Cover Story: Capitalising on the big tech divorce

This article first appeared in The Edge Malaysia Weekly, on February 3, 2020 - February 09, 2020.
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NOISE surrounding the US-­China trade war has quietened down after the two superpowers signed the first phase of a trade agreement in January, and has been partly drowned out by the spread of the Wuhan virus.

However, the effects of the tech war between the two — which started when the US imposed sanctions on Chinese telecommunications giant Huawei — are still percolating in the industry, with reports of China looking to be more self-sufficient in terms of developing its own technology.

For years, factories in China manufactured components for various goods including consumer electronics, establishing technological supply chains across the region. However, claims of intellectual property theft and other issues led to a protracted trade spat between the country and the US, disrupting some of these supply chains.

For clarity, the definition of technology here encompasses everything from artificial intelligence (AI) to the internet of things and electronic manufacturing services. The core of the tech war, however, is semiconductors. This is because semiconductors are vital to all future industries such as AI and quantum computing.

In his report “Semiconductors at the Heart of the US-China Tech War: How a New Era of Techno-Nationalism is Shaking up Semiconductor Value Chains”, Hinrich Foundation research fellow Alex Capri notes that the decoupling of certain US-China value chains in the semiconductor industry has become inevitable.

“Even if the two superpowers are able to repair ongoing trade tensions and hammer out a series of trade deals, there will be no turning back from the pervasive effects of techno-nationalist policies and the salient connection between semiconductors and national security.

“By definition, decoupling involves the divorcing or separation of previously joined, embedded, intertwined value chains. ­Although the name implies that just two primary parties are involved, many more entities and stakeholders are involved, including primary and secondary suppliers up and down the value chain,” says Capri.

He defines techno-nationalism as a “new strain of mercantilist thought that links tech innovation directly to economic prosperity, social stability and to the national security policies of a nation”.

The impact of a potential tech decoupling depends on how much technology is being decoupled, says Roger Entner, founder and lead analyst of US-based consulting firm Recon Analytics.

“There are a number of key technological pieces that are American IP [intellectual property] that cannot be replicated in chip design [such as the] ARM and x86, and the computer OS [operating system]. The greater the decoupling, the bigger the impact on China [because] modern technology as we know it does not work without American IP,” Entner tells The Edge.

 

Impact on Malaysia

Capri, who is also a senior fellow and lecturer at the National University of Singapore, says a disruption in the value chain of large technology players, be it from the US or China, would affect the global tech supply chain, including that of Malaysia.

He explains that a supply chain needs to be looked at as more of an ecosystem, or more broadly, a value chain. In an ecosystem, there are large original equipment manufacturers such as Huawei and big semiconductors like Qualcomm or Intel, as well as first and second-tier suppliers that support those large entities.

“So, if you start with a major disruption to the big players, for example, Huawei, Intel or Micron [Technology], that is going to kick off a chain reaction. Every time you get a concentric layer out from the big players, the collateral damage gets multiplied, because the smaller the company is, the harder it is to absorb the shock.

“However, value chains and ecosystems are a force of nature, meaning they are organic and evolving, so they are constantly looking to replenish and restructure to survive. So, in the case of Malaysian suppliers, which may be first- or second-tier suppliers, they are going to try to fit in to what the next phase of restructuring is. If that means that an extended global supply chain is now ­going to be more fragmented and chopped up, then it’s likely that there would be a more regionalised or localised focus, or a focus within a ring-fenced environment,” Capri tells The Edge via phone.

He qualifies, however, that this does not mean critical parts of the technology value chain could move to Malaysia.

“We have to divide technology into super high end,  which is semiconductors, which is capital intensive and requires the full cluster of complements [to support it], and low end. Therefore, I don’t think there would be significant semiconductor activity moving to Malaysia,” he says.

Nevertheless, Capri sees opportunities for Malaysia in the electronics manufacturing services (EMS) space, through the “China Plus One” model, where companies in China look to diversify their operations and reduce operating costs by adding another location in Asia.

“Looking at the China Plus One model in the consumer electronics [space], I think that is a net win if Malaysia plays it right and creates a receptive investment environment regulatory-wise, and has the right kind of governance frameworks in place,” he says.

However, he points out that it is important that policymakers do not fall into the binary trap.

“If I am a policymaker anywhere in Southeast Asia and I want to capitalise on the US-China trade issues by making my country a more attractive alternative, one of the things I am going to try and avoid is falling into this so-called binary trap.

“In other words, I do not, as a policymaker, want to be in a situation where I am forced to choose between the US and China, as that is a really self-destructive act, as it means I am overcommitting to one entity and limiting myself in terms of opportunities,” Capri says.

Lim Tze Cheng, head of research at EquitiesTracker Holdings Bhd, a stock investment research platform and training provider, is of the view that Malaysian tech players involved in the manufacturing of automatic test equipment (ATE) are likely to be beneficiaries of the tech war.

Malaysian tech players typically fall into three broad categories: OSAT (outsourced semiconductor assembly and test), ATE and EMS.

“Those involved in test equipment are indirect beneficiaries of the tech war due to capacity building. The US is currently building capacity — in other words, equipment and machinery — out of China, while China is building its capacity within China.

