLOGY September 2018 By: Frank He (S1700517120005) https://www.research.hsbc.com China Semiconductors Narrowing the gap – China’s great chip challenge China’s semiconductor industry is making rapid advances but still falls far short of meeting domestic demand We identify investment opportunities in areas where the technology gap with foreign rivals is narrowing We initiate coverage on the A-share semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold) Play interview with Frank He Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Why read this report? China’s high-tech economy needs far more home-grown chips – we explain where they will come from We identify which A-share companies stand to benefit most from this move up the technology ladder We initiate coverage on four major players in China’s semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold) 1 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Contents Narrowing the gap 3 The rise of China’s IC makers 11 Three opportunities 20 Company updates 44 Naura (002371 CH) 45 Han’s Laser (002008 CH) 59 Tongfu Microelectronics (002156 CH) 72 GigaDevice (603986 CH) 83 Disclosure appendix 98 Disclaimer 101 2 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Narrowing the gap As in so many other industries, the market for semiconductors in China is the biggest in the world. The problem is that only a fraction are made by domestic companies, creating a technology gap that is too wide for comfort. This report looks at how China plans to close the gap and identifies the most promising A-share investments linked to this theme. We initiate coverage on Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold). Few can dispute that China’s tech industry is now a force to be reckoned with. In areas such as mobile payments, e-commerce and telecom equipment, Chinese companies are already the envy of the world. Elsewhere, however, a great deal of work remains to be done. Nowhere is this more apparent than in the realm of semiconductors, the integrated circuits used in everything from telecom equipment and personal computers to giant servers and applications for artificial intelligence and robotics. One stat helps to tell the story – while China is the world’s biggest chip market, an industry estimate suggests that only 13% of the semiconductors required by the country’s tech industry were manufactured by domestic companies last year (this figure rises to 42% if the output by foreign companies in China is included). This reliance on products imported from other countries is a concern for China’s government. It This reliance on products imported from other has made technological independence a policy priority, especially now that trade tensions with countries is a concern the US are rising. China has no desire to remain the world’s No 1 assembler of electronics. It wants to be at the forefront of designing and manufacturing the semiconductors that will drive its new, high-tech and smarter economy in the age of artificial intelligence, 5G telecom, the Internet of Things (IoT), and autonomous driving. In this report we: Identify investment opportunities in areas where we believe Chinese companies have competitive advantages or can gain market share, such as the design of integrated circuits (ICs), semiconductor equipment, and IC packaging and testing. Assess the drivers that will help to close the technology gap, including huge investments in capital expenditure and R&D, as well as supportive government policy. Look at the obstacles that stand in China’s way, such as restrictions on imports, the difficulty of making overseas acquisitions, and limited domestic supply of key materials in the semiconductor supply chain. Initiate coverage on four A-share companies in that supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy) and GigaDevice (Hold). 3 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Investment opportunities China has been looking to accelerate the development its domestic semiconductor market for The recent trade tensions with the US have underlined several years. According the roadmap outlined in the high-profile “Made in China 2025” the importance of this policy industrial development policy, China’s self-sufficiency in integrated circuits will increase to 49% in 2020 and 75% in 2030, including production by foreign companies. The recent trade tensions with the US have underlined the importance of this policy. For example, the ban on US sales to domestic telecom equipment manufacturer ZTE Corp – since lifted – highlighted the dependence of Chinese companies on imported chips. It’s a huge market. China is the biggest consumer and importer of semiconductors, accounting for USD193bn of USD343bn of global sales of integrated circuits last year. China produced 1.9bn smartphones, 307m PCs and 172m TVs in 2017, accounting for over 90%, 70% and 80% of global supply, respectively. At the same time, we estimate that Huawei and ZTE share over 50% of the global telecom equipment market. So, given current trade relations with the US, the need for technological independence has never been greater. As usual in China, growth has been remarkable. According to data from PWC, China’s semiconductor consumption growth exceeded worldwide growth for the sixth consecutive year in 2016. Domestic semiconductor consumption grew 2.9% in 2016 to reach record 60.6% of the global market, while the worldwide semiconductor market only grew 1.1%. During the past 10 years, semiconductor consumption in China has grown at CAGR of 12%, far ahead of the global rate of 3.2%. And, as always in China, policy support is a major factor. To accelerate efforts to gain As always in China, policy support is a major factor self-sufficiency in semiconductors, in 2014 the government set up the China National Integrated Circuit Industry Investment Fund. According the Ministry of Industry and Information Technology (MIIT), the goal is to invest in chip manufacturing, boost industrial production and research, and promote mergers and acquisitions. The fund operates as a corporate entity under the MIIT and the Ministry of Finance. Commonly referred to as the “Big Fund”, it has previously backed major projects including a Tsinghua Unigroup memory chip plant worth USD24bn that is under construction in the city of Wuhan (source: Reuters, 25 April 2018). A second fund is being put together to provide further support for the sector. In another policy move, China’s finance ministry has introduced tax breaks for domestic chipmakers (Reuters, 30 March 2018). Chipmakers will be exempt from corporate taxes for two to five years followed by partial deductions. The exemptions cover a range of products, from very basic to cutting-edge chips, for use in computers, smartphones and other electronic devices. We think that all these developments create opportunities for investors, especially in areas where we believe Chinese companies have a competitive edge or are well positioned to gain market share. They include: IC design Ten Chinese companies were ranked in the world’s top 50 IC design companies last year, up from one in 2009. Their market share has increased from 5% in 2010 to 11% in 2017. Chinese companies have a particularly strong presence in application-specific integrated circuit (ASIC) based artificial intelligence (AI) and blockchain as well as the NOR flash memory segment. The addressable market size of ASIC-based AI chips will surge from USD1bn in 2017 to USD4.6bn in 2020, according to Frost & Sullivan, and account for 30% of the total chip market in 2020, up from 19% in 2017. We see a balanced demand and supply outlook for NOR flash in 2018-19, which would favour leading suppliers such as GigaDevice. 4 EQUITIES ● SEMICONDUCTORS & EQUIPMENT September 2018 Equipment China’s spending on fab equipment is set to increase by 57% y-o-y in 2018 and 60% in 2019 according to SEMI, a provider of data on the electronics supply chain. This means China is likely to overtake Korea, the world’s biggest spender in this area, in 2019. Since May last year Chinese companies have been able to mass produce over 16 kinds of front-end wafer fabrication equipment (mainly covering 28nm and above). The issue here is that their aggregate market share in equipment installation in Chinese foundries is still only 5%. The big gap between the high capex cycle and the low self-sufficiency ratio creates ample opportunities for domestic semi equipment makers. We believe Naura will be the major beneficiary in this localization trend in wafer fabrication. Packaging and testing IC packaging and testing is the sector where the technology gap between Chinese companies IC packaging and testing is the sector where the technology and global rivals is the smallest. Industry consolidation via M&A has increased the competitive gap is the smallest strength of Chinese vendors in the past three years. Among the global top 10 outsourced assembly and test (OSAT) companies the revenue contribution from China’s three leaders – JECT, Huatian, Tongfu – has increased from 6.6% in 2011 to 21.2% in 2017, driven by organic growth and acquisition. We think a shift in industry drivers from smartphones to automobiles and the Internet of Things (IoT) will change