Semiconductor Equipment – Geopolitics

China makes all the difference.

• The ideological struggle between the USA and China is making itself felt especially in the semiconductor industry where it has hit Lam Research hard but, as of yet, left ASML unscathed.
• Lam Research reported a disappointing set of results, reduced forecasts and cut staff while ASML reported a record order backlog and forecast a 25% YoY growth in revenues in 2023.
• The difference here is China and while Lam Research is baking in a lot of the China risk into its numbers, ASML is not.
• Firstly, Lam Research’s (and Applied Materials) exposure to China is currently 30%+ of revenues while ASML is closer to 15% meaning that whatever the hit is, it will be twice as hard on Lam.
• Secondly, Lam is a USA company meaning that it has to abide by the October 7^th restrictions now while The Netherlands and Japan-based companies do not.
• There is currently a lot of back-room politicking going on right now in order to get The Netherlands and Japan to implement similar restrictions which would completely cut China off from 20nm and below equipment.
• While ASML will not sell any EUV equipment to China it is still selling DUV or Deep Ultraviolet equipment which can be used down to about 10nm or so.
• The continuation of these revenues is clearly included in ASML’s forecast meaning that there is scope for a cut should The Netherlands decide to adopt the same level of restrictions that the USA has put in place.
• This is why ASML’s management is calling for “sensible” export controls which in English means “We are already restricted on the sensitive stuff, please don’t take away our bread and butter as well”.
• Without Japan and The Netherlands, it will be more difficult to keep the Chinese stuck at 20nm, but the moves being made by the Chinese companies indicate that many are already giving up on processes below 20nm.
• This means that China will focus on 28nm – 45nm where there is plenty of business to be done but which may now become much more competitive.
• In the long term, these restrictions don’t mean very much for the equipment suppliers because if demand continues to grow, the factories will still have to be built.
• Hence, over time companies like Lam Research and Applied Materials will be able to replace the China business they lose now with revenues from customers in other countries.
• Overall in the equipment sector, ASML looks to me like it has a higher risk profile as there is scope for a downgrade of up to 15% should the Netherlands be convinced by the USA to put in the same restrictions.
• These risks are already implicitly included in the outlook for the USA-based semiconductor equipment makers.
• I continue to be nervous about the semiconductor sector as demand has weakened from consumers and the factories are being built for geopolitical reasons, not economic ones.
• This leads to a very real risk of oversupply and heavy pressure on pricing and margins for the sector.
• I continue to like Qualcomm, MediaTek, TSMC and Samsung who offer a lot of value but remain reluctant to own companies that have their own factories at the moment.