The First Direct Victims from US/CN Trade War: QUALCOMM and NXP – Info Gadgets

As we can see from the comments excerpted from transcripts, Qualcomm had scrapped its $44 billion purchase of Dutch chip maker NXP after failing to secure approval in China, making the deal one of the most prominent victims of spiraling U.S.-China trade tensions and derailing a central part of the U.S. chip giant’s strategy. When Qualcomm and NXP announced the deal, the general perception was that the products and resources of the two complemented each other. Qualcomm would gain access to one of the top 3 market share holders in automotive semiconductor, a large MCU portfolio (that Qualcomm completely lacks presence), industry-leading NFC technology (one of the few key wireless technologies that Qualcomm doesn’t truly control), a global distribution network that includes key OEMs in consumer, automotive and industrial segments. NXP would gain access to the Snapdragon technologies, such as the Adreno GPU, Hexagon DSP, and Spectra ISP; leading solutions in wireless technologies, including 5G, NB-IoT, Wi-Fi, and Bluetooth; and Qualcomm’s efforts in edge machine learning and AI. NXP’s “more legacy” automotive solutions (compared to Nvidia) would get an instant boost from Qualcomm, and the combined Qualcomm-NXP would instantly become the favorite to lead, in all those important emerging segments, beyond 2020.

Qualcomm’s decision to walk away follows a round of last-minute lobbying on the company’s behalf by senior U.S. officials including Treasury Secretary Steven Mnuchin and Commerce Secretary Wilbur Ross, who tried to persuade their Chinese counterparts to separate the deal’s approval process from broader trade tensions, U.S. industry executives said.

“It’s not just a trade war anymore. It’s becoming a more open economic conflict between the two countries. The deal’s collapse certainly is a strong signal that China is going to use every available lever against U.S..”

– Eswar Prasad, Cornell University Economist/Former IMF China Specialist

Chinese officials previously have said the deal presented potentially negative issues that were difficult to resolve.

What Were Those Difficulties Other Than Trade War Spats?

Just four months ago, the Trump administration intervened to save Qualcomm from a $117 billion hostile takeover by Broadcom on the grounds that Qualcomm’s technology was vital to U.S. national security. Qualcomm is one of the leaders in the development of 5G cellular technology that will help connect a slew of new devices to wireless networks, and the White House’s intervention effectively designated Qualcomm a national champion essential to battling China’s rising might in 5G.

According to PIIE and Vox, a broad range of experts and market observers agrees that China has repeatedly forced foreign multinational corporations
(MNCs) to transfer technology. In many respects, studies undertaken by the US International Trade Commission (USITC) in 2011 and the bipartisan Commission on the Theft of American Intellectual Property in 2013 and 2017 had noted that in addition to o China’s significant weaknesses in enforcing intellectual property rights (IPR), China has adopted a set of policies deliberately designed to force foreign multinationals to transfer strategically sensitive technologies to indigenous Chinese firms. In many cases, technology transfers are effectively required by China’s foreign direct investment (FDI) regime, which closes off important sectors of the economy to foreign firms unless they enter into joint ventures with Chinese entities they do not control.

Qualcomm, which has been fined by China multiple times, has several notable joint ventures in China. In 2016, Qualcomm partnered with the provincial government of Guizhou in southwest China for a joint venture worth approximately $280M, named Guizhou Huaxintong Semiconductor Technology Co., Ltd (GHST). “We are not only providing investment capital, but we also are licensing our server technology to the joint venture and assisting with R&D process and implementation expertise,” said Derek Aberle, then president of Qualcomm. Qualcomm upped the ante in GHST by pouring another $144M in 2017. Despite over $400M of investment, Qualcomm still owns only about 45% of GHST. GHST expects to start shipping China-customized server chips around mid-2018. The technology transfer might have doomed Qualcomm’s server ambition as its potential market was seized by this JV with Chinese government.

Qualcomm also has a joint venture with a unit of China’s state-owned Datang’s subsidiary, Leadcore, approved on 2018/5/4. The JV is set to design smartphone chipsets, and would compete directly with companies producing processors for low-cost smartphones, including China’s Spreadtrum, which is owned by China’s semiconductor national champion, Tsinghua Unigroup (the JV move made UNIS a potential foe against Qualcomm), and Qualcomm itself too. Imagine that: forming a JV to compete against yourself by providing both the funds and technologies. After forming the JV, Qualcomm and Datang quickly announced 5G NR interoperability testing on 2018/6/20.

