Taiwan Chipmakers Caught Between Rock and Hard Place

Progress: An 8-inch silicon wafer from 1993 on display at the ITRI Exhibition hall. (Photo: Matthew Fulco)
Progress: An 8-inch silicon wafer from 1993 on display at the ITRI Exhibition hall. (Photo: Matthew Fulco)

Allowing Chinese investment in the sector could give Beijing immoderate influence over Taiwan’s most prized industry, yet shunning it could undermine competitiveness.

 

The semiconductor sector is one of the last areas of the global consumer electronics supply chain where Taiwanese firms retain an edge over their Chinese competitors. Taiwanese integrated circuit (IC) makers have superior technology, produce better quality products, and are more trusted by global customers.

Taiwanese firms dominate contract chipmaking with more than a 67% share of the global market, according to research firm Gartner. Last year, the Taiwan semiconductor industry’s revenue reached a record high of NT$1.17 trillion (US$35.4 billion) on the back of strong demand from global brands like Apple, according to a January statement from the Ministry of Economic Affairs (MOEA).

Now China hopes to make some of those prime assets its own. State-backed Tsinghua Unigroup, the private-equity arm of Beijing’s elite Tsinghua University, is moving to buy stakes in several of Taiwan’s top IC packaging and testing companies and has expressed interest in a tie-up with leading IC designer MediaTek.

MediaTek Offices (Photo: Matthew Fulco)

Unigroup’s foray into Taiwan’s IC sector comes amid an overseas deal-making spree by the Beijing-based company as part of its state-sanctioned quest to become the world’s number-three chipmaker by 2020. With a war chest of US$47 billion, Unigroup should be taken seriously, experts say.

“Global vendors are underestimating China’s aggressiveness,” says Samuel Tuan Wang, Gartner’s head of semiconductor research and a 35-year veteran of the IC sector. Beijing is determined to build its own IC supply chain to resolve a severe domestic supply shortage, upgrade its manufacturing sector, and buttress national security, Wang says. Given those ambitious goals, he sees the current scale of M&A activity as merely “the tip of the iceberg.”

“Looking at what China has done to build up its own panel and solar industries in the past, it is not hard to predict what it has in mind for its semiconductor industry,” says Kevin Tu, a semiconductor analyst at Taiwan’s government-backed Market Intelligence & Consulting Institute (MIC).

The results have been inconsistent so far. Unigroup successfully acquired a controlling 51% stake in Hewlett-Packard Co.’s China networking unit for US$2.3 billion in May 2015 and a 15% stake in disk-drive maker Western Digital for US$3.8 billion last September.

But some larger initiatives have been unsuccessful. In July 2015, Idaho-based chipmaker Micron rejected Unigroup’s informal US$23 billion bid. Last November, a spokesperson for South Korean chip-making giant SK Hynix said the company had declined a “collaboration proposal” from Unigroup. According to reports in the Taiwanese media, Unigroup offered to buy 20% of SK Hynix for roughly US$5.3 billion on condition that the company build a wafer fab in China to make NAND flash memory chips.

Trio of acquisitions

Those failures have not deterred Unigroup from aggressively courting Taiwanese IC packaging and testing companies, which have responded positively to its overtures. In October 2015, Unigroup struck a deal for a 25% stake in Powertech Technology worth NT$19.4 billion (US$591 million). Powertech chairman and CEO Tsai Duh-kung told reporters at a press conference in October that he hopes the alliance with Unigroup will help the company safeguard its market position and fend off rising competition,.

In December, Unigroup followed that move by announcing plans to buy 25% stakes in Silicon Precision Industries (SPIL) and its subsidiary ChipMOS Technologies for a combined NT$68.7 billion (US$2.08 billion). If the deals are approved, Unigroup would become the second-biggest shareholder in ChipMOS, while SPIL’s holding in the venture would fall to roughly 10%.

“The strategic alliance with Tsinghua Unigroup will assist SPIL to maintain its current customers and help the company win new orders from Tsinghua Unigroup’s semiconductor subsidiaries,” SPIL chairman Bough Lin said at a press conference in December. RDA Microelectronics and smartphone chipmaker Spreadtrum Communications are two of Unigroup’s subsidiaries.

