(Editor's Note: This is the second of a three-part series, and follows our Nov. 2 publication, "China's Chip 'Moon Shot'--The Response To Restrictions." The next report in our series will look at the coming winners and losers from the boom in investment into artificial intelligence. )
The U.S. has made its objective clear in the latest restrictions on chip sales to China. It aims to limit China's high-performance computing capabilities, particularly for artificial intelligence (AI). Moreover, S&P Global Ratings believes supply-chain bifurcation and tit-for-tat measures could continue for the foreseeable future.
While the understanding and interpretation of the new ruling is still very fluid, our initial assessment is that the updated restrictions could have meaningful implications for the global technology companies we rate. In our view, risks are growing for global semiconductor companies, Chinese internet companies, and Chinese companies focused on AI and high-performance computing.
In this piece, we address investor questions on the outlook for technology geopolitics, and the implications for global tech firms.
Frequently Asked Questions
What has changed from the previous round of U.S. restrictions?
The U.S. updated rules both regarding the export of advanced chips and semiconductor equipment for the manufacturing of such chips. Advanced chips are defined in this case as those made using 16 nanometer (nm) processes and below.
For more details on the previous U.S. restrictions announced in Oct.7, 2022, see "U.S. Controls Cast Uncertainty Over Tech Majors' China Ties," published on RatingsDirect on Nov. 14, 2022.
See below for a summary of the latest round of U.S. measures.
Why did the U.S. issue additional restrictions?
To "close loopholes in regulations released last October  and will probably be updated at least annually," according to the Commerce Department Secretary, Gina Raimondo.
Ms. Raimondo says the objective is "to limit China's access to advanced semiconductors that could fuel breakthroughs in artificial intelligence and sophisticated computers that are critical to Chinese military applications."
We expect the U.S. to continue issuing new rulings to adjust restrictions as necessary as China invests heavily to advance its technology industry (see "China's Chip 'Moon Shot'--The Response To Restrictions," published on Nov. 2, 2023).
What has NOT changed from the previous ruling?
The restrictions on the export of semiconductor equipment remain focused on advanced chip production with provisions to target specific production facilities and not entire fabrication plants. Restrictions are therefore unlikely to affect mature chip production in China (28 nm and above).
Nonetheless, it is unclear how the U.S. Bureau of Industry and Security (BIS) will implement, monitor, and maintain such targeted restrictions. For example, certain lithography tools are used in the production of both advanced and mature chips (such as the ASML Holding's TWINSCAN NXT:1980Di immersion lithography system).
Hence, it's still possible that the U.S. government could tighten restrictions around such materials and tools in the future. This would be particularly likely if China shows progress in advanced chip production by leveraging existing semiconductor tools and materials. Such a risk is highlighted by recent investigations by the U.S. Commerce Department (which heads the BIS agency) regarding the use of domestically produced 7 nm chips for Huawei's Mate 60 Pro smartphone.
How will the restrictions affect U.S. chip firms?
Demand for AI chips, including those outside of the restricted countries, currently exceeds supply. As such, the restrictions are unlikely to have a notable effect on U.S. chipmakers over the next year or two. Over time, the latest restrictions could limit longer-term growth prospects considering China's sizable market for such chips. For example, the country accounts for roughly a quarter of NVIDIA's data center revenues.
For NVIDIA Corp., it's unclear how much data-center revenues it might lose from the restrictions, and how much impact this could have on its longer term growth prospects. NVIDIA recently announced it will no longer be able export several high-end AI chips to the restricted countries, including the A800 and H800 chips. These chips were specially designed for the China market following U.S. export restrictions implemented in 2022.
Nevertheless, NVIDIA's near term growth prospects are immense. When we upgraded the company in June 2023 to 'A+' from 'A', we projected that its revenues would increase 55% in fiscal 2024 (ending Jan. 29, 2024) and another 15% in fiscal 2025. We were too conservative. We believe China revenue shortfall can be made up over the next one to two years from outsized demand in U.S. Europe and rest of Asia, and now believe revenues could nearly double in fiscal 2024 and expand by another 30 to 40% in fiscal 2025.