“I am also bullish on semiconductor players, but I would say that is only partially due to the tech war, as what will actually be driving the semiconductor industry is 5G-related infrastructure, which is creating a lot of demand for chips. Semiconductor players, not just in Malaysia but globally, had a tough 2019 due to the trade war, as it delayed demand due to uncertainties on tariffs. But with 5G coming, global semiconductor numbers already started to pick up from November last year.

“Stock-wise, I am positive on KESM Industries Bhd, which provides burn-in test services for the semiconductor industry, as I believe the company could be a beneficiary once the semiconductor demand returns [in full swing], ” Lim tells The Edge.

 

Penang FDI’s up 445%

In the first nine months of 2019, Penang, once dubbed the “Silicone Valley of The East” because of its position as a hub for electrical and electronics manufacturing companies, saw a whopping 445% year-on-year increase in foreign direct investment to RM12 billion, representing 31% of Malaysia’s total manufacturing FDI.

“The top FDIs were from the US, Singapore and the UK. [These] included projects from Micron Technology, Jabil Circuit, as well as Smith+Nephew.

“Electrical and electronics, and scientific and measuring equipment [which encompasses medical devices] industries collectively contributed 86% of Penang’s total investment in January-September 2019. US companies are the key contributors to Penang’s FDI in the same period,” InvestPenang CEO Datuk Loo Lee Lian tells The Edge.

Loo says, however, that InvestPenang is unable to quantify how much of these investments are a direct result of the technology decoupling between the US and China. Nevertheless, Penang has received more investment enquiries from Chinese companies since the trade war started, she adds.

“While direct investment is one of the options for investors, there is also interest from Chinese companies to form joint ventures with local companies, or outsource their jobs to local companies.

“The US, historically, has been one of the key FDI contributors to Penang. In fact, in January to September 2019, 57% of Penang’s total FDI came from US companies. Based on our engagement with potential investors, we gauge that interest from US companies in Penang is still encouraging,” she says.

Loo adds that the state government will continue to focus on attracting high-­quality investments that fit the state’s industry profile, without any preference for the companies’ country of origin.

 

What tech players say

Penang-based Globetronics Technology Bhd, which is involved in the manufacturing, assembly, testing and sale of integrated circuits, chip carrier quartz crystal products as well as sensors and optical products, views the tech war as an opportunity for expansion.

“From Globetronics’ standpoint, the decoupling has rendered us many new opportunities to work with the global companies that have relocated here, both for products that we are currently doing [sensors] as well as for new products, for example in the medical space and power ICs [integrated circuits].

“As for enquiries from China companies, these are a mixed bag in the sense that a lot of them are looking to transfer their more mature, labour-intensive lines to Penang, which is not sustainable and [not] what Globetronics is looking for, so we are picking our opportunities at this point,” Globetronics corporate director Ng Kok Yu tells The Edge.

“Although we do not have any tangible wins at this time, we believe the preliminary discussions that we have with potential customers would eventually lead us to a good win, getting new products for our business portfolio.

“The recent signing of the phase one trade deal has also alleviated some of the uncertainty [and] we are hopeful [it] will lead to increased business confidence and spending that will help kick-start the next upturn in the electronics sector after a turbulent 2019,” he adds.

The decoupling has also been advantageous to test contacting solutions provider JF Technology Bhd.

“I would say that we are a beneficiary of the decoupling, as China which has [in the past] been well serviced by American suppliers, has [started] to look for other suppliers, and hence, we are in picture. This is specifically for products related to radio frequency and 5G, where they find our products provide a more optimal cost of testing,” JF managing director Datuk Foong Wei Kuong tells The Edge.

Digital security solutions provider ­Securemetric Bhd, which counts Shenzhen Stock Exchange-listed Feitian Technologies Co Ltd as a substantial shareholder, says the latter has been on an aggressive drive.

“We have started working on a few very interesting collaborations after [Feitian] became our shareholder, like FIDO [fast identity online] devices, of which Feitian is one of the world’s leading providers, and devices related to mobile payments, such as Cloud Payment Voice Box and Smart POS.

“They have been more aggressively expanding their business portfolio into many regions, including Southeast Asia, through us,” Securemetric CEO Edward Law Seeh Key tells The Edge.

 

Downside of tech war

In some ways, the tech war could bring about a deceleration in new technologies, says Capri.

Where once there were global value chains where ideas were exchanged and companies worked together to achieve economies of scale, now those collaborative networks are being restricted, he explains.

“So, in some cases, we are going into the dark ages of innovation, because with a complete lack of collaboration and with regionalisation and localisation, those benefits are lost, and things are becoming harder and more expensive, and progress in certain sectors will go much more slowly,” Capri says.

Recon’s Entner believes that a shift of supply chains to Southeast Asian countries such as Vietnam, Malaysia and Thailand would be a slow and painful process.

“Integrated supply chains take a long time to change as having two paths makes everything slower and more expensive,” he says.

As the effects of a prolonged tech war and the decoupling of US and China technology are being played out, it remains to be seen if the countries can thrive as two separate tech heavyweights. It is an irony that in a world that is striving to stay interconnected through technology, the two superpowers are choosing to do so through a great, big tech disconnect.

 

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