In the deepening trade negotiations between China and the U.S., the bargaining chips are quite literally chips.
According to multiple reports, China has offered to increase the percentage of semiconductor chips it buys from American sources, replacing offerings from South Korea and Taiwan, if the two countries can come to an economic agreement on moving their trade relationship forward. The hope is that the redirected purchases could lower the trade deficit between China and the U.S., which hit an all-time high last year of $375 billion. China is the largest consumer of semiconductors in the world, so its trade decisions have an outsized impact on the industry and its players.
These negotiations are a response to the Trump administration’s announcement last Thursday that it would place a tariff on roughly $60 billion worth of Chinese goods, with a presumed focus on high-tech goods. China, still playing catch up from an earlier declared tariff on steel and aluminum, announced on Friday tariffs on $3 billion worth of goods, which covered goods like pork, apples, and steel pipe.
The tariff on steel pipes is a reciprocal response to the original steel tariffs, but why would China choose pork and apples? Well, the states that produce those two goods also happen to be high-priority states in the U.S. presidential election system. The largest pork producing state by a long shot is Iowa, which happens to be the first nominating contest for the presidency. The same is true of apples: among the top 10 states are Michigan, Pennsylvania, Virginia, and Ohio, all of which are critically important for Trump’s reelection campaign.
Clever, but obvious. But there is another interesting card for China to play in these complex negotiations, and that is Qualcomm’s purchase of NXP Semiconductors.
I have talked a lot about Qualcomm and the complicated strategic position it finds itself in. Qualcomm’s corporate strategy has been to invest in growing markets outside smartphones, since the smartphone market has saturated and future growth is believed to be more limited. NXP is a market leader in hot areas like automotive, growth that could be quite accretive to its acquirer. The leadership of Qualcomm has made the purchase of NXP an absolute must win for the future of the company, particularly after it fended off Broadcom’s hostile takeover.
There’s just one problem. The NXP transaction has received regulatory approval in all jurisdictions except one: China.
According to Bloomberg, China’s Ministry of Commerce, which has jurisdiction over the Qualcomm-NXP decision, is under heavy pressure to increase protections for local semiconductor players, or even more aggressively, outright block the deal. A decision from China has been expected for some time now, and Qualcomm was forced to extend its tender offer to April 2nd to accommodate China’s widening timeline.
Such a move wouldn’t be unprecedented given that China has taken Qualcomm to task before. In early 2015, Qualcomm signed an agreement with Chinese antitrust regulators to pay a $975 million fine and also to lower royalty rates for local manufacturers. Royalties are a uniquely critical part of Qualcomm’s revenue mix, and given that China is the world’s largest semiconductor market, the deal foreshadowed the challenges Qualcomm was going to face from a government determined to stand up its own semiconductor industry.
China’s government has made building a world-class semiconductor industry a major national priority, investing billions of dollars and using a variety of industrial policy tools like competition policy to protect, nurture, and develop its indigenous chip industry.
The collapse of the NXP deal could be a remarkably strong blow to Qualcomm. It would represent the collapse of almost two years of work to prepare for the transaction, forcing the company to deeply consider its future. It would also raise questions about what exactly it can do to grow, given that NXP is one of a vanishing few number of companies that could drive major value for Qualcomm shareholders. Even if it found other potential transactions, China could theoretically intervene in those deals as well.
That’s a terrible negotiation position to be in with China. Little wonder then that last week’s shareholder meeting led to remarkably low support for the election of its board members. The current CEO of Qualcomm, Steve Mollenkopf, failed to get a majority of support from shareholders, a highly unusual situation given that board members of publicly-traded U.S. companies are often reelected with vote totals exceeding dictators in third-world countries. Many shareholders voted against the slate — which ran unopposed — as a protest over Qualcomm’s handling of the Broadcom takeover among many other grievances.
Buying more U.S. semiconductors then, while simultaneously knocking Qualcomm, looks like an amazing win-win for China right now. China’s import of semiconductors stays the same, since it is merely replacing U.S. parts for other Asian suppliers, while at the same time, its decision with Qualcomm could hurt America’s sole company fighting Huawei for dominance in 5G wireless technologies.
Ultimately, I predict the NXP transaction to be approved. For all of the trade negotiations and complex strategies going on here, China needs to be seen as a place open to doing business, now more than ever as its trade practices are placed in the spotlight. However, that doesn’t mean it won’t exact serious concessions from Qualcomm, which could further erode the company’s revenues and standing in China.
For a president who came to power arguing that America needed to get smart about negotiations, maybe it is time to look at how the Chinese government is playing its hand. They are not just playing their cards well, but also securing better cards all the time from other players around the table. Little wonder then that the chips in the center increasingly seem to be heading in its direction.