Semiconductors – Game of subsidies

No one is thinking about economics at the moment.

• It looks like Intel’s requests for more subsidies to build leading-edge fabs in Germany will pay off, but the subsidies are still likely to be below those available in Asia once again underlining that semiconductors right now are all about geopolitics and not economics.
• Intel is currently in line to receive €6.8bn from Germany to build a leading edge fab but it now looks like it will receive around €10bn but only if it also increases its level of investment.
• This is not a big surprise as inflation has been pushing construction costs up and €6.8bn does not buy nearly as much now as it did in 2019.
• Inflation is how the public is paying for the rampant money printing and spending that occurred during the pandemic and I continue to think that it will not ease until the middle of next year.
• At that point the value of money will have inflated away roughly the amount that was printed, bringing the economy and the money supply back into balance.
• Hence, for now, I continue to expect this difficult macro outlook to persist and it is against this backdrop that Intel will continue to have difficulties.
• Hence, I am not expecting a very good Q1 report from Intel next week but more generally, Europe and USA are going to struggle to compete against Asia.
• An excellent study by BCG in September 2020 pointed out just how big the differences are and how much of the difference is due to state subsidisation.
• It also demonstrates in my mind that geopolitics is clearly in the driving seat of the semiconductor industry which could lead to an unusually large downturn for the industry overall.
• BCG indexes the total cost of ownership in the USA at 100 and estimates that for advanced logic TCO in South Korea and Taiwan is 20% cheaper while China is 28% to 37% cheaper depending on the willingness to transfer technology.
• Germany for advanced analogue is 1% more expensive than the USA.
• It also estimates that state subsidies are responsible for 50% to 70% of the advantage in China while South Korea and Taiwan are in the same range but a little bit lower.
• It is important to note that this does not include the EU’s program of €43bn of subsidies (1.9 leading edge fabs) and the CHIPS act which offers $50bn of subsidies (2.0 leading edge fabs).
• The data clearly indicates that anyone wanting to build a leading-edge fab from a purely economic perspective would immediately select China but for years now, there have been no takers.
• This is due to the long-held concern about technology transfer and IP protection but more recently this has been greatly exacerbated by the ideological and technological rivalry between the USA and China.
• It also indicates that the CHIPS Act and the EU have not gone far enough to level the playing field in terms of TCO partly explaining why Intel is out asking for more subsidy to move forward with its German fab.
• Hence, I suspect the geopolitically driven agenda to diversify leading-edge semiconductor manufacturing from Asia is going to become more expensive as all semiconductor companies I know are always keen to receive more subsidies.
• The net result is that capex is currently being driven by geopolitics rather than economics raising the question of whether these new fabs are actually needed within the time frame within which they are being built.
• The semiconductor sector is notoriously lumpy and if a large amount of geopolitically-driven supply comes onstream before the market is ready to absorb it, then a large downturn will result.
• This means that delays to these new fabs coming onstream are probably good for the sector overall as the economy will have more time to get back on track after paying for the pandemic through the current, persistently high inflation.
• This theme leads straight to GlobalFoundries which although it does not have leading-edge, already has highly depreciated and hence, competitive fabs in locations that the geopolitical mood prefers.
• The stock is not cheap, but it is a no-brainer when compared to Intel at the moment.
• The same cannot be said for TSMC, MediaTek and Qualcomm who trade at lower multiples but are not nearly as well positioned when it comes to the geopolitical climate.