Qi Yaoliang of Yuanhe Puhua: Opportunities in domestic substitution/industry upgrading under abnormal cycles

From June 25 to 26, the 5th Jiwei Semiconductor Summit was held in Haicang, Xiamen. The theme of this summit was "The Heart and the Core are in the Same Place, Changes are Like Kunpeng", which brought together thousands of industry elites to discuss the future of the industry. At the investment and financing forum held on the afternoon of the 26th, Qi Yaoliang, managing director of Yuanhe Puhua, gave a keynote speech on "Semiconductor Investment under the Distortion of Industry Cycles".

In his speech, Qi Yaoliang mainly shared the investment logic of the semiconductor industry chain under the distorted industry cycle, mainly focusing on three aspects: semiconductor industry cycle, semiconductor investment direction under abnormal cycle, and investment opportunity analysis.

According to Qi Yaoliang, Yuanhe Puhua was jointly established by the Puhua team, the National Integrated Circuit Industry Fund (Big Fund) and Suzhou Yuanhe Holdings. The team has led and managed a total fund size of more than 10 billion yuan and has rich experience and resources in the integrated circuit industry. At present, Yuanhe Puhua has managed a total fund size of more than 10 billion yuan and invested in more than 100 projects. Among the projects at various stages, semiconductors account for 90%, design companies account for 75%, and the rest are wafers/packaging/testing/equipment materials, etc. At present, there are 23 projects under management that have been listed/passed the review, and about 30 have been reported or are in listing guidance.

At present, global semiconductor investment enthusiasm is high. The establishment of large funds and semiconductor industry funds of local governments have given new life to industrial investment in the semiconductor industry. At the same time, the tense relations between China and the United States, the ZTE and Huawei incidents, the launch of the Science and Technology Innovation Board, and the gradual implementation of the registration system have brought the semiconductor industry into the public eye. Coupled with the influx of state-owned funds, private capital, US dollar funds, and CVCs, it has quickly become one of the main investment directions of various institutions, and valuations have risen.

According to statistics, as of June 16, 2021, there are 293 companies listed on the Science and Technology Innovation Board, of which 55 are engaged in semiconductor industry-related businesses. Among them, there are 23 chip design companies, 3 manufacturing and packaging and testing companies, 11 equipment companies, and 17 materials companies.

It is well known in the industry that the semiconductor industry is cyclical. According to different classification standards, it can be divided into product cycle, capital expenditure/capacity cycle, and inventory cycle. Qi Yaoliang pointed out, "New technology products appear every 10 years or so, and market demand has shown explosive growth for several consecutive years. At this time, products in all links of the industrial chain are in short supply, and product prices rise; semiconductor companies increase capital expenditures and production capacity investment. When the market enters a saturated state, companies enter into stock competition, overcapacity, and sales and prices decline; before the new product cycle is formed, companies passively destock until demand picks up and then actively replenish inventory."

Although semiconductors are a cyclical industry, the industry-wide shortage that began in the second half of 2020 is unprecedented. The shutdown of overseas factories caused by the epidemic has led to insufficient IDM capacity; the breakdown of globalization has led to a lack of security in terminal companies and frantic stockpiling; Sino-US relations have led to a shift to the domestic supply chain, resulting in a shortage of capacity; new applications such as new energy vehicles and 5G have brought about an increase in chip specifications and quantity; wafer packaging and testing plants have not expanded their capacity in a timely manner... Under the combined influence of multiple factors, the semiconductor industry is in an unprecedented cycle.

How to invest in the semiconductor industry during an abnormal cycle? Qi Yaoliang believes that "chips are the final product of the semiconductor industry. Design companies provide chips to terminal companies and are the theoretical core of the industry. Manufacturing companies have large investments and high barriers to entry, and are the de facto core of the semiconductor industry in China. The field of equipment and materials EDA is the key to preventing the industry from being controlled by others and is a bottleneck that the industry urgently needs to solve."

