With the latest news of yet another senior professional at China’s “Big IC Fund” under investigation, we have been fielding a fair amount of questions as to what exactly is going on, and an overload of online speculation that China is rethinking its broad semis ambitions. Put simply, that is not the case, China’s government remains intent on doing everything it can to grow domestic semiconductor capabilities. Still, these investigations leave open a lot of questions as to what is actually going on?
For starters, we highly recommend Stewart Randall’s piece in TechNode, laying out the details of who and what exactly are being investigated. We generally agree with his analysis of the situation, but we think it is worth teasing out a few of the more commonly heard theories.
The first possibility is that there actually was some form of corruption taking place. We do not think this is the case, at least not in the way we think about “corruption”. It is certainly possible that a combustible mix of giant piles of cash, accelerated timeframes and immense pressure to deliver led to holes in corporate governance. That being said, we think there are many in the US who want to rush to judgment here, and just write off the whole situation as “China is corrupt”. There are a lot of people who hold this view, probably too many in policy circles, but we think this misses the mark considerably.
Another related theme is the idea that the China IC Fund and all of China’s semis investment are just investment scams. Again, this plays into dated stereotypes. As with any massive government funding program in any country at any time in history, there are certainly abuses. The notion that China created 10,000 chip companies overnight is absurd. There is considerable waste and probably a big dose of outright fraud with proverbial cement companies putting the word “半导体” in their name to tap into government funds. However, from our experience China did create 1,000 – 2,000 legitimate semis-related companies. We have detailed how this investment process works, and for the most part the investors are professionals with real semis experience and knowledge. So while that the 10,000 is a mess, the core of the process has been fairly well allocated.
Instead, we think that the real issue is that China’s corporate governance operates in a fashion that is just very different from what we in the US understand. China’s government has put a lot of money into semis and has every right to measure the successes and failures of those investments. And while all those fabless companies we mentioned above can be rated a success, the situation with the rest of the semis ecosystem is not. China can still not manufacture semis anywhere near the leading edge. (Yes, SMIC can “produce” 7nm, but take that with a healthy dose of salt.) If this were a US corporation, they would have long ago rotated out the management team for someone who could better deliver results. China’s corporate system is not exactly built for that kind of operation. High level jobs carry requirements both for management capability as well as adherence to government policy. As such, commercial failures can be seen as a failure to adhere to those policies, not merely incompetence but also disloyalty. Frankly, that is alien to US executives, and many are uncomfortable with the notion that executives can be punished personally and criminally for failures at work. We sympathize with that discomfort, but by the same token, when Solyndra collapsed, how many people in the US had a knee-jerk reaction that those “crooks should be in jail”.
Setting aside cross-cultural translations, there are some unintended consequences of China’s approach here. Policy implementation in China suffers from a lot of complex problems that are beyond our scope here (although this recent SupChina podcast has a decent introduction to the problem). As we have noted, China is not a monolith, and there is a constant struggle between the Central government’s intentions and the reality in the provinces and cities. Chinese officials, including those with commercial executive roles, have to navigate between sometimes vague signals from the Center and their own local needs.
These investigations seem to be a signal that the Central Government wants to readjust its investment strategy, likely towards more upstream manufacturing-related technologies. They have not really said this publicly, and probably will not do so for some time, but by arresting the people seen as leading the strategy, they seem to be sending a signal that they want change. Again, we have seen this pattern in many other areas of policy over the years. That leaves a lot of people stuck in limbo – they have funds to invest, but are not sure what they should be investing in. A natural response to this is to do nothing and await further clarification from the top (while still collecting 2% and 20%). So just as US VC investors slow down investments when they get negative signals from the stock market, China’s semis investors appear to have greatly slowed down their pace of deals. Earlier this year, we were seeing a company a day getting funded. That pace appears to have slowed to maybe one a week. We first noticed this about a month ago, and now there is actual data backing this up – the South China Morning Post has reported on this slowdown noting a decrease of companies with semis in their name in China’s business registry statistics. Obviously, there is a lot going on in that data, but it certainly makes sense that things are slowing down. Admittedly, China is still likely to do do more semis investing in the last three months of 2022 than the US will do all year, but the slowdown is starting to become noticeable.