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For investment professionals only The race for 5G connectivity leadership is the root cause of today’s escalating US-China trade war. This tech trade war has firmly set in motion the decoupling of the global tech supply chain with implications across geopolitics, economic growth and future technological standards. We have been tracking these developments for some time, meeting with political and industry experts and conducting field trips to understand how to navigate the pitfalls and opportunities offered by these tectonic changes. We believe there are exciting technology investment opportunities in ‘neutral’ territories such as Europe, Taiwan and Japan, production shifting to India and the onshoring of supply chains to North America and Europe. By: Sumant Wahi and Jon Guinness, Portfolio managers, Equities
The US DoD dossier on 5G The US-China trade war can be traced back to a now infamous Department of Defense (DoD) study ‘The 5G Ecosystem: Risks & Opportunities’ published in April 2019, just as US hostility towards Huawei started to escalate materially. It’s a fairly hefty report but the key takeaway is the importance of leadership in communication technology as the crucial driver of economic growth, setting up 5G as a geopolitical battleground. The report states how Europe gained first-mover competitive advantage in 2G, Japan in 3G and the US in 4G, and how leadership in the technologies led to significant windfalls for their economies. It also predicts that the leader in 5G will gain similar rewards but at a greater magnitude and acknowledges China’s lead at that time: “The shift to 5G will carry the same potential risks and rewards as previous generational transitions, but at an even larger scale. The leader of 5G stands to gain hundreds of billions of dollars in revenue over the next decade, with widespread job creation across the wireless technology sector. 5G has the potential to revolutionize other industries as well, as technologies like autonomous vehicles will gain huge benefits from the faster, larger data transfer… The country that owns 5G will own many of these innovations and set the standards for the rest of the world. “First-mover advantage is particularly pronounced in wireless generation transitions because the leader can set the foundational infrastructure and specifications for all future products. For example, China is in the process of laying down fiber optic cables in its own territory and plans to do the same for the countries participating in its Belt and Road initiative, in addition to building 5G networks throughout Europe. This will allow China to selectively grant access to certain 5G companies and products to ride on that infrastructure. China is using this opportunity to promote sub-6 spectrum usage, which will shape the entire 5G product market going forward.” We believe that the thinking behind this DoD paper has been influential in the US policy against China over the past 24 months. The targeting of 5G network provider Huawei, as opposed to handset vendors such as Oppo or Xiaomi, is instructive given its foundational role in China’s 5G ecosystem. However, after successfully stalling Huawei’s semiconductor supply chain and disrupting its 5G customer base, the US government is now broadening its focus to protect both foundational and emerging technologies from shifting to China. Chinese semiconductor manufacturer SMIC is the latest company to being considered for restrictions. TikTok and possibly WeChat could also be banned in the US.
5G adoption could be a massive boost for the US economy
China responds by seeking self-sufficiency While China has been relatively patient in its response to US action, they have doubled the pace of investments in chip production to gain self-sufficiency. Emerging countries already represent a significantly larger export market for China than the US, and US policymakers appreciate their economic interdependence. Nevertheless, fast, affordable and ubiquitous connectivity is the key to future technological and economic leadership.
China exports to emerging market now dwarf exports to US
The US, with its cutting-edge semiconductor industry, clearly has the lead today but China’s coherent national industrial policy should help it catch up. It is clear that over the next ten years the US will have a relatively smaller share of the global chip industry while China will have a higher share. We have been tracking China’s progress in semiconductor self-sufficiency ever since the country’s 13th five-year national strategic plan was made public in 2015. The plan includes a US$ 300bn+ investment to increase domestic content in 10 key industries from a then low single digit to 40% by 2020 and 70% by 2025. These industries include next generation IT, robotics, aerospace, autonomous and electric vehicles. In 2017, the EU Chamber of Commerce in China published a detailed report on the drivers and impact of China’s ambition to transition from being just the “world’s factory” of cheap labour to a technically-advanced, high-tech production house. 5G is one of the most critical enablers in China’s ambition to evolve itself from “Made in China” to “Made by China”.
