The recently announced U.S. Department of Commerce export controls restrictions, including the sale of semiconductors to limit China's ability to purchase and manufacture advanced chips used in military applications, came at an inopportune time for U.S. chipmakers. The industry faces a global economy contending with a potential recession, high inflation, lingering supply chain concerns, and a cyclical decline that appears to be broadening beyond consumer end markets and into enterprise and data centers.

While the development is clearly negative for the U.S. semiconductor industry, the extent will only be clear when more details and clarification of the restrictions become available. Trailing edge nodes, which make up most global semiconductor production such as microchips, analog, or lower-grade graphics processing units, are not within the scope of the restrictions. Similar to prior trade and export restrictions, its impact on the business performance of U.S. semiconductor firms will depend on the tightness of enforcement efforts. Based on how broadly the U.S. enforces the restrictions, the impact could over time extend beyond semiconductor and technology into sectors such as auto, aerospace and defense, energy, and others.

Breaking Down The Impact

Here is what we know:

Notable U.S. export control restrictions

• New license requirements for certain advanced and high-performance computing chips and semiconductor manufacturing equipment destined for supercomputer or semiconductor development or production end use in China;
• Imposed on shipments of advanced computing chips with relevant thresholds:
• --Logic chips with nonplanar transistor architectures of 16 nanometers (nm), 14 nm, or below;
• --DRAM memory chips of 18 nm half-pitch or less;
• --NAND flash memory chips with 128 layers or more; and
• Restricts Americans' ability to support the development or production of semiconductors at certain China locations without a license.

Effect on select semiconductor firms

Semiconductor capital equipment manufacturers:

• Applied Materials Inc. estimates the regulations will reduce its fourth quarter (October fiscal year-end) net sales by about $400 million, plus or minus $150 million. It expects fourth-quarter net sales will be approximately $6.4 billion, plus or minus $250 million.
• Lam Research Corp. has removed American engineers from its operations in China, according to South China Morning Post, and asked its U.S. employees to refrain from serving customers in China until further notice.
• KLA Corp. stopped offering services for China-based manufacturing lines producing advanced chips.

U.S. chipmakers:

• Intel Corp. received a one-year authorization to continue its NAND memory chip operations in Dalian, China. On Oct. 19, 2022, Intel agreed to sell its NAND and solid-state drive business and the Dalian NAND memory manufacturing facility in China to SK Hynix Inc. for $7 billion. The first phase was completed in December 2021. Intel will continue to manufacture NAND wafers at SK Hynix's Dalian memory manufacturing facility until the transaction closes in March 2025, when SK Hynix will acquire the remaining NAND business assets for $2 billion.
• Nvidia Corp. on Aug. 26, 2022, was notified by the U.S. government that a new license requirement was effective immediately for any export to China and Russia of its A100 and H100 chips. However, Nvidia is authorized to perform exports needed to provide support for U.S. customers of A100 through March 1, 2023. Nvidia is engaging with customers in China and seeking to satisfy their future purchases of its data center products that are not subject to the new license requirements. Nvidia provided its fiscal third-quarter outlook (ending in October) that included about $400 million in potential sales to China that may be subject to the new license requirement if customers do not want to purchase its alternative products. Nvidia expects fiscal third-quarter 2022 revenue to be $5.9 billion, plus or minus 2%.
• Advanced Micro Devices Inc. said U.S. officials have asked it to stop exporting its Instinct MI250 artificial intelligence accelerator chip to China. The company said it does not believe the new rules will have a substantial impact on its business.

Foreign chipmakers:

• Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), the world's largest contract chip manufacturer, had received a one-year exemption for its Nanjing fab.
• Samsung Electronics Co. Ltd. and SK Hynix, South Korean memory chipmakers, received a one-year grace period that would allow their China-based chip plants to continue to import U.S. chipmaking tools without the licensing requirement. Samsung operates its China plant in Xi'an and SK Hynix in Wuxi.