Advanced Micro Devices Inc. (AMD) will similarly be restricted from exporting its MI250 or more advanced chips, while Intel Corp. is reviewing the regulations and assessing the potential implications concerning its Gaudi chips. These chips are used in data centers, particularly for AI.
AMD indicated that it expects sales for its data center graphics processing units (GPUs), inclusive for its AI GPUs and accelerators, to be about US$400 million in the fourth quarter of 2023 and rise to over US$2 billion in 2024.
Intel's AI accelerator pipeline has nearly doubled over the past 90 days to nearly US$2 billion through 2024 by our estimate (representing 3% of our 2024 revenue estimate).
How will restrictions affect chipmakers?
For Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), we see a limited impact on the company's operating performance for the next 12-24 months, considering the undersupply of AI chips. As of now, advanced packaging capacity is a key bottleneck for AI chip production and one that TSMC is working to overcome. The problem specifically centers on chip-on-wafer-on-substrate (CoWoS). However, the shortfall may not be alleviated until the end of 2024 at the earliest.
Longer term, China's meaningful contribution to end-chip demand could limit TSMC's growth opportunities. This is because:
- China currently accounts for more than 10% or more of AI server procurement and is growing quickly.
- High-performance computing (HPC) chips, including for AI, account for more than 40% of TSMC's revenue in 2023 and is a major growth driver over the next two to three years.
- The latest restrictions will reduce future demand growth from U.S. chipmakers. For now, TSMC produces nearly 100% of chips using the 7 nm process technology and below.
Moreover, TSMC will lose orders from an increasing number of Chinese integrated circuit (IC) companies that are being added to the U.S. Entity List, especially those focused on AI chips. Chinese IC companies may also gradually shift orders for mature chips to domestic foundries to offset future regulatory risk. Domestic foundries are aggressively growing their capacity for mature chip production.
These pressures could reduce TSMC's utilization and profitability or at a minimum limit TSMC's revenue growth opportunities.
For Semiconductor Manufacturing International Corp. (SMIC), signs indicate that U.S. restrictions will remain targeted on advanced chip production and will not significantly impede SMIC's mature chip production. Though the company no longer discloses revenue breakdown by process nodes, its exposure to 28 nm chip production is likely to be significant and growing.
We still see risks that overseas customers could diversify away from Chinese suppliers amid heightening U.S. and China tensions. Overseas revenues accounted for 20% of SMIC's total revenues as of second-quarter 2023, albeit already down from 37% in second quarter of 2021.
However, such an overhaul could be offset by growing support from domestic IC companies. The widening number of Chinese IC design companies on the U.S. Entity List should help to stimulate domestic demand for SMIC and fill its expanding capacity.
What are the implications for rated Chinese technology hardware companies?
The impact of the latest restrictions is still uncertain for Lenovo Group Ltd. For now, our base case is that Lenovo will receive licenses to acquire the chips it needs to produce high-performance servers, so long as the end demand is outside of China. This considers Lenovo's global operations, management team, and production facilities, and its adherence to regulations worldwide. The U.S. is unlikely to grant licenses for the sale of such products into China.
As a company headquartered in Beijing, China and North Carolina, U.S., Lenovo could be subject to additional licensing requirements. This adds complexity to the supply chain for its Infrastructure Solutions Group (ISG)--the segment that produces technology hardware products and solutions for datacenters. And it could increase costs within this segment.
While any U.S. restrictions on Lenovo's purchase of advanced chips may not meaningfully affect cash flows or profitability, such measures would effectively preclude the company from capitalizing on the fast-growing and important AI segment. In the long run, such a scenario would also limit Lenovo's capacity to diversify away from PCs.
Roughly US$2 billion of ISG revenues (20% of ISG) are AI-related products and solutions. However, not all products will fall under such restrictions (such as storage products or servers below the restrictions' threshold). And while China accounted for over 20% of group revenues as of the fiscal year ending in March 31, 2023, ISG's exposure to China revenue is likely to be less than that.
Xiaomi Corp.'s key technology products are smartphones and laptops, which are unlikely to face any meaningful restrictions. Hence, we see limited implications from the latest restrictions. There is also little risk that restrictions will tighten for consumer-grade IC over the next few years, given the U.S. objective is focused on high-performance computing and AI.
What are the implications for Chinese internet companies?