Under the table, I believe that China asked for more technology transfers via Qualcomm’s several JVs with China’s state-owned companies for the NXP deal to pass. There have been multiple reports of China asking for more concessions from Qualcomm since Broadcom’s failed bid. Bloomberg reported that Chinese regulators were seeking more protection for local players on 2018/3/21. China’s Ministry of Commerce wasn’t satisfied with the remedies that Qualcomm offered and had told Qualcomm to propose more concessions. Many Chinese companies (probably led by Spreadtrum) were also lobbying the powerful ministry, arguing the deal would hurt them and should be blocked. They’re particularly concerned the combined entity would extend Qualcomm’s patent licensing business into the areas of mobile payments (NXP’s NFC) and parts for autonomous driving systems (a potential outcome from the combined Qualcomm and NXP).

“The news is consistent with China’s supportive policy for local semiconductor players.”

Zhang Haidong, Jinkuang Investment Management Fund Manager

On 2018/4/19, Chinese regulators sought even more concessions (believed to be on top of the 3/21 request) from Qualcomm. The new requests came after Trump’s threat of $150B tariffs on Chinese imports and the 7-year ban on ZTE. Ministry of Commerce of the People’s Republic of China (MOFCOM) responded by vowing it’s “ready to take necessary steps” to protect domestic companies. Upon the second request, Qualcomm reportedly re-submitted its M&A application, effectively resetting the timetable for a decision and giving Chinese regulators another 180 days to review the deal. In other words, by (likely) re-submitting on 2018/4/13, Qualcomm in theory has until 2018/10/11 before being turned down by China government. The termination of the NXP deal before the deadline must have struck something immovable…especially after Qualcomm extended the proposed deadline 29 times already (according to Reuters).

U.S. FBI, Treasury and Commerce have started looking into Huawei, especially sales to Iran, on 2018/4/26, days after MOFCOM asking for more concessions from Qualcomm. After Trump administration agrees with China on the “broad outline” of a settlement for ZTE dispute, WSJ reported that Qualcomm/NXP deal is looking more optimisitc on 2018/5/18. After China announcing intention to buy more U.S. coal and would cut tariffs on some consumer goods on 2018/5/30, U.S. and China hit the table talking again between 2018/6/2 and 2018/6/4. China again offered to buy $25B more U.S. goods in 2018 on 2018/6/6, and U.S. responds by announcing allowing ZTE to get back into business on 2018/6/7. Immediately, WSJ reported that China is ready to approve Qualcomm’s acquisition of NXP. Chinese regulators were reportedly working with Qualcomm’s legal team on “technical details” needed for the approval. On 2018/6/14, South China Morning Post reported that Chinese regulators have approved Qualcomm/NXP deal. But as U.S. announced tariffs on $50B of imports from China, Reuters reported that Qualcomm/NXP deal is still on hold. On 2018/6/27, Trump agrees to limit Chinese investment in U.S. through CIFUS. China countered by ordering Micron to halt memory module sales in China. $34B of the proposed $50B import tariffs (from both sides) went effective on 2018/7/6. Soon after, on 2018/7/12, CNBC reported that Qualcomm could walk away from its NXP acquisition if Chinese regulators cannot approve the deal by 2018/7/25. Qualcomm CEO confirmed the 7/12 report on 2018/7/19 with an interview with The New York Times. Even though the Senate backed off reimposing ZTE penalities on 7/20, another positive report from South China Morning Post on 7/23 amounted to nothing as Trump softened its stance a bit and agrees with Europe on ironing out their trade difference, leaving China without its most desirable trade war partner facing U.S. Without the support from Europe, China would be facing a much taller challenge at WTO as U.S. has officially accused China of imposing laws that result in the theft of U.S. tech and IP.

If China was indeed asking Qualcomm to transfer some critical 5G technology (coincidentally, after Qualcomm officially announcing its intention to walk away from NXP deal on 7/19, it debuts the 1st 5G mmWave antenna module, QTM052, that could fits smartphone on 7/23) and seeking NXP’s IP in automotive and autonomous driving, Trump’s assistance to save Qualcomm from Broadcom’s hostile takeover was probably based on the agreement that Qualcomm won’t transfer “critical” intellectual property to China, especially state-owned company. Moreover, China likely has asked Qualcomm to rely heavier on Chinese semiconductor manufacturers, such as SMIC, JCET, TongFu, etc., than on its close Taiwanese/Korean partners, such as TSMC, ASE, Amkor, etc. China has failed to develop a world-class semiconductor manufacturer despite billions of dollars of investment on top of walls of national protective policies. I believe that Chinese grand scheme was to acquire 5G (emerging technology with bright future) and automotive (steady business with high profitability) technology to seize semiconductor manufacturing leadership from Taiwan and Korea (both have been targeted by China recently) so that it could be in the driver seat with its control of largest market and leading manufacturing capacity.

What’s Next for Qualcomm, NXP, U.S. and China?

