Last month we noted that the flagship of China’s national semiconductor policy, Tsinghua Unigroup, had defaulted on payments for $199 million of domestic bonds. Last week, the Wall Street Journal reported that Tsinghua has defaulted on interest payments for a further $450 million of bonds held by foreigners, and that default trips covenants on another $2 billion in bonds, also held by foreigners. If the leading Chinese chip company is on the verge of bankruptcy does that mean the whole project is doomed?
No. You can stop reading now. Categorically no. China is absolutely committed to its strategy.
The vagaries of individual companies under the project will ebb and flow, but the core policy, and the will behind it, is unchanged. Going further, we would argue that Unigroup is not going away either.
As we noted in our earlier post, Unigroup is owned by Tsinghua University, the second most prestigious university in China, and the academic heart of much of China’s technology industry. Earlier in the year, the government issued new rules mandating that academic institutions separate themselves from commercial enterprises. The background of that decision are beyond our scope here, but may merit attention in the future. The result was that Unigroup was left without a clear backer. That being said, we imagine that there are many groups who would be very interested in stepping in.
As we have highlighted often, China’s semis policy has been largely implemented through a very smart, pragmatic investment tactic. While the government is willing to provide essentially unlimited funding to semis companies, they have largely funneled this money through private equity funds staffed by experienced semiconductor executives (with some exceptions) who are rewarded on financial performance. Investment terms are premised on financial terms, and to a degree this extends to state-owned entities like Unigroup.
Among many subsidiaries Unigroup owns or controls China’s leading cellular modem vendor (Unisoc, aka Spreadtrum/RDA) and one of China’s highest profile memory companies Yangtze Memory. Unigroup has a controlling stake in publicly traded Guoxin Micro, a designer of a broad range of chips, and for what it’s worth their stock price does not seem to have been affected with the news about its parent’s defaults. These companies are not going away.
A few things to help explain this disconnect.
First, China’s bond markets are a rough and tumble place. The majority of China’s debt is owned onshore, with state-owned enterprises and banks owning the vast majority of it. This often means that foreign bondholders are treated with… let’s call it a noticeable lack of attention. If foreign bondholders all walked away tomorrow, China’s capital markets would not collapse, or even react all that much.
China also has a very low level of corporate bankruptcies, not because all Chinese companies are doing well, but instead, companies usually get restructured through state direction, the proverbial back room deal.
Our best guess is that is what is happening to Unigroup. Foreign bondholders may face a haircut (maybe), but the company is not going to be unwound or sold at fire sale prices. Some other entity is likely to step in. This is a struggle for control not a fight for life.