Each of the three Taiwanese testing and packing companies has a different specialty attractive to China, says Tu of MIC. SPIL specializes in logics IC, PTI in memory IC, and ChipMOS in driver IC, he notes.

China is one of the world’s largest buyers of machinery for semiconductor packaging and testing, according to a 2015 report on the IC sector by the U.S. Department of Commerce. According to the report, China accounts for 27% of floor space globally for semiconductor packaging and testing.

In the future, it will be difficult for Taiwanese chipmakers to increase their market share as individual vendors, observes Wang of Gartner. “Having Tsing- hua Unigroup as a partner will almost guarantee them business – and it will create jobs in Taiwan.”

Taiwanese regulators, however, have sounded a cautionarys note. After the deals were announced, Investment Commission Executive Secretary Emile Chang told reporters: “It is very unlikely that the commission would approve all three, as it will severely hurt Taiwan’s semiconductor industry.”

The remark reflects concern that the deals would give a state-owned Chinese firm undue influence over one of Taiwan’s most globally competitive industries. Together, Powertech, SPIL, and ChipMOS have a combined market share of 17.4% of the global chip testing and packaging sector, according to the Industrial Development Bureau (IDB).

Given that Taiwan is in the midst of a poltical transition, awaiting the inauguration of President-elect Tsai Ing-wen in May, “the Investment Commission will not hurry to discuss this case,” says Cheng Cheng-mount, president of the Agricultural Bank of Taiwan and one of the nation’s top economists. Even though “IC packaging and testing are not so sensitive in terms of technology,” he observes, “it’s not always easy for these types of deals to be approved.”

Eyes on the prize

Even as those deals are pending, Unigroup has begun to target Taiwan’s prized IC design sector. In that endeavor, the Beijing-based firm has enlisted the aid of Hsinchu-based IC designer MediaTek, the leader supplier of chips for Chinese mobile phones, and its chairman Tsai Ming-kai. Unigroup has expressed strong interest publicly in investing in MediaTek or merging the company with its chip subsidiary.

HTC smartphones equipped with MediaTek chips. (Photo: Matthew Fulco)
HTC smartphones equipped with MediaTek chips. (Photo: Matthew Fulco)

For its part, MediaTek appears eager to be receptive. “Taiwan should open up to global markets, including China,” Tsai said in January, speaking at a technology industry conference. MediaTek did not respond to a request for comment from Taiwan Business TOPICS.

However, Market insiders say Tsai is working behind the scenes to pressure the government to ease restrictions on Chinese investment in the IC design sector. Currently, Chinese companies are barred from investing in semiconductor design in Taiwan. And in June 2015, the Investment Commission rejected Unigroup’s bid to establish a research and development center in Taiwan, citing concerns the company would lure away Taiwanese IC designers.

Tsai’s “heart is in China,” says Wang of Gartner. “MediaTek’s success is due entirely to the sale of smartphones in China.” In recent years, MediaTek has grown exponentially by selling inexpensive chips to China’s fast-growing smartphone makers. Globally, Chinese brands comprise nine of the top 12 smartphone brands by sales, according to a 2015 report by Counterpoint Research.

Reliance on China has put MediaTek in a vulnerable position as growth cools in the world’s largest smartphone market. In 2015, MediaTek’s net profit plunged nearly 45% to NT$25.8 billion (US$780.5 million) from NT$46.4 billion (US$1.4 billion) a year earlier. In the quarter ended December 2015, MediaTek’s earnings fell 60% annually to NT$4.2 billion (US$127 million), the company’s worst performance since the first quarter of 2013. Gross margins in the October to December period hit a historical nadir of 38.5% as MediaTek struggled amidst an ongoing price war.

“MediaTek is suffering,” says Cheng of the Agricultural Bank of Taiwan, noting the fierce competition the company faces in China from both U.S. chipmaker Qualcomm and local Chinese brands.

By contrast, prospects for China’s chip designers look bright, according to Taiwan’s state-backed Industrial Economics and Knowledge Center (IEK), a division of the Industrial Technology Research Institute (ITRI). IEK forecasts that the PRC’s share of the global IC design market will increase to 11% this year from 7% in 2015, while Taiwan’s share of that market will fall to 21% from 22% last year.