Why U.S. Semiconductor Export Restrictions Could Further Expand

China's ambition to vastly increase its domestic semiconductor production was well telegraphed in its "Made in China 2025" strategy initiated in 2015. The country's desire to improve its material and technological foundations and achieve its modernization goals was also emphasized at China's 20th National Congress on Oct. 17, 2022. President Xi Jinping affirmed the country's recent shift from rapid growth and greater focus on national self-sufficiency, especially in technology. This is a direct aim at U.S. major semiconductor suppliers to the Chinese economy, in our view.

While China's tech firms have yet to close the technology gap against their U.S. counterparts, significant progress has been by their "national champions" such as Semiconductor Manufacturing International Corp., a partially state-owned foundry (contract manufacturer); Yangtze Memory Technologies Co. Ltd., a state-owned NAND flash memory chipmaker, and ChangXin Memory Technologies, partially state-owned DRAM flash memory chipmaker.

Additionally, China's blend of military and civil technology research strategy makes it difficult for the U.S. to narrowly identify technologies or entities that pose the greatest national security concern when designing its own protective measures. As a result, we anticipate future U.S. export control restrictions would be harmful to U.S. semiconductor or technology firms, regardless of whether these companies have direct sales to the China military that may pose national security concerns to the U.S.

Evolving U.S. And China Economic Policies Will Determine Longer-Term Path For Tech Firms

The Biden administration's expanded export control restrictions added tension to the already strained relationship between the world's two largest economies. We believe China's resolve in building a domestic chip industry has only strengthened following the U.S.-China trade spat during the Trump administration and the latest expanded export control restrictions. While we cannot rule out any retaliatory efforts by the Chinese government or consumers on the U.S. tech sector, we do not consider that a high probability event over the near term. This is given the importance of U.S. technology access to China's advancement in its economic and technology roadmaps. Longer term, however, we anticipate China will be more aggressive in encouraging the sourcing of domestic chips and technology products to satisfy its needs, rather than sourcing externally, ultimately hurting U.S. semiconductor and technology firms.

We believe the U.S. government will also be increasingly protective of the domestic chip industry, especially manufacturing. After years of outsourcing semiconductor manufacturing to foreign countries, reducing share of global manufacturing capacity in the U.S. to 12% from about 37% in 1990, we believe the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act is an important first step in attracting U.S. and foreign-owned semiconductor firms to add manufacturing capacity in America. Congress passed the legislation in July 2022 to provide $52 billion of subsidies and tax incentives to strengthen domestic semiconductor manufacturing, design, and research. Beneficiaries will likely include Intel, Micron, and GlobalFoundries Inc..

As geopolitical tension continues to rise between the two major economies, we expect U.S. tech firms to gradually broaden their manufacturing footprint and seek to become less reliant on China. It will be easier said than done given the decades spent to create complex global tech supply chains with China at the center. U.S. tech firms will also have to tread carefully while shifting or adding manufacturing presence outside of China so as to not alienate its China customer base.

Ratings On U.S. Semiconductor Firms Are Intact Despite Near-Term Constraints

There is no immediate rating impact on U.S. semiconductor firms that we rate based on preliminary findings of the recent export control restrictions. Many have strong balance sheets, and our ratings incorporate volatility through normal industry cycles. Our near-term ratings outlook is more sensitive to macroeconomic challenges such as significant inflationary pressure, supply chain constraints, and aggressive rate hikes in North America; an energy shortfall in Europe; and the COVID-zero policy and weak consumer spending in China. PC and smartphone sales have been weak since early 2022, but enterprise and data center information technology spending have only started showing signs of softness since August. Tech bellwethers TSMC, Intel, Micron, Samsung, and SK Hynix have all indicated capital expenditure cuts on softening demand and desire to manage inventory. We expect the Russia-Ukraine conflict, global inflationary pressure, China's COVID-19 response, and financial market stability to be important factors in determining business and consumer confidence, the trajectory of macroeconomic growth, and information technology spending.

Longer term, we continue to view favorably the growth path of the semiconductor industry, which benefits from increasing electronic content by the digitization of the global economies. SEMI, a global industry association representing the electronics manufacturing and design supply chain, estimates the semiconductor industry will reach $1 trillion in sales by 2030, up from $556 billion in 2021.

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