As Huawei boldly proclaimed the comeback of its flagship 5G smartphone in early August, rumors about Huawei commissioning China's largest semiconductor foundry SMIC to break through the US export sanctions flared up again. Apparently, SMIC is the most likely source of Huawei's 5G chips, which has to be made by advanced semiconductor processing technologies. What did SMIC not say about its advanced foundry services? How is it coping with the business downcycle, alongside new export controls by the US, Japan, and the Netherlands on semiconductor equipment, to stay competitive?
According to SMIC's latest 2Q23 financial report, among the sources of revenue, the share contributed by smartphones rebounded to 26.8%, an increase of 1.4 percentage points year-over-year and 3.3 percentage points quarter-over-quarter. Why did SMIC achieve growth against the trend of double-digit declines reported by others as well as compared to the revenue contributed by the Internet of Things (IoT) and other consumer electronics products, which were both down year-over-year and quarter-over-quarter?
Could it be that China's smartphone market has recovered significantly across the board and is helping SMIC? Apparently not. In 2Q23, China's smartphone market shipped 65.7 million units, a 2.1% year-on-year decrease, and in 1H23, 130 million units, a 7.4% year-on-year decrease. That is to say, under the premise of weak overall sales, SMIC's smartphone business has shown significant growth against the trend. Where did the momentum come from?
One of the keys is the reshuffling of China's supply chain under US sanctions. Under the import substitution policy, China's chip makers have increased their previous market share, which in turn has benefited SMIC as a foundry partner. In particular, in the second quarter of 2023, the shipment of China's high-end smartphones ($600+ per unit) not only did not decline but increased by 3.1%.
SMIC benefited from the rush orders, including 28/40/55nm, and increased its fab capacity utilization by more than 10 percentage points quarter-over-quarter. However, while the Chinese market supported SMIC's rebound, the recovery was not necessarily a result of the overall smartphone market, but rather an increase in the market share of some of the Chinese companies that have been working closely with SMIC. The sustainability of this demand momentum remains to be seen.
Now, since SMIC co-CEO Zhao Haijun has repeatedly expressed pessimism over the business outlook and said it took a longer-than-expected time for the consumer electronics market to recover, where did that sudden burst of growth momentum for premium smartphones come from? The answer is already very clear.
The "unspoken" part
Yet SMIC has mummed over the development of its advanced semiconductor manufacturing technologies over the past 2 years. The last time co-CEO Liang Mong Song, who is in charge of SMIC's cutting-edge technologies, commented on public information was at the second-quarter 2021 financial report press conference two years ago.
In fact, Liang Mong Song made high-profile revelations about details of SMIC's FinFET process 14nm and 12nm customer validation and customer introduction in 2019. In SMIC press conferences between 2020 and 2021, he still mentioned the progress of the second-generation pilot production of the advanced process and advanced technology, as well as how to strengthen the development and deployment of the first-generation (14nm) and second-generation (12nm) FinFET multi-platforms under the impact of the US sanctions.
Since November 2021, when SMIC last mentioned the slow ramp-up of its advanced manufacturing process considerations, SMIC has seldom been seen mentioning its advanced manufacturing process progress, whether in a press conference or in a press release. In contrast, SMIC's recent press conferences have been dominated by demonstrations of its "mature process" expansion and order intake.
Has SMIC stopped developing advanced manufacturing processes? Is it possible that Liang Mong Song has left his job? On the contrary, SMIC's official website still displays a photo of Liang Mong Song as co-chief executive officer. Various sources over the past few years have also revealed that SMIC has been pushing forward the mass production of 7nm chips and that it has teamed up with Huawei to produce 5G and AI chips, among others.
SMIC's advanced process development seems to be the "unspoken" aspect of the advancement of China's semiconductor industry; and as for the "spoken" mature process expansion, it naturally became the main focus of Zhao's communication with the outside world in his past press conferences.
SMIC's new chairman, Liu Xunfeng, took office in mid-July on the "recommendation of the Big Fund". The Chinese semiconductor industry has interpreted that the will of SMIC's major shareholders, such as the Big Fund, should have set the course after Liu took over the chairmanship of SMIC or from the time he joined SMIC in May and assumed the position of vice chairman.
SMIC's aggressive investment in 12-inch fabs is also suspicious. Zhao emphasizes that the largest portion of SMIC's capital expenditures will be used to build capacity. "SMIC must expand its 12-inch fab capacity to an economic scale, whether it is 6,000 wafers, 10,000 wafers, or even 15,000 wafers, it will not be enough," said Zhao. SMIC will build four major fabs, one in Tianjin, one in Lingang, one in Beijing, and one in Shenzhen, and build them simultaneously so that it can reach an economic 12-inch capacity at the fastest possible speed, according to Zhao, undeterred by the painstaking destocking seen all over the world.
In addition, under the procurement policy of import substitution, as Chinese suppliers have gained a larger market share in the supply chain of smartphones, consumer electronics, and electric vehicles, where there are a large number of SMIC chip customers, SMIC's revenue from Chinese customers has also been growing, and the contribution from the Chinese market in 2Q23 has reached 80%.
The question is whether the rush orders in the past one to two quarters, even with the continued full capacity of 28/40/55nm nodes in Q3, are equivalent to the recovery of the overall terminal market.
In the 23 years since SMIC's founding, there have been seven replacements for the chairman of the board. Today, the number of SMIC's board of directors has been reduced from 15 to 8, with Liu Xunfeng the only remaining executive director, and Liang Mong Song and Zhao Haijun exited from board decision-making in 2022. Does this mean that the board of directors, which is dominated by SMIC's major shareholders such as the Big Fund and Datang Telecom, will make the decision in SMIC's future strategy?
And is the expansion of mature process capacity the only important task for China's leading foundry, SMIC, which is Beijing's crown jewel? The "unspoken" nature of China's semiconductor manufacturing process, even if it burns a lot of money in the process of executing its mission, maybe a financial burden that the shareholders of SMIC must bear. SMIC's mature process platform will continue to play its role in generating revenues and making profits, so as to allow its unspoken advanced processing nodes to move forward with its other "missions."
