Is AI a New Engine for Emerging Market Equity Investors?

There’s more to AI than the US tech giants. Equity investors can find overlooked opportunities in emerging market companies.

Historically known for low-cost manufacturing, emerging markets have rapidly shifted focus to become active participants—and in some cases leaders—in the global technology revolution. More than 10,000 tech companies have been founded in emerging markets since 2014 with Asia, Africa, Latin America and the Middle East all participating in this innovation boom. And while this growth spans the broad technology spectrum, emerging markets are playing an increasingly influential role in the delivery of AI-enabled technologies.

AI is set to change the way we live. From information processing to transportation—AI is having a profound effect on the way we interact, work and socialise. As a result, the global AI market is projected to grow from US$86.9 billion in 2022 to US$407.0 billion 2027, a compound annual growth rate of more than 36%.¹ Amazon, Microsoft, Google and Meta are forecast to spend hundreds of billions each year on building data centres to manage the rise of AI. US giant NVIDIA, which increased its profit by 769% in the last quarter of 2023, has become a symbol of this transformation, with its dominant AI chip technology. 

Finding Opportunities in Asian Semiconductors

While AI processing chips like NVIDIA’s tend to dominate the headlines, high-speed memory is also a critical component for AI servers. Two Korean companies, SK Hynix and Samsung Electronics, are competing with US-based Micron for control of this market. SK Hynix is currently the dominant market player in so-called high-bandwidth memory (HBM) chips which is experiencing rapid demand (Display). In April, Hynix announced plans to invest close to US$4 billion to build an advanced fabrication and R&D facility in the US. We think that Hynix’s relatively cheap earnings multiple potentially underestimates the sustainability of its leading position in HBM.

And NVIDIA itself is a chip designer, not manufacturer. Someone else needs to etch those chips onto silicon wafers, and Taiwanese company TSMC is currently the leading-edge semiconductor foundry, and another example of a relatively attractively valued AI semiconductor exposure. The company recorded US$69.3 billion in sales last year, controls almost 60% of the foundry market and maintains a dominant position as the main supplier of processor chips for Apple and NVIDIA. Even allowing for the asset-intensive nature of TSMC’s business, we think its valuation is far less excessive than the lofty multiples currently enjoyed by the AI chip design companies.   

There’s More to AI than Chips

AI applications rely on advanced computer servers that can handle the massive computing power required for new AI-enabled applications. These complex servers require a multitude of high-performance components, in addition to the core processor and other semiconductors like memory chips, and demand advanced assembly, cooling and power supply solutions.

While chip design companies like NVIDIA and applications giants like Microsoft dominate the market’s attention, many other companies in the “middle” of the AI supply chain offer exposure to this rapidly growing market at more attractive valuations. Many of these companies are based in emerging markets such as Korea and Taiwan. Using bottom-up research, investors can find technology hardware companies that are critical to the AI supply chain, have market dominance and pricing power, yet trade at more attractive valuations than the headline-grabbing US heavyweights.

For example, King Yuan Electronics is a Taiwan-based company that provides testing and measurement services for the semiconductor back-end supply chain to companies like NVIDIA (Display). With such expensive processing chips, a robust testing process is critical to ensure that the final product works properly.

Unimicron, a Taiwanese technology company, is another critical player in the AI supply chain. The Taoyuan-based company makes Ajinomoto buildup film (ABF) substrate, a key component of the interconnection that joins advanced chips with circuit boards. Unimicron’s customers include NVIDIA and Apple and its materials go into central processing units, graphic units for computers servers and gaming consoles. Major semiconductor companies such as Intel and NVIDIA depend on ABF substrates to produce high performance chips.

Capturing the Power of a Technology Revolution

Despite an impressive roster of technology companies, Asia appears to have been left behind in the global sector’s re-rating over the last few years. While technology sector valuations in the US, Europe and Japan have risen substantially since 2019, in Asia ex-Japan, technology valuations have hardly budged (Display). We think investors could be potentially overlooking some attractive opportunities today.

To be sure, Asia’s technology industry has been volatile in recent years. Following the surge in technology demand during the Covid-19 pandemic, many Asian technology companies suffered from overcapacity and falling profitability; stock prices rose dramatically only to fall rapidly again in 2022. Companies are finally restoring a natural supply and demand pipeline and a cyclical recovery is underway. On top of that, the AI-related infrastructure boom is now boosting the recovery. 

The AI theme enjoys strong momentum but as a value-based investor in emerging markets, we search for more durable fundamentals. We target companies that are inextricably linked to the supply chain and boast pricing and supply power backed by products that are essential ingredients for the high-profile AI players to succeed. 

Our emerging market equities process and investment approach—incorporating both fundamental and quantitative research—supports our search for quality businesses with these attributes that trade at more compelling valuations than the US technology giants. This approach may help investors capture the power of AI and find surprising return potential in the unsung, innovative emerging-market companies that are quietly enabling a global technology revolution.

1. MarketsandMarkets