In terms of design companies, the leading domestic design companies will have good growth potential in 2021 due to the combined effects of their own strength improvement, domestic substitution, shortages and other factors. Due to the continued shortage of production capacity of 28nm, 40nm, 180nm, etc., production capacity is the lifeblood of design companies, making many companies realize that operation is the core competitiveness of design companies; leading companies are deploying IDM, small chip start-ups have no production capacity, and large SOCs take a long time to verify, so they hope for the next cycle.

In terms of manufacturing companies, the first batch of wafer fab bubbles has burst, and some excellent companies have emerged; at the same time, leading design companies and private capital have accelerated the layout of the second batch of factories, and the investment wave of packaging and testing companies has come to an end. The listing of SMIC and Huarun Microelectronics has provided an exit path for heavy asset investment, and the financing difficulties of various types of manufacturing companies have been broken, and some companies have developed rapidly. Packaging and testing companies started by experienced teams have emerged one after another and have developed rapidly, with the right time, place and people.

For equipment and material enterprises, they need the cooperation and verification of the factory, and the product design company to confirm the yield and reliability; in addition to the main equipment and main materials, the market capacity of many sub-sectors is not large, the input-output is not proportional, and mergers and acquisitions are required; new enterprises mostly start with eight-inch equipment and three-and-a-half generations, and chemical/gas enterprises are involved in the fields of electronic chemicals and special gases; the traditional chemical/gas/equipment industry has a low PE, while the semiconductor industry has a high PE;

The bottleneck is sometimes just a small piece of material.

After comprehensive analysis, it can be seen that there are greater investment opportunities in the direction where the self-sufficiency rate is insufficient and domestic substitution is imperative. Against the backdrop of the Sino-US trade war, the ZTE and Huawei incidents, and the strong restrictions on the domestic integrated circuit supply chain by US companies, China needs to get rid of its dependence on foreign markets in core technologies and ensure the stability and security of the industrial supply chain. Mainland terminal brand manufacturers represented by Huawei are accelerating the cultivation of upstream industrial clusters in the mainland, especially the key upstream links, and local IC manufacturers are facing opportunities.

At the same time, the new markets created by emerging applications bring new impetus to the development of integrated circuits, which is an investment opportunity for semiconductors at the application level. With the launch of mobile phones and smart phones, the scale of the semiconductor market has ushered in explosive growth. In the post-Moore era and the post-smartphone era, emerging applications will become a new driving force for the development of integrated circuits. Automotive electronics and industrial electronics will become the two fastest growing areas in the semiconductor industry, bringing new development opportunities for integrated circuit design companies.

In addition, the integrated circuit industry upgrades and cultivates leading enterprises through mergers and acquisitions. This process contains investment opportunities brought by mergers and acquisitions. Consumption upgrades and the development of upstream and downstream industrial chains have promoted industrial upgrading in the field of integrated circuits. But overall, domestic integrated circuit companies are not large in scale, and the industry concentration is lower than the world level. In recent years, through industrial mergers and acquisitions, industrial upgrading has been promoted, and several leading integrated circuit companies with a market value of hundreds of billions have been formed.

Different investment opportunities correspond to different investment strategies. Qi Yaoliang analyzed, "In terms of domestic substitution, we focus on manufacturing companies that have industry experience, can quickly scale up mass production to form effective production capacity, and can also improve technology; heavy asset companies have become the investment direction. In terms of industrial upgrading, we use the advantages of industrial collaborative resources and agglomeration to play a unique role in the introduction of upstream and downstream customers, integration of industrial chain resources, and the introduction of key talents."

In terms of mergers and acquisitions, Qi Yaoliang believes that we should look for mature investment opportunities such as overseas mergers and acquisitions and asset splitting and restructuring; through mergers and acquisitions, we can help platform-based leading companies make up for their shortcomings, form economies of scale, and achieve rapid development. In addition, we should pay attention to emerging areas with growth potential spawned by new technologies, invest in technology-based potential companies, and avoid entering the homogeneous red ocean market.