What Will China Do Next?

China’s attempts to buy up U.S. chip companies is undergoing more gyrations, this time spurred by the exchange rate set by the People’s Bank of China and the U.S. Federal Reserve’s expected interest rate hikes.

The central bank dropped the exchange rate of the yuan versus the dollar to its lowest rate since 2011, according to Bloomberg. The current rate is now 6.55 yuan per dollar, compared with a high of 8.03 in 2006, according to XE. (See chart below.)

This sets in motion a couple of events that will have repercussions for the semiconductor industry, although exactly how this plays out remains to be seen.

It’s well known that the Committee on Foreign Investment in the United States—a secretive branch of the Treasury Department—has been slapping down attempted acquisitions by Chinese government-backed investors to buy up U.S. semiconductor companies. The most public of those was the attempt by China’s state-owned Tsinghua Unigroup to buy Micron last year for $23 billion.

China’s big problem is that it has a $150 billion trade deficit in semiconductors because it consumes 60% of the world’s semiconductors and trails other countries in IC technology. The government set aside about $20 billion for M&A and startups in 2014, under the National Guideline for Development of the IC Industry, which has been combined with $100 billion in private equity.

The plan was an ambitious way to jump start China’s IC market, but results have been mixed. Acquisitions outside of China have been blocked, particularly in the United States, and attempts to organically grow businesses inside of China have been spotty. Grace Semiconductor fared badly in the foundry race, while SMIC has become something of a national legend. China also has made acquisitions in advanced packaging, and its internal chip industry has a couple of stars, notably HiSilicon and Spreadtrum.

Chinese tech has fared well in other areas, such as drones and robotics, less so in automotive and agricultural machinery. But the trade balance is still weighted against China, which helps explain the exchange rate adjustment. The devaluation of the yuan against the dollar makes imports and foreign companies more expensive for China, and raises the stakes for internal innovation and organic growth. Devaluations work something like a one-way valve, so it’s cheaper to buy Chinese goods for outsiders, but more expensive for Chinese consumers to buy non-Chinese goods.

Some of this is tied up with the U.S. Federal Reserve’s expected interest rate hike in July. It makes it harder for Chinese investors to buy up dollars. But it also may trigger some unusual behind-the-scenes discussions as the gap between what is affordable to Chinese investors and what they are willing to pay in U.S. dollars begins to widen.

And that leads to two possible scenarios.

First, for U.S. companies that have been holding out for a higher price, the game may be over. By the time necessary approvals are in place, the window will be firmly closed. And for Chinese investors who have been sitting on the sidelines waiting for U.S. markets to weaken, the ante will be higher.

Second, if interest rates begin to rise in the U.S., stocks could fall. Depending upon how high those interest rates go, and how quickly, investors either will hang with the stock market or they will begin moving their investments to safer havens. The more money that exits the stock market, lower the stock prices, the lower the company valuations, and the greater the buying opportunity. And that is where things may get really interesting.

Related Stories
China: Strong Market Growth And Innovation In Packaging
Domestic packaging houses have developed strong expertise over the past two decades.
China Demand Slowdown
How a softening market in China could affect global sales, and where the biggest impact will be.
Ray Zinn Reflects On 37 Years As CEO Of Micrel
China’s investment in the semiconductor market and how it will move forward.
What China Is Planning
With about $120 billion in funding at its disposal, China is looking to buy key technologies it doesn’t already have.