Deployment of new 5G networks will create more non-mobile opportunities for Qualcomm, which has been aiming to diversify for a long time. But NXP would have accelerated the company’s path to diversification, with a more solid ground too. Going it alone is possible, but that will take Qualcomm more time. The downfall of Qualcomm/NXP deal has pushed the trade war to a new height and driven semiconductor industry to a new junction. Here’s some analysis on their paths forward:

QUALCOMM

Repairing the licensing business while preserving as much profitability as possible is crucial to Qualcomm’s long-term future. Qualcomm has confirmed that Apple will be moving away from Qualcomm’s baseband processor in the upcoming iteration of iPhones. Would that help Qualcomm settle with Apple? A deal with Apple seems a long way off, as most of those lawsuits are still in their early phases. In addition, Qualcomm also needs to settle with Huawei, but the trade war tension could complicate things. Meanwhile, Qualcomm will also need to keep adding diversity to its chip business. Chipset revenue from non-mobile sources jumped 75% to $3 billion in the company’s last fiscal year. But smartphones still drive the vast majority of that segment, and smartphone growth is slowing to a halt.

Qualcomm is relying on 5G to revive its growth, and automotive is by far the most important driver in that regard. Qualcomm has a growing pipeline of designs wins that expanded dramatically this year to $5B, up $2B from last fiscal year, as Automotive OEMs and Tier-1 suppliers prepare for 5G-enabled cars in 2021 and beyond. However, over 50% of the $5B pipeline is related to infotainment solutions. In other words, Qualcomm is indeed diversifying from mobile phone, but it still cannot move out of its comfort zone “connectivity”. Worse yet, without NXP and Apple, along with Samsung’s in-house strategy, Qualcomm would become more and more reliant on China (and thus become a hostage of China government) if it cannot find a non-mobility market.

NXP

NXP remains well-positioned to drive continued solid content growth in automotive. The company grew its automotive business by 11.3% in 2017, well above SAAR growth of passenger vehicle. This was mostly driven by content growth in its existing markets of secure car access, in-vehicle networking, and infotainment, as well as rising penetration of ADAS.

Looking forward, NXP could see a brighter future as NXP holds a leadership position in Radar for level 3 ADAS applications with its single chip 77 GHz Radar solution and partnerships with 9 of the top 10 OEMs. ADAS could represent 10% of NXP revenue in 2019. V2X, an essential element in level 4 or above autonomous driving, could also be a major revenue contributor by 2020.

With the $2B breakup fee coming from Qualcomm, NXP could alleviate its financial pressure from the incurred debt ($3B) in Freescale M&A. The cleaner balance sheet would make NXP a very desirable acquisition target. However, as the trade war has proven, there would be a lot of uncertainty for companies that are interested in acquiring NXP. The higher price tag would also limit the number of suitors. U.S. department of Commerce’s investigation to see if auto imports pose a national security threat also cast another long shadow on NXP’s growth momentum. In all likelihood, NXP probably won’t live as an independent company for long. Broadcom could re-engage M&A talk with NXP but there would be more risks than before as Broadcom is a U.S.-based company now. Intel could also consider NXP since it is fully committed to automotive market with its Mobileye acquisition.

U.S.

Trump administration probably viewed Qualcomm/NXP M&A failure as a start of full-scale trade war with China. Logically, the top priority would be securing the support from your most important ally, Europe. U.S. has achieved this goal on 7/25, immediately after Qualcomm/NXP’s deal failed.

President Donald Trump and European Commission President Jean-Claude Juncker turned down the heat on a trade dispute between two of the world’s largest economic powers, suggesting Wednesday they would hold off on further tariffs while they talk through their differences.

Speaking in a joint news conference in the Rose Garden on Wednesday, the two leaders agreed to begin discussions on eliminating the tariffs and subsidies that hamper trade across the Atlantic, and to resolve the steel and aluminum tariffs the Trump administration had imposed this year as well as the retaliatory tariffsthe European Union imposed in response.

The package of measures announced by Messrs. Trump and Juncker would have the EU buying more liquefied natural gas and soybeans from the U.S.

Addressing China’s tariffs on soybeans and other farmer products, U.S. has found Europe to absorb those supplies. Next step would be reconciliation with Japan, Canada, and to a less extent, Mexico. Recent development should allow U.S. to secure support from South Korea (de-nuke by Kim) and Taiwan (forcing airlines to erase Taiwan’s name among other actions). While the paths Trump have taken were odd, a curtain surrounding China is coming to form with the aid from very China.

CHINA

NXP is a dutch chip maker. Qualcomm has multiple JVs with Chinese government in China. 8 out of 9 countries have approved the Qualcomm/NXP deal. It’s probably hard for China to argue that its failure to approve the deal wasn’t part of trade war. There is probably no country out there that is a fan of Trump’s trade tactics. However, China’s failure to explain publicly why Qualcomm cannot complete the NXP deal would be a major blow to its FDI. In one move, China has infuriated countries from both sides of Atlantic. There’s a lot of explaining expected from China…but we will likely get no response. Trade war is heating up, and sadly, companies are becoming the victims.