Semiconductor Companies Love Biden’s CHIPS Law. But Will Taxpayer Money End Up In China?

Semiconductor manufacturers love President Biden’s recently signed CHIPS and Science Act. It’s not just Wednesday’s lower inflation print helping these companies. It’s the $50 billion that’s coming their way to build semiconductor fabrication plants, or fabs. Free money for localizing supply chains in a key, global industry. What’s not to love?

“If I’m an investor right now, I am buying all of the stocks that are going to be helped out by Washington,” Vladimir Signorelli of Bretton Woods Research said last week in an interview.

Advanced Micron Devices, Global Foundries, IntelINTC
and Micron Technology are all trading higher and could finally catch up to the S&P 500 as the market weighs these new tax incentives and other benefits of the CHIPS Act.

“We’ve wanted to build a mega-fab in the U.S. for a long time,” Micron’s senior vice president and General Counsel, Rob Beard, told a hometown business publication in Idaho on Aug. 8. Beard neither confirmed nor denied rumors that Micron would build one in Idaho. “Now that this legislation is in place, we are able to make some investment decisions. We are looking at several different places and it’s a competitive process,” Beard reportedly said.

The grant money has to go to building a fab in the U.S. It can be for manufacturing any type of chip, though the primary focus is for the high-end, advanced chips and the machines that make those chips. As it is now, the U.S. designs the machines and the chips, and lives off the intellectual property, outsourcing their manufacture to Taiwan, South Korea, Japan and – increasingly – to China.

The Hologram Phone

The “hologram phone” isn’t a thing yet. But it will be. Where will it be invented? If here in the U.S., where will it be made? One can imagine that AppleAAPL
contract with Stanford and MIT scientists to look into making one. And then Stanford and MIT, or maybe even Apple itself, spends that grant money to partner with researchers at Peking University, or with Apple partner Yangtze Memory Technologies Co., or YMTC. Under the existing CHIPS and Sciences Act, nothing is stopping this from happening.

The opposition to the CHIPS Act in Congress largely came from the lack of guardrails in the roughly $200 billion in new federal grant money that will go to new tech research.

“This CHIPS Act is what we must do to compensate for 20 years of lost semiconductor manufacturing capacity to Asia. But it is only a start. More needs to be done,” said Jeff Ferry, chief economist at the Coalition for a Prosperous America, a think tank in Washington advocating for U.S. manufacturers.

“It is good to have safeguards, but I don’t think they’ll make a huge difference because U.S. chip makers only make legacy chips in China,” Ferry said. “They know IP theft is a regular occurrence when you have a facility in China.”

Ferry and Roslyn Layton, head of China Tech Threat and a Forbes contributor, wrote about a recent Apple/YMTC deal in a report titled “Silicon Sellout” in June. Two months later, on August 1, Reuters reported that Washington was considering limiting shipments of American chipmaking equipment to memory chip makers in China, including YMTC, as part of a bid to halt China’s semiconductor sector advances and protect U.S. companies.

Such partnerships remain the most significant risk in the science portion of the new law.

As it is, the law allows for companies to use grant money or other incentives to build out legacy chips in foreign markets if they already have a fab there that they are expanding on, or are doing so just to serve that foreign market and not to export to the U.S.

It is also unclear if once that money dries up from the government, companies would turn around and mothball the fabs in the future, preferring a return to the old model of outsourcing production to Asian firms. This may have to become permanent.

China is becoming a larger player in this space, but animosities between the two countries make it a significant geopolitical risk for U.S. chip makers to manufacture advanced chips there.

Industry Policy Shift

The overall takeaway of the law, Biden’s second big package after the Infrastructure Law and the soon-to-come Inflation Reduction Act, is that Congress is finally doing industrial policy. With this law, the government took an active role in boosting domestic production.

It’s a good start, but Congress should look at other sectors that need to localize supply chains, too, U.S. Trade Representative Katherine Tai said.

“I think that if we can keep replicating this for other industries, especially ones who are facing really, really stiff competition from economies that are not structured like ours, that are much more focused and state-directed, that that is the key to American competitiveness going forward,” Tai told KVUE TV in Austin, Texas on August 5. “We’ve just got to keep doing what we’re doing, and the growth that we’re going to see, the creation of jobs, the leadership in the international economy…let’s make a habit of this,” she said.

As a general rule, the U.S. does not engage in industrial policy. But when China is your biggest competitor, or a strategic rival as the White House now refers to it, then the U.S. may be forced to adopt similar measures at times or risk watching its multinationals invest in China and Asia instead of domestically. Even ex-Google CEO Eric Schmidt recognizes this. He wrote a letter in response to a WSJ editorial that said the CHIPS Act was useless, published on July 24.

“China’s largest chip maker is processing chips more advanced than any U.S. or European firm,” Schmidt wrote. “This should puncture complacency about tech dominance. Passing and fully funding….the CHIPS Act is one small part. (It) is our best chance to regain lost momentum.”

Investors, meanwhile, can buy into companies that will benefit from these new state subsidies. Some have already drawn the market’s attention and are too expensive for average retail investors.

Stock Pickers Beware

Year-to-date, Global Foundries has been the only outperformer. It’s beating the S&P 500 and is trading above its 50-day moving average. Momentum is strong and its price-to-earnings ratio is off the charts. Unless Global Foundries will be on the receiving end of most of the CHIPS funding (it won’t be), this company is too expensive compared to its peers.

Micron, AMD and Intel are all underperforming the S&P 500. All three are down by more than 30% this year.

Of those three, Intel and Micron are priced about the same at 7-times earnings, with Intel losing the most momentum since its weak earnings report last month.

For investors just learning about the CHIPS Act, these two companies look like value stocks compared to AMD and Global Foundries.

Outside of the positive news related to government funding, the tech sector is bracing for new challenges following massive supply chain bottlenecks, higher interest rates, and declining consumer sentiment in some sectors.

Natixis Asia put out a note Thursday explaining some headwinds, saying “demand may weaken due to sinking consumer sentiment and higher interest rates.”

Companies with difficulty increasing sales will start to draw on their accumulated inventories and delay new orders. This is especially true for the Asian fabs — namely Taiwan Semiconductor and Samsung. Natixis said both have either scaled down production or have warned of the potential impact of destocking.

This week, Micron said in a pre-earnings release that the company expects “significant sequential declines in revenue and margins” for the next few quarters.

Intel suffered the same fate in late July, slashing earnings guidance after one of its worst quarters in years. Intel CEO Pat Gelsinger said in an earnings call on July 28 that supply chain shortages were ongoing. Intel called for 35 cents in adjusted earnings per share on $15 billion to $16 billion in revenue, but analysts polled by Refinitiv guessed 86 cents and revenues of $18.62 billion.

All of the major chip makers were up in Thursday’s pre-market hours. Taiwan Semiconductor was also up. Global Foundries appears set to have another banner trading session, up over 2.25% before the opening bell.

Intel will likely benefit from the CHIPS Act. The company has hired new executives to manage new fabs it plans to build, thanks to legislation signed into law this week.