On Monday, Chinese policymakers prohibited the sale of memory chips of the largest American memory chipmaker, Micron Technology Inc. (MU,) to critical domestic industries. This move has escalated tensions in an ongoing trade dispute between China and the United States.
Earlier this week, China's cyberspace regulator announced that Micron failed its network security evaluation, prompting it to block key infrastructure operators from purchasing the company's products. However, specific details regarding the identified risks or the affected products have not been disclosed yet.
In response to China's decision, Micron's stock declined by around 5% before gaining some lost ground. Similarly, other prominent U.S. chipmakers, including Qualcomm (QCOM, Financial) and Intel Corp. (INTC, Financial), which have substantial exposure to the Chinese market, witnessed a nearly 1% decline in their market value. While the ban was met with opposition from Washington, it had a positive impact on the stock prices of Micron's competitors, including Samsung Electronics Co. Ltd. (SSNLF, Financial) and SK Hynix Inc. (HXSCL, Financial).
The Chinese ban explained
Micron Technology has faced a setback as China's cybersecurity watchdog announced a ban on its products due to serious network security risks. The ban prohibits operators of critical information infrastructure in China from purchasing Micron products, and regulators have highlighted potential threats to China's national security and critical information infrastructure supply chain resulting from doing business with the company. Although analysts believe that the direct impact of this ban on Micron will be limited, concerns are rising that companies might eliminate the company from their supply chains entirely due to political risks.
The U.S. Commerce Department expressed opposition to the restrictions, stating they lacked a factual basis and were inconsistent with China's claims of opening its markets and maintaining a transparent regulatory framework. Tensions between Washington and Beijing have escalated in recent months, with Chinese authorities conducting raids and visits to U.S. companies such as Mintz Group and Bain, stirring further discontent.
Micron confirmed receiving the regulator's review and expressed the intention to continue engaging in discussions with Chinese authorities. This move marks China's first major action against a U.S. chipmaker and follows the ongoing trade dispute over chip technology between the two countries. Additionally, the ban coincides with the recent agreement among G7 nations to "de-risk, not decouple" economic engagement with China and U.S. President Joe Biden's call for an "open hotline" between the two countries.
The U.S. Commerce Department intends to clarify China's actions by directly engaging with authorities in Beijing and coordinating efforts with key allies and partners to address distortions in the memory chip market caused by the decision. While China maintains this decision should be seen as an individual case related to national security concerns rather than geopolitics, Chinese commentator Hu Xijin took a different stance, highlighting the suspicion of U.S. companies endangering China's national security.
The ongoing chip war between the U.S. and China has witnessed America imposing restrictions on China's access to advanced chips, chipmaking equipment and software. This includes blacklisting Chinese companies like Yangtze Memory Technologies Co. Ltd. The U.S. has also sought to persuade allies like the Netherlands and Japan to impose restrictions on exporting certain products without specifically naming China. In response, China has condemned these actions as bullying tactics and expressed a determination to achieve self-reliance in the semiconductor sector.
China's review of Micron's products began in March amid the chip technology dispute and deteriorating relations between the U.S. and China. The Asian country's commitment to safeguarding critical information infrastructure and strengthening data security and anti-espionage laws has prompted stricter requirements and increased enforcement. The ban on Micron products comes as a significant escalation in the ongoing dispute between the two countries, with far-reaching implications for the technology sector that plays a vital role in the global economy.
The impact on Micron will be limited in the short term
China has broadly defined critical industries such as public communication and transportation, but the exact businesses affected by the ban have not been specified. As the world's largest semiconductor buyer, China has been reducing its reliance on foreign-made chips to enhance self-sufficiency. However, the impact on sales to foreign buyers remains uncertain due to a significant portion of Micron's products sold in China being purchased by foreign manufacturers. Micron Chief Financial Officer Mark Murphy predicts an impact in the low single-digit percentage of total company sales at the low end and a high single-digit percentage of entire company revenue at the high end.
