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Chinese tech companies spooked about becoming 'next ZTE'

Ban on using US-made components would spell disaster for Huawei or Lenovo

Mobile phones under endurance test for their semiconductor parts are seen at Tsinghua Unigroup research centre in Beijing.   © Reuters

TAIPEI -- Many Chinese tech companies are wary of becoming the next ZTE. The country's No. 2 telecom equipment provider and major smartphone maker was recently penalized by the U.S. government with a seven-year ban on buying American-made components.

The severe punishment imposed by the U.S. over ZTE's violation of a ban on selling products to Iran and North Korea could get the company in a big trouble. The company currently sources some 20-30% of its parts from American suppliers, according to Sinolink Securities, and it's not likely it will find alternatives for crucial chips and high-end optic components anytime soon.

The Chinese company could also be barred from using Android operating systems provided by Google, which run on every handset ZTE is shipping. The company suspended trading of its shares in China and Hong Kong on April 17 and postponed its earnings release.

Though some say it's an isolated case, the ZTE ban came amid tit-for-tat trade tensions between the U.S. and China, and many Chinese tech companies are starting to fret that similar restrictions could be a blow to their business, according to analysts and industry sources. It is also part of Washington's ongoing efforts to curb Beijing's ambition to quickly gain technological dominance by pouring enormous amounts of funds into building a competitive semiconductor industry.

"The U.S. wants to show China its ability to really hit its tech companies badly ... there could be more to come," said Wang Yanhui, secretary general of Mobile China Alliance, an agency affiliated with China's Ministry of Industry and Information in Beijing. "Currently, only Beijing could save ZTE with some negotiations with Washington."

According to Wang, Chinese tech companies, such as Huawei Technologies, Lenovo Group, Xiaomi, Oppo and Vivo could also be hit hard if the U.S. expands similar bans to them, as they still need to use various chips and critical components provided by U.S. vendors.

China's Ministry of Commerce responded that it hopes the U.S. will handle the situation properly in accordance with laws and policies. It said it is prepared to take necessary measures to protect the legitimate interests of Chinese companies.

On April 19, the U.S.-China Economic and Security Review Commission released a report, naming Huawei, ZTE and Lenovo as companies that pose cyberespionage risks to the U.S. It also flagged Dell supplier Lishen Power Battery Systems and Apple supplier GoerTek, an audio component maker, for links to China's military, nuclear or cyberespionage programs. More than 10 Chinese enterprises were picked in the report.

In the near term, for mobile processors and other wireless chips, if access to the U.S. market were cut, these Chinese device makers could look to Taiwan's MediaTek and Realtek and their homegrown Unigroup Spreadtrum & RDA for quick alternatives. For memory chips, they could ask Samsung Electronics, SK Hynix, Toshiba and Nanya Technology to help fill the gaps. However, they would face large-scale product redesigns if they need to switch key suppliers.

Meanwhile, the U.S. still controls the most crucial intellectual properties, operating systems and high-end chip components needed to operate smartphones, base stations and networking equipment. For instance, it's impossible to replace core processor chips for data center servers from Intel and radio frequency components from Qorvo and Skyworks, or find quality optical parts from Lumentum elsewhere anytime soon.

Even Huawei Technologies, the world's biggest networking equipment builder and No. 3 smartphone maker, which aggressively develops its own chipset, boosts patent portfolios and localizes its supply chain, still finds it extremely difficult to eliminate U.S. components, said Andrew Lu, a longtime semiconductor analyst at Hong Kong-based Sinolink Securities.

"Take Huawei's latest Premium P20 Pro phone, for instance -- the company still uses many chips from Skyworks, Texas Instruments and Micron Technology," Lu said.

"The U.S. tech companies hold the most leading technologies in hand, which are not something the Chinese firms can easily find alternatives to or catch up in a short period of time," Yuanta Securities Investment Consulting analyst James Wei said.

Many emerging chip production projects and Chinese homegrown chip manufacturers would also be vulnerable if the U.S. were to impose bans on them.

For instance, state-backed Tsinghua Unigroup's affiliate Yangtze Memory Technologies is building a $24 billion memory chip facility in Wuhan, while Innotron Memory, another government-sponsored program, is constructing an $8 billion factory in Hefei. Semiconductor Manufacturing International Co., the country's biggest contract chipmaker, is also expanding its facility in Shanghai. 

These are all part of Beijing's relentless push to slash dependence on overseas technologies, but it's not fast enough to bear fruit. These facilities rely heavily on U.S. semiconductor equipment providers such as Applied Materials, Lam Research and KLA-Tencor to go into operation.

More than 40% of capital expenditure from these Chinese companies goes to American equipment makers. Of that spending, they have no way to replace up to 30% of the components with alternatives from other parts of the world, noted Sinolink's Lu.

"If any of this kind of embargo is further imposed, that could be a serious blow to these emerging state-backed players," Lu added.

Nevertheless, the aggressive measure by the U.S. has sent a clear and strong warning to China, and could reinforce that country's determination to continue to boost local players.

Shares of many Chinese semiconductor-related companies, including state-sponsored Goodix and Gigadevice, on domestic stock exchanges surged during the week of April 16 amid reports that government bodies are discussing adding funding to the chip segment.

"It is foreseeable that China will accelerate the development of key components and its semiconductor industry in the wake of ZTE's case," said Liu Meng-chun, the head economic researcher at Taiwan's Chung-Hua Institute for Economic Research.

"ZTE will not be the only case. The U.S. could target rising Chinese tech companies like Alibaba Group Holding and Huawei to limit China's development in the global tech race," Liu said.

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