Alternate paths

Meanwhile, harsh public comments from Unigroup chairman Zhao Weiguo have not helped his company’s cause in Taiwan. In a November 2015 interview with Taiwan’s Chinese-language DigiTimes, he advised the Chinese government to “prohibit the sales of Taiwan-made chips and related products in China if Taiwan is not treating China-based companies equally…as we treat Taiwan’s firms in China.”

“That strategy isn’t going to work,” says Cheng of the Agricultural Bank of Taiwan, in reference to Zhao’s proposal. “There is no valid reason for blocking Taiwan IC imports to China and it doesn’t make sense from a business perspective.”

Last November, Taiwan Economics Minister John Deng said the government was considering opening the IC sector to Chinese investment before President Ma Ying-jeou stepped down in May 2016. But Deng had to backtrack after the presidential candidates from both the Chinese Nationalist Party (KMT) and Democratic Progressive Party (DPP) spoke out in December against Chinese investment in the local semiconductor sector. Tsai Ing-wen said at the time that Unigroup’s investments in Taiwan could pose “a dire threat to Taiwan’s industries,” pointing to the company’s close ties to the Chinese government.

Market observers are now skeptical that the Taiwanese authorities will approve any of Unigroup’s deals in Taiwan. “It would take a very bold regulator to approve a transaction that the president-elect opposes,” says Ross Darrell Feingold, a Taipei-based senior adviser at DC International Advisory, a political risk and market access consultancy.

Yet partnering with Unigroup has the potential to allow the trio of chipmakers to invest more in research and development and improve their technology, Feingold says, citing Intel’s tie-up with Tsinghua Unigroup. Participating in that relationship “can only benefit the Taiwan companies,” he says.

To counter Beijing’s moves in the semiconductor sector, Advanced Semiconductor Engineering (ASE) chief operating officer Tien Wu has proposed that Taiwanese chipmakers work more closely together. By joining forces, they would be better able to secure the global talent and intellectual property rights necessary to develop innovative products, Wu said at a semiconductor industry conference in September 2015.

But efforts at domestic cooperation or consolidation have failed to bear fruit thus far. In August 2015, ASE announced a tender offer for roughly 25% of SPIL’s shares, but SPIL rejected the offer, calling it an attempt at a hostile takeover.

Among Taiwanese chipmakers, only Taiwan Semiconductor Manufacturing Co. (TSMC) seems to have a viable strategy for managing the challenge from China. TSMC has been cautious about moving manufacturing to China and insistent on not sharing its most valuable technology with Chinese partners.

In December 2015, TSMC announced plans to build a US$3 billion factory in the southeastern Chinese city of Nanjing. Taiwanese regulators approved the project in February, making it the largest investment to date by a Taiwanese company in China. The approval was the first by Taiwanese authorities following the Ma administration’s move last August to allow Taiwanese chipmakers to wholly own production facilities in China.

The Nanjing plant is scheduled to begin manufacturing 16-nanometer chips made from 12-inch wafers – the type of chip used in Apple’s newest iPhones – in the second half of 2018. As required by Taiwanese law, those chips are one generation less advanced than the 10-nanometer chips manufactured in Taiwan. Before TSMC sets up the Nanjing plant, it must “submit evidence of its 10-nanometer production in Taiwan” to the IDB, according to the Investment Commission.

Executive Secretary Emile Chang announces the investment Comission's approval of TSMC's investment plan in China. (Photo: CNA)
Executive Secretary Emile Chang announces the investment Comission’s approval of TSMC’s investment plan in China. (Photo: CNA)

At a February press conference, Investment Commission Executive Secretary Chang said the Nanjing plant has the potential to increase TSMC’s share of global contract chipmaking to 57% from 55%. TSMC’s share of the China market could rise to 50% from 46%, he added.

The rise of the Chinese fabless IC design industry “has enticed Taiwan’s foundries to set up production lines in China to help them win orders,” notes Tu of MIC. “In the short run, this trend will continue, as the Chinese government will keep encouraging international IC brands to invest in China and manufacture locally.”

A main reason TSMC is willing to produce the chips in China is that the company is the sole owner of the plant, experts say. That will keep TSMC’s intellectual property more secure than if the Hsinchu-based chipmaker had a local joint-venture partner.

“TSMC is rigid on technology protection,” observes Cheng of the Agricultural Bank. “The government has to trust the chairman,” he concludes, referring to the highly respected octogenarian head of TSMC, Morris Chang.

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