US cracks down on Huawei again. How badly would it affect US semiconductor companies this time?

• Last week, it was reported that the Biden administration plans to stop granting licenses for US companies to export to Huawei, a move that is equivalent to a total ban on the sale of US semiconductors to Huawei.

• Before this, US companies were still able to conduct business with Huawei by applying for an export license beforehand. 

• As most US chipmakers do not have significant revenue exposure to Huawei today, we believe that the financial impact coming from the loss of Huawei as a customer should be minimal. 

• We continue to hold a positive view on the US semiconductor industry, and encourage investors to stay on the lookout for opportunities to enter the market. 

US plans to stop all license approvals for exports to Huawei

Last week, it was reported that the Biden administration is planning to halt all license approvals for US companies to export their products to Huawei, a move that is equivalent to imposing a total ban on the sale of US semiconductors to the Chinese telecommunications equipment giant. 

A spokesperson for China’s foreign ministry responded by saying that “China is strongly against the US’s abuse of state power to hobble Chinese companies by stretching the concept of national security”.

This development marks the latest escalation in the US-China tech war, which began after the US Commerce Department placed Huawei and 68 of its affiliates on its Entity List in May 2019. Back then, the decision was made on national security grounds, after US security agencies expressed concerns that the hardware manufactured by Huawei could be used for espionage. Similarly, the latest crackdown on Huawei also stems from the same motivation, with the US seeking to slow China’s push to develop its own cutting edge technology. 

Companies that are on the Entity List are subject to US export restrictions, which means that US companies that wish to conduct business with Huawei are required to apply for an export license beforehand, and these applications are received on a presumption of denial basis. 

Even so, regulators have continued to grant export licenses to US companies, such as Qualcomm (NASDAQ:QCOM), to export chips used for older technologies such as 4G. Documents released by the US Department of Commerce showed that between November 2020 and April 2021, it received a total of 169 applications for Huawei, of which 113 were granted. This represents an approval rate of nearly 70% and a total license value of just over USD 60 billion. Suppliers of SMIC (HKEX:998) – another company on the Entity List – fared even better, with an approval rate of 91% (Table 1). 

Table 1: US suppliers which applied for export licenses to Huawei had an approval rate of 69%

These license approvals not only helped Huawei to avoid a complete shutdown of its operations, but more importantly, it also helped to cushion the financial impact on US chipmakers coming from a sudden loss in revenue. With a complete ban now in the works and the possibility that regulators will revoke all previously granted licenses, what will be the consequences for US chipmakers?

Latest restrictions should have limited impact on US chipmakers

To assess the impact of the latest development, we first revisit 2019 when the Trump administration first took action against Huawei. Back then, when the news of Huawei’s ban broke, the share prices of US chipmakers – as measured by the Vaneck Vectors Semiconductor ETF (NYSE:SMH) - immediately plunged by nearly -10%. 

Taking a closer look Huawei’s supply chain, we can see that even in 2019, most US chipmakers did not have significant revenue exposure to Huawei. Out of the 25 constituents in the VanEck Vectors Semiconductor ETF, only seven companies have more than 4% revenue exposure to Huawei. On a weighted-average basis, SMH’s overall exposure to Huawei is merely 2.6%, a relatively small amount in the grand scheme of things. 

While the latest development has no doubt cast a shadow over the future of US chipmakers, we think that investors today have even less to worry about. This is because since the early days of the US-China tech war, many US chipmakers have trimmed their exposure to Huawei and China as a whole. Today, the weighted average revenue exposure of SMH to Huawei is significantly lower than before, at only 0.54%. 

Table 2: SMH constituents have even lesser exposure to Huawei today 

As such, considering the fact that SMH constituents do not have significant revenue exposure to Huawei, we believe that the financial impact on US chipmakers coming from the loss of Huawei as a customer should be minimal. 

Looking beyond Huawei, China as a whole accounts for approximately one quarter of SMH’s revenue (Table 3). If there comes a day when the US government decides to restrict the sale of all semiconductors to China (an unlikely scenario), the share prices of US chipmakers are bound to take a hit, especially those with the majority of their revenues coming from China. 

That being said, the bans that have been imposed so far only target the sale of advanced semiconductors, and not all semiconductors. American companies have also demonstrated their willingness to work around the bans, a sign that they still value their relationship with Chinese customers. 

For instance, NVIDIA announced that it has produced an alternative high end chip used for AI applications which conforms to the latest restrictions, softening the financial blow. AMD on the other hand said that it does not believe that the restrictions will have a material impact on its business, and the company plans to apply for exemptions in the event that any of their products are affected. And if worse comes to worse, American companies can still sell their less advanced chips/equipment to Chinese customers, therefore the hit to earnings should be manageable. 

That being said, we think that this is an extremely unlikely scenario as it will certainly trigger a strong retaliation from China. China could hit back with a ban on rare earth exports, a market which it dominates. As of 2022, China is estimated to account for approximately 60% of the world’s rare earth mining and 85% of processing. With the US importing as much as 80% of its supply of rare earths from China, such a ban would be devastating for US industries such as electric vehicles, aerospace/defense, and even healthcare. 

Table 3: SMH constituents have limited exposure to China 

US semiconductors to be among the top performing industries over the next decade 

Overall, we continue to hold a positive view on the US semiconductor industry. Even with the ongoing geopolitical tensions between the US and China, not to mention the down-cycle the industry is current in, we firmly believe that US semiconductors will still be one of the top-performing industries over the next decade. 

The long-term growth story of US chipmakers remains well supported by structural trends, particularly how quickly the world is becoming increasingly tech-driven. Semiconductors are the bedrock of all technology, past, present and future. It is not difficult to see that as the world we live in becomes increasingly digitalised, the demand for semiconductors will rise as well. 

Recent innovations, such as the insanely popular artificial intelligence powered chatbot ChatGPT, would not have been possible without the help of cutting edge chips manufactured by the likes of NVDIA (NASDAQ:NVDA) and AMD (NASDAQ:AMD). In ChatGPT’s own words, the future of semiconductors is bright.  

Even though share prices have rallied lately, they are still down by roughly -25% since reaching a peak of USD 318 back in 2021. We hope investors can continue to share our optimism for this sector and to stay on the lookout for opportunities to enter the market. Those who are interested may consider our recommended ETF, the VanEck Vectors Semiconductor ETF (NASDAQ:SMH).

Figure 1: Over the long run, share prices are ultimately driven by earnings

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report holds a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.