Amidst a declining market, businesses are facing unfavorable operating conditions, and there have been a few merger and acquisition cases in the past two years. Some in the industry also predict that there will be a significant wave of mergers and acquisitions in China’s semiconductor sector shortly. Despite mergers and acquisitions aligning with industry trends and frequent mergers among international companies, research suggests that there will be no merger and acquisition frenzy in the domestic market, and heavyweight mergers are even less likely to occur. A few years ago, a businessman, faced with the irrational investment frenzy that surged like a tide, confidently said, ‘Let them invest; I’ll come to collect the corpses (referring to mergers and acquisitions) in a few years.’ At the time, I also told him that mergers and acquisitions would not happen. The challenges in semiconductor mergers and acquisitions are mainly due to the following reasons.
01
The Integration of the ‘Prefer to be a Chicken’s Head than a Phoenix’s Tail’ culture with the current industrial situation
In China, regardless of a company’s size, top executives have traditionally enjoyed certain privileges. Initially, these privileges were primarily associated with ‘prestige,’ but nowadays, it’s more about ‘profit.’
Due to the government’s emphasis on industry policies and incentives, semiconductor entrepreneurs are basking in the limelight. Even leaders of small or startup companies can become honored guests of the government and darlings of the media, reaping various tangible and intangible benefits. These benefits include the recognition of their ‘prestige’ through appearances on stages, under spotlights, meetings with leaders, and government attention. Additionally, they receive various ‘benefits’ such as talent incentives, tax exemptions, housing subsidies, and household registration perks, whether overt or covert.
However, these ‘prestige’ and ‘benefits’ are mostly enjoyed to the fullest extent by the company’s top executives. Even if a company’s performance is subpar, the executive’s status ensures that these privileges remain intact. If the top executive’s status is lost after a merger or acquisition, these advantages either disappear or are significantly diminished. Therefore, many small companies generally resist being acquired. Despite their financial struggles, the allure of these real-world advantages compels them to choose to be the head of a chicken rather than the tail of a phoenix and resist acquisition.
Especially in recent years, the government’s increased focus on the semiconductor industry has lowered the threshold for companies to go public compared to other sectors (though the recent economic slowdown has resulted in an overall slowdown in the semiconductor industry’s growth). As long as companies find ways to meet the listing criteria, the enormous benefits of going public far outweigh the gains from being acquired.
The reason these companies have the confidence to resist acquisition lies in their unique survival strategies tailored to the Chinese context. For example, in the case of design firms, if a company’s performance falters and losses accrue, they can cut staff to reduce costs. In more extreme cases, they can choose not to engage in production or chip fabrication and instead go into hibernation. Some companies even abandon their core businesses to pivot towards design service outsourcing. Research suggests that approximately 50% of Chinese design companies now focus on providing design services.
For top executives of these companies, the rewards they receive now offer tangible ‘profits’ in addition to ‘prestige.’ Therefore, they cross turbulent waters, each demonstrating their abilities, to endure and thrive. Because the leader of an underperforming company may very well be better off than becoming a deputy manager in a more profitable company after a merger.
02
Prefer to Reap, not to Acquire
The semiconductor industry is a sector strongly encouraged by the government. Despite the current downturn in the market, companies in this industry generally have high valuations. During this downward cycle, valuations are not particularly high, and both buyers and sellers often exhibit reluctance similar to the real estate industry, where they wait for the best opportunities. Moreover, companies willing to be acquired typically have poor financial performance or are facing losses. Such companies with questionable qualifications often lack products or substantial intellectual property rights. Therefore, even if a transaction occurs, the perceived value may not be significant.
For many domestic companies, poaching talent from competitors is often easier and more cost-effective than pursuing mergers and acquisitions. If there are assets of interest to potential buyers, they can simply offer double the salary to key team members and recruit them, thereby replicating those assets in a short time.
In some cases, even obtaining technology through talent poaching is considered ethical, whereas directly ‘following’ a competitor might be viewed as unethical. If problems cannot be solved through talent acquisition, companies can wait for the target’s price to drop significantly or even wait for it to fail before swooping in to acquire it at a bargain.
03
No Transaction, no Liquidation
In recent years, most of the heavy investments in the semiconductor industry have been concentrated in the manufacturing sector. Ironically, there haven’t been substantial mergers and acquisitions in the manufacturing sector. In the history of China’s semiconductor industry, there have been only two significant mergers and acquisitions in the manufacturing sector: the merger of Huahong NEC and HLMC, which was a collaboration between state-owned enterprises and central enterprises, and the acquisition of ZTE Microelectronics by China Resources, which was an unconditional transfer between central enterprises. In recent years, there have been some mergers and restructurings that seemed to be market-driven, such as Rongxin’s acquisition of Dehuai, but these were essentially the handling of troubled projects and not genuine mergers and restructurings.
The underlying reason is that many of these heavy-asset manufacturing projects are backed by state-owned assets. If these projects are performing well, local governments and companies are naturally reluctant to sell them. If the projects are underperforming, government investments can depreciate significantly. Dealing with the loss of state-owned assets often involves high-ranking officials, and local governments are often hesitant to get involved. Local authorities are unwilling to sell these projects at market prices or let them fail. These manufacturing projects typically involve investments of tens of billions, representing significant assets for local governments. State asset management is stringent, and nobody wants to be responsible for causing a loss of state-owned assets. If local leaders involved in the projects face issues, bankruptcy or other means can be used to deal with the troubled assets. If the leaders overseeing the projects remain in their positions or get promoted, even if the projects are underperforming or become burdensome, they are often sustained. As long as they don’t collapse and no transactions occur, the loss of state-owned assets is not confirmed.
There have been cases of projects being traded through auctions, but these typically happen when the decision-makers responsible for the projects have faced consequences, bearing responsibility for the loss of state-owned assets. Some troubled mergers and acquisitions have also occurred where external losses are compensated internally to prevent the loss of state-owned assets, effectively incentivizing transactions. Consequently, manufacturing projects that should ideally undergo mergers and restructurings are often difficult to transact. Even these two modes of handling mergers and acquisitions are unlikely to reoccur in the future.
04
Reflection on China’s Semiconductor Industry
The challenges facing semiconductor mergers and acquisitions in China are a result of both institutional mechanisms and cultural factors, along with dynamics in the capital market. When we review the truly successful mergers and acquisitions in China, we find cases where Chinese companies acquired international firms, such as Wingtech’s acquisition of Ansys, Unigroup’s acquisition of Spreadtrum, and OmniVision’s acquisition by Will Semiconductor.
For those projects with lower capabilities, insufficient funding, and a lack of talent, seemingly without hope, there should be a comprehensive merger and acquisition mechanism that involves policy relaxation, innovative processes, and legal support. Additionally, actions should be taken in the capital market to reduce the threshold for mergers and acquisitions by public companies. Companies should not receive a ‘get out of jail free’ card immediately upon going public, where their valuations skyrocket, and they can pursue mergers regardless of their actual performance.
A market downturn provides an opportunity for self-cleansing, and long-standing issues often become too severe to ignore during crises. All stakeholders must seize the opportunity of industry adjustment and promote mergers and restructurings in the semiconductor sector. This will contribute to the growth and strengthening of China’s semiconductor industry.
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