Investing in the 5G battle for supremacy The battle for supremacy in 5G is leading to a decoupling of the global tech supply chain as the US and China seek to reduce dependence on each other. We think that there are three distinct ways investors can exploit these changes:
Invest in ‘neutral’ territories Before entering the US banned entity list, Huawei was the largest supplier in the world for smartphones and telecommunication equipment. With the US government actively lobbying its allies to ban Huawei ban, Ericsson and Nokia are likely to fill the void, and to some extent Samsung, gaining market share. If China is the low-cost workshop of the world, Taiwan is the high-tech chip fabricator of the world. Most cutting-edge chips in almost any electronic product are made in Taiwan - primarily by the Taiwan Semiconductor Manufacturing Company (TMSC). As the race between the US and China for technological superiority continues, Taiwanese chip supply will become an important component for both ecosystems. There are complex issues around economic dependence and sovereignty between Taiwan and China and some risk from an escalating US-China trade war, but broadly speaking we believe that both Taiwanese and Japanese companies will be seen as ‘neutral’ suppliers to the two ecosystems. Companies such as Taiwan’s MediaTek and Japan’s Murata have technological leadership and now arguably a geopolitical advantage to gain share in their respective sub-sectors.
Resurgent India If Silicon Valley perceives China’s market as inaccessible due to the trade war, it may have spotted an opening in India, which has its own geopolitical dispute with China. Apple recently announced it will shift some of its production lines from China to India to cater for export markets and India’s domestic demand. There is a similar but more subtle shift from internet companies too. The titans of US tech have been building their India presence for years with the market today reaching an inflection point in online consumption driven by India’s growing middle class. While companies such as Google, Facebook and Amazon already dominate their respective vertical business lines in India of search, social networking and ecommerce, the domestic startup scene is also gaining traction. Large swathes of the market are still up for grabs, particularly in areas such as online education and groceries. India’s internet adoption occurred later than China’s, but it’s happening at a faster pace aided by digital leapfrogging, where users bypass fixed broadband connections for cheaper and more readily available mobile technologies. Domestic conglomerate Reliance spurred a big change by offering the cheapest data access in the world to help boost the number of India’s wireless broadband subscribers from 150 million to around 650 million within four years. Yet that is still only 50 per cent of the country’s population, compared with an internet penetration rate of around 65 per cent in China.
India offers the cheapest access to mobile data
On-shoring manufacturing to the US Moore’s law that chips double in power every two years is not so much a technological rule but more an economic one. Cutting-edge chip making requires low-cost, high-precision manufacturing at scale, which has forced the industry to consolidate production in a handful of companies in Taiwan. Over the past two decades, US semiconductor companies have outsourced the fabrication of chips to Taiwan. The critical role of Taiwanese chip manufacturing to US tech and the inherent risk of Taiwan’s proximity to China is also driving onshoring in the US. In response, TSMC recently announced a project to build a US$ 12 billion chip factory in the US. Intel is the last big US semiconductor company to manufacture the majority of its chips in-house, although recent misses in research milestones has materially hurt the stock price. Some observers even forecast a mass shift of Intel chip making to TSMC. We believe this is a temporary setback for Intel and it should be able to emerge stronger from this issue and the company remains in the portfolio. Analog Devices is another company that is a beneficiary of the US trend towards onshoring the tech supply chain.
A new group of tech winners and losers US-China trade war news ebbs and flows together with loosely related events such as the Hong Kong protests, Indo-China border dispute or the US presidential election. However, what’s particularly exceptional about the trade war is its longevity. It’s set in motion the long-term decoupling of the global supply chain, with the potential to create new leadership in almost every stage of the process, and we are just at the start of it. This will create a host of winners and losers that investors in the technology space can profit from. |
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