Broadly speaking, the latest restrictions are moderately credit negative. We see less of an impact for the large internet giants such as Tencent Holdings Ltd. and Alibaba Group Holding Ltd. This is because China's internet giants have significant resources to overcome the challenges from chip restrictions.
The largest players have likely stockpiled the necessary chips in advance of the restrictions. Moreover, global internet companies are unlikely to enter China to compete with Chinese internet majors, considering regulatory impediments. Most of Tencent's and Alibaba's profitable operations remain in China.
For smaller internet companies, such restrictions could significantly increase the capital outlay and time resource requirements. The latest large language models (LLM) can require months to develop and tens of thousands of NVIDIA's A100 chips--each costing roughly US$20,000. Compared with older generations of NVIDIA's top-of-the-line GPU chips (such as the V100), A100's are 3x-5x faster and more energy efficient. Therefore, to achieve similar computational power, the additional cost of space, equipment, and energy are likely to be meaningfully higher (see table 1 in Appendix).
What are the long-term risks following the recent U.S. ruling?
Further bifurcation in the semiconductor supply chain and tit-for-tat policies are likely. U.S., China, Europe, and other places in Asia will continue to incentivize local chip production.
The restrictions will push domestic Chinese technology companies to rely more heavily on domestic suppliers. The risk of losing access to Western technology and suppliers is gradually outweighing the higher costs and inefficiencies associated with domestic suppliers. Given enough support and time from domestic customers, domestic suppliers may be able to work out the kinks to reduce costs over time. Such a trend could benefit domestic companies such as SMIC.
We expect more U.S. policies and regulations, and this could maintain the U.S.-China technology gap. This is a risk for both Western suppliers that have large revenue exposures to China, and for Chinese technology companies reliant on Western suppliers.
By our assessment, U.S. regulators look likely to stick with a "small yard and high fence" policy. It's possible this could change, with more restrictions and penalties, if China continues to progress with advanced chip production using foreign equipment and materials.
|Country Group D:5|
|License applications for advanced chip exports to these countries will be under presumption of denial, as well as for companies whose ultimate parents are in these countries|
|Belarus||Haiti||Republic of South Sudan|
|Central African Republic||North Korea||Venezuela|
|Democratic Republic of Congo||Libya|
|*Includes the Special Administrative Regions of Hong Kong and Macau. Sources: U.S. Bureau of Industry and Security, S&P Global Ratings.|
|Country Groups D:1 and D:4, and those that don't fall under A:5 or A:6|
|Licensing for advanced chip imports will be reviewed on a case-by-case basis|
|Bahrain||Moldova||United Arab Emirates|
|Sources: U.S. Bureau of Industry and Security, S&P Global Ratings.|
|Companies cited in this report|
|NVIDIA Corp.||Fabless Semiconductor||A+/Stable/--|
|Advanced Micro Devices, Inc.||Fabless Semiconductor||A-/Stable/--|
|Intel Corp.||Integrated Device Manufacturer||A/Negative/--|
|Semiconductor Manufacturing International Corp.||Foundry||NR|
|Taiwan Semiconductor Manufacturing Co. Ltd.||Foundry||AA-/Stable/--|
|Lenovo Group Ltd.||Technology Hardware||BBB/Stable/--|
|Xiaomi Corp.||Technology Hardware||BBB-/Stable/--|
|Alibaba Group Holding Ltd.||Internet||A+/Stable/--|
|Tencent Holdings Ltd.||Internet||A+/Stable/--|
|Source: S&P Global Ratings.|
Digital design: Evy Cheung
- China's Chip 'Moon Shot'--The Response To Restrictions, Nov. 2, 2023
- U.S. Controls Cast Uncertainty Over Tech Majors' China Ties, Nov. 14, 2022.
This report does not constitute a rating action.
|Primary Credit Analysts:||Clifford Waits Kurz, CFA, Hong Kong + 852 2533 3534;|
|David T Tsui, CFA, CPA, San Francisco + 1 415-371-5063;|
|Andrew Chang, San Francisco + 1 (415) 371 5043;|
|David L Hsu, Taipei +886-2-2175-6828;|
|HINS LI, Hong Kong + 852 2533 3587;|
|Cathy Lai, Hong Kong (852) 2533-3569;|
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