Even as the coronavirus dominates headlines about China, the tech war with the US has rumbled on. Despite the fallout that has rippled through US tech stocks, investors should consider the fringe benefits to certain parts of the sector.
Technology companies are facing daunting conditions amid tense US-China relations. The phase-one trade deal in December hasn't quelled the intensifying struggle for tech supremacy between the two countries. Beyond just tariffs, the gloves-off tactics by the Trump administration also include blanket bans on specific technology companies, such as the US blacklisting of exports to equipment-maker Huawei Technologies over concerns that it may present a national security threat. And even though the steps are supposed to help US companies grapple with Chinese rivals, the rivalry is taking a toll.
A Cloud over Tech Stocks
Semiconductor manufacturers have been taking the brunt. Restrictions on selling components and technology to Chinese companies weighed on share prices of US-listed chipmakers last year because China is a primary source of demand for their products. After all, China consumes a quarter of global smartphone and PC units and around 15%–20% of global memory supply.
When Cisco said in 2019 that its China sales had been hurt because of negative sentiment over the trade war, its stock price took a swift hit. Meanwhile, electronics-makers like Apple have been warning the US government about the negative impact that tariffs could have for sales of their products. And even though the phase–one accord defused US threats to levy tariffs on laptops and cellphones, experts remain concerned that this possibility may arise if trade tensions escalate again.
In China, manufacturers have been hobbled by the US export ban. The trade war has prompted Beijing to accelerate its long-term strategy of strengthening its domestic technology industry in order to eliminate a dependence on US suppliers. China wants to make everything from Tesla cars to memory chips to cutting-edge mobile handsets; its leaders are now convinced that they need to achieve this goal as fast as possible.
Made in China for China
That means Beijing's “Made in China 2025” plan is being accelerated. This ambitious program, which aspires to replace US chipmakers, such as Micron Technology, Texas Instruments, QUALCOMM or even Intel, with domestic vendors, will now resemble a “Made in China 2023” plan. Indeed, at the end of 2019, China's government set up two major investment funds: a US$29 billion fund to build chipmakers and US$21 billion to boost China's technology manufacturing sector.
Yet China's strategic decision has created a silver lining for a specific category of global tech companies, in our view. In order to innovate, Chinese companies still need machines that can only be found abroad. Equipment manufacturers for semiconductor fabrication complexes have emerged as key enablers of China's aspiration for self-sufficiency.
The "Semi-Caps": Enablers of China's Tech Independence
So, even as other US technology companies are getting hurt by China's slowdown and business restrictions, semiconductor capital equipment makers—known as “semi-cap” companies—are poised to win a chunk of the investment that China's public sector is deploying. Companies that supply equipment to Chinese chip vendors actually enjoyed better-than-expected order growth from China. According to industry sources, orders for semi-cap equipment orders grew from US$3.5 billion in 2017 to US$5 billion in 2018 and US$6 billion in 2019. Robust demand is expected to continue in the coming years.
Companies that manufacture essential equipment for semiconductor fabrication include ASML, manufacturer of leading-edge lithography systems, and Lam Research, which makes the etch systems that create features of individual chips. Applied Materials makes equipment used over the entire semiconductor fabrication process. KLA-Tencor specializes in process control equipment for semiconductor manufacturing. All four have little competition, thanks to high barriers to entry and recent consolidation in the semi-cap industry.
As the US-China economic rivalry plays out, Beijing's redoubled drive for technology independence will no doubt continue to cloud the prospects for US exporters that have relied on China as a source of bottomless demand. Electronics retailers may have to grapple with new import tariffs at some point. But selective technology investors should recognize that the rise of China's innovation industry isn't all doom and gloom. For global semi-cap companies, Beijing's drive for tech independence may even represent a compelling opportunity.