As chips are crucial for the modern global economy, China is investing billions of dollars to accelerate chip development and reduce dependence on foreign technology. The global chip market is projected to become a $1 trillion industry worldwide by 2030, powered by applications from cars to smartphones. However, Chinese semiconductor manufacturers still rely on foreign suppliers for chips supporting advanced applications like smartphones and artificial intelligence, as they can currently only supply low-end chips for automobiles and home appliances.
Despite China being a significant market for Micron, generating around 16% of its full-year sales in 2022, Jefferies analysts believe the ban's ultimate impact will be limited because Micron's major customers in China are primarily consumer electronics manufacturers, such as smartphone and computer manufacturers, rather than infrastructure suppliers such as telecoms or the government. Further, Bernstein estimates a projected 2% decrease in sales, considering Micron's relatively small exposure to the enterprise and cloud server segment. However, there is a possibility, according to analyst CJ Muse from Evercore ISI, that Micron's customers in China may switch to competitors such as Samsung and SK Hynix in light of this decision.
Exhibit 1: China's contribution to Micron's revenue
Source: Reuters
China's semiconductor industry has faced challenges in recent months, resulting in a significant drop in integrated circuit output. According to data released by the National Bureau of Statistics, IC production in January and February decreased by 17% compared to the same period last year. This decline was much higher than the 1.20% drop observed in the previous year. This was likely driven by the economic headwinds and escalating U.S. trade sanctions. Further, following the announcement of the ban on Micron products, the U.S. is urging South Korean chipmakers not to fill the potential supply gaps in China, highlighting the complexities and geopolitical implications surrounding the ban.
The decline in IC output has also affected other sectors. Shipments of microcomputers dropped by 21.9% year over year in the first two months of 2023, while smartphone output fell by 14.1% during the same period due to weak consumer demand. These statistics highlight the broader impact of the challenges faced by China's semiconductor industry.
The decline is further driven by tighter export controls imposed by the U.S. in October 2022. These controls limit China's ability to manufacture advanced semiconductors and options for imports. According to Reuters, China accounted for 21% of NAND and 15% of DRAM flash memory production in 2022, and the country’s market share is expected to decline in the next three years.
Exhibit 2: China's share of the global chip market
Source: Reuters
Additionally, a joint agreement with Japan and the Netherlands in January further tightened export controls on certain chip-making equipment destined for China. Consequently, the volume of China's chip imports plummeted by 26.5% in the first two months of 2023, exceeding the decline recorded for the entire year of 2022. Despite the challenges faced by the industry, demand for chipmaking equipment is expected to rise further in 2023, particularly in anticipation of new U.S. export restrictions.
Chinese chipmaking suppliers and state-backed funds are investing 50 billion yuan ($7.26 billion) to enhance the domestic supply chain and mitigate the impact of export restrictions. This investment aims to reduce reliance on imported chipmaking machines and strengthen domestic capabilities. Chinese semiconductor companies are actively increasing their usage of domestic equipment, signaling a shift toward self-sufficiency. State-backed enterprises have also emerged as strong players, securing a significant share of public bids from leading chipmakers. This trend highlights the growing prominence of domestic manufacturers in the chipmaking equipment sector.
Prominent examples of this growth can be seen in companies like Naura Technology Group (SZSE:002371, Financial) and Advanced Micro-Fabrication Equipment (SHSE:688012, Financial). These companies have experienced remarkable revenue growth and have expanded their product portfolios to cater to the evolving demands of the industry. As China strengthens its domestic capabilities and reduces reliance on imported technology, the presence and operations of international companies could face significant challenges.
Takeaway
The long-term impact of China’s sales ban on Micron and the wider chip industry remains uncertain. The ban signifies the country's drive to enhance self-sufficiency in chip manufacturing and decrease reliance on foreign technology. However, the consequences of these actions extend beyond individual companies, with potential implications for global supply chains and market dynamics in the semiconductor industry.
Although Micron investors do not have to worry about the company's short-term financial performance, long-term-oriented investors might want to keep a close eye on how its Chinese customers react to the ban in the coming months.
