By ZHOU Yixue
Last year, two hundred billion yuan (US$ 30 billion) of government money has just been tossed into a semiconductor fund, China Integrated Circuit Industry Investment Fund. Speculators squat ravenously below ripe IPOs and wait for them to drop. WANG Lu was quietly minding his own business, harmless developing chips at a domestic unicorn, when, quite out of the blue, a pack of vulpine investors descended.
Semiconductor geeks like Wang have become such hot commodities this year that spontaneous combustion has become a very real fear. As China takes the firefight against western semiconductor hegemony to the very gates of Silicon Valley, fearing neither bluster nor sanction, a scorching spending spree has set the battle for the nation’s top talent aflame.
Hot money means hotter valuations. Regulators warm their hands as they look carefully on: If the wind changes, the fire beneath China’s chip kettle could set the whole industry aflame. This is no bubble but ablaze; a fire in which the domestic semiconductor industry will be tempered, from which the Fenghuang, or the phoenix, shall rise, or an inferno that will burn briefly bright and leave a basted landscape in its wake.
A new order of magnitude
Private investors had little interest in the semiconductor industry until this year. The state-owned National Integrated Circuit Industry Investment Fund — the Big Fund — was set up in 2014 with 140 billion yuan, a crutch for the staggering semiconductor industry. Another 200 billion yuan arrived last year. Stellar IPOs, including chipmaker SMIC on Shanghai’s STAR market, have fueled the frenzy in an otherwise lethargic primary market, where total investment is down 22. In glowing contrast, semiconductor investment in the first seven months exceeded 600 billion yuan, twice last year’s total already with the number expected to reach 100 billion yuan before the end of the year.
Giant US-dollar funds such as IDG and Sequoia Capital, with no track record in the semiconductor industry, have shown up at the party and knocked down the door. “Every other investor I met is talking about semiconductors,” said ZHENG Hengleng, CEO of Lighthouse Capital.
Without really trying, Wang's new company nailed a 350 million yuan pre-A round financing, based on a 2-billion-yuan valuation. His newborn startup designs cybersecurity chips — a niche market — but he reckons that even a ten percent market share will bring at least a hundred million yuan a year; attractive enough.
“Few investors really understand the technology,” Wang said. Decisions are often based on the credentials of the founder and team. Wang has a partner with forty years’ experience in Silicon Valley, a very rare bird indeed.
The chip business is not cheap. It requires money of a different order of magnitude. Wang did a back-of-the-envelope calculation for Jiemian News. For the first three years, he needs 100 million yuan for equipment, 40 million for labor and an unfeasible and unpredictable number of millions for testing and prototyping.
“That’s two hundred million yuan, absolute minimum, just to get started,” he smiled. “Anything less? Forget about it.”
Invest in haste, exit at leisure
Is it all a gamble? Not really: It’s much worse than that. Growth projection is impossible. Most startups are benchmarked against established western companies operating in similar segments of the value chain, but the comparison is no more instructive than best guesses.
Confidence has been greatly boosted by the equity market, which reacted enthusiastically to several high-profile semiconductor IPOs this year. The shares of SMIC jumped nearly 250 percent at the opening on its first day of trading on the Star market. Other Star-market-listed chip companies have blazed just as brightly. CCID, a research institute, reported a 124 average price-to-earnings ratio among semiconductor companies on the Star market, almost ten times higher than the overall 16 in Shanghai’s A-share index.
“I was stunned,” said YANG Lei, of West Summit Capital. The firm has done well in semiconductor IPOs this year. “Valuations were much higher than we expected… much higher than they would’ve got on Nasdaq.”
“I knew Cambricon’s market cap would reach 100 billion at some point, but didn’t expect it at the opening,” said SONG Chunyu, partner at Lenovo Capital. “It was a pleasant surprise.”
Investors are directing firehoses of cash on the matter. Song expects primary market funding to increase “a hundredfold” this year, and for the tepid semiconductor sector to boil over with pre-listing deals. When OnMicro, a startup developing the radio-frequency (RF) integrated circuit chips that Lenovo Capital wants, it announced a plan to raise 100 million yuan, and soon had 500 million. Some venture capital firms are completely foregoing due diligence just to get a seat at the table.
The relatively loose listing requirements of the Star market are attracting the kind of investors who revere the old in-out. Late-stage rounds (post series C funding) now make up 22 percent of overall funding, up from 8 percent of last year, according to Yunxiu Capital.
“About one in twenty investors know anything at all about semiconductors,” Song said. “But everyone wants to take a punt. Valuations are up 80 percent this year.”
Blazing in a cash inferno, the fear is that a bubble may arise, burst spectacularly and drench the market. It can take years or even decades for a semiconductor business to incubate its technology and penetrate a market. Quick returns are so much smoke and mirrors. “Investors will need a lot of patience. This is about grit. Sure, there might be a lot of gold among the grit, but still...” Song said.
Yang Lei is even more forthright. “Ludicrous. I’ve seen companies asking for 100 PE valuation in series A funding,” he said. “Some startups tell investors that an IPO is ‘imminent’, after which it will be ‘too late’ and ‘too expensive’ to get in. What if the market cools? Markets have cooled before. How do you exit if no one wants to buy?”
All smoke, no fire
The reality is, many have failed to deliver. U Precision was once China’s contender to ASML, a leading lithography equipment maker. Its lithography machine business made nothing at all last year. The technology is still ‘in development.’ Blah, blah, blah. The shining star of the Star market, Camboricon reported a 200-million-yuan loss last year, six times larger than the previous year’s.
Lofty goals quickly become technology and commercialization hurdles. Investors, many with their money stagnating projects they have no hope of understanding, have learned to be more scrupulous in screening.
“It’s a little more than just awkward to be stuck in such deals,” Wang said. “Investors want concrete progress, but have no way out. No one wants to talk about such things.”
High-profile bankruptcies are springing up like root fires. Wuhan Hongxin, a 128-billion-yuan project that to manufacture nanochips, collapsed this summer, leaving ghostly factory shells unfinished and tens of millions of bills unpaid. Many multi-billion-yuan investments have turned to ashes since 2016, according to the 21st Century Business Herald.
“It takes years of research and dozens of product iterations to build a chip business. Talent is important. It’s not just about the fanciest equipment,” KAI Yun told Jiemian. “Some stated goals are about as realistic as lighting a fire on the moon.”
Smoke clears
Kai works for KLA-Tencor, a California-based company, makes precision measuring equipment for chipmakers. Many startups have popped up in the market, but KLA-Tencor retains 70 percent of the market. He reckons it would be “almost impossible” for any of these upstarts to challenge KLA’s monopoly. “Chinese chipmakers might be catching, but domestic technology in measuring equipment is primitive at best,” he said.
EDA (electronic design automation) provides software for chip design. An EAD project by Tsinghua Unigroup lasted less than a year due to technical obstacles and unable to hire researchers with the right qualifications.
For Wang, the market is coming back down to earth, as investors begin to do some sums before splashing their cash. “Many products seem easy in theory. But domestic companies just don’t have what it takes,” he said. “Those who can deliver will survive. The smoke will clear within three years.
(Wang Lu is an assumed name to protect the interviewee's privacy.)
