Obama leaves Trump plan to prevent Chinese domination of the chipmaking world
The former president left a departing gift Trump actually might want: a road map for countering China's plans to dominate the semiconductor business.
A big part of President Donald Trump's economic message during the campaign was his promise to get tough on China, which he singled out for drawing jobs from the U.S. with the lure of cheap workers and generous government subsidies and for erecting trade barriers that favor exports from that country over imports.
If he wants to take concrete action to fend off some of the threats China poses to the U.S. economy, he might send his White House staff searching for a Jan. 6 report issued by Obama White House science officers as the previous administration drew to a close. The web link to the report, which recommended steps U.S. officials can take to protect the U.S. semiconductor industry, no longer works, no doubt because of the new President's zeal to scrub all things Obama from the White House's communications outreach. A link to The Deal's copy is here.
But Trump would probably be receptive to the theme of the report: that China's industrial policy designed to eliminate the U.S. lead in the global semiconductor market and place itself in that role is a threat to U.S. economic and national security and the U.S. should counteract those efforts.
Regulators' wariness of semiconductor sector acquisitions by buyers with Chinese ties already has killed a number of deals in recent years, but typically the challenges are targeted at only deals involving products sold to the military or that are critical to the U.S. telecommunications infrastructure. Fujian Grand Chip Investment Fund LP on December 8 dropped its €670 million ($717.5 million) bid for German chip-making equipment supplier Aixtron SE after President Obama said he would block the Chinese investment fund from acquiring the Aixtron's U.S assets. Lam Research Corp. (LRCX) and KLA-Tencor Corp. (KLAC) spiked their $10.6 billion merger in October due to an extended investigation by the Committee on Foreign Investment in the U.S. In January 2016 Royal Philips NV backed out of its $3.3 billion agreement to sell its Lumileds lighting components business to a Sino-U.S. consortium, citing opposition by Cfius. Others deals halted under U.S. government threat include Fairchild Semiconductor International Inc.'s (FCS) $2.46 billion takeover offer from China Resources Microelectronics and Hua Capital Management, China's Unisplendour Corp. Ltd planned investment in Western Digital Corp. (WDC), and Tokyo Electron Ltd.'s 2015 effort to acquire Applied Materials Inc. (AMAT) for $9.4 billion.
It's not as if semiconductor deals involving Chinese buyers can't get done. In December 2015 GlobalWafers Co., Ltd. was cleared for its $683 million acquisition of SunEdison Semiconductor Limited (SEMI), and three other semiconductor-related deals involving Chinese and other foreign buyers were approved in 2015: Globalfoundries Inc.'s acquisition of IBM Corp.'s (IBM) microelectronics business, NXP Semiconductors N.V.'s (NSPI) $1.8 billion sale of its RF Power unit to Jianguang Asset Management Co. Ltd. and Integrated Silicon Solution Inc.'s (ISSI) acquisition by Uphill Investment Co.
According to the report, economic threats should be added to the list of national security concerns that could result in an acquisition of U.S. assets by foreign buyers being blocked by Cfius, particularly if the buyer's home country (i.e. China) is violating international trade agreements. Under the Obama administration's plan, the U.S. would only expand the definition of national security threat to take much more widespread action blocking deals involving China when the negotiated rules have been violated. The report hinted that China's non-cooperation on economic and trade issues would provide additional evidence of a national security threat. Trump's only real reservation about the plan might be to quibble with the some of the steps Obama's team recommended as being too plodding and requiring naïve faith in China's willingness to negotiate and follow a set of rules governing such issues as each countries' import restrictions and use of government subsidies.
"President Trump's attitude toward the report is going to be interesting," said Claire Reade, senior counsel specializing in Chinese trade at Arnold & Porter Kaye Scholer LLP. "This is an important report and should have legs in a Trump Administration. The attempt to be more sophisticated and to use a broader gauge of what nation security concerns should be is a line of thinking the Trump Administration should be receptive to, based on their views expressed on the campaign trail."
"The fundamental point is that to the extent China is taking significant action to open its markets to the world and is truly willing to adopt market decision-making globally in non-sensitive industries where semiconductors are involved, that would be helpful and avoid the U.S. needing to protect a broader swath of the industry," she said. "The open question is their interest and ability to do so."
The report bluntly lays out the threat China's industrial policy regarding semiconductors poses to U.S. leadership in the sector and the potential consequences to the overall U.S. economy.
China has stated that it intends to have "advanced world-level" semiconductor capability in all segments of the industry by 2030. The Chinese government has committed $150 billion over 10 years to subsidize investment and acquisition. China also conditions access to its market on local production and technology transfer.
Coupled with these initiatives, China's gambit its timed to take advantage of the fading phenomenon of Moore's Law, the expectation that the semiconductor industry will double the number of transistors on a chip every 18 to 24 months. That pace is much harder to keep up today as industry R&D is spread across more numerous types of products. Because semiconductor technology is advancing more slowly, it is now easier for China to narrow the gap in its capabilities, according to the report.
Anne Salladin of Stroock & Stroock & Lavan LLP said the report could launch an important conversation within the Trump Administration should the president give it a look.
"CFIUS is intended to deal with acquisitions on a transaction-by-transaction basis," she said. "This is an inexact tool for dealing with repeated purchases by a determined government like those we have seen over the past year," she said. While the CFIUS process is designed to prevent deals that could put a specific military or telecom technology in the hands of a hostile government, the statutory criteria it relies on to challenge a transaction were not designed to prevent a string of acquisitions that could supplant U.S. economic leadership bit-by-bit.
Trump, however, is unlikely to adopt the report without making major revisions, particularly to recommendations urging U.S. and Chinese officials, to the extent possible, to engage first in dialogue to agree in principle upon the types of measures that are reasonable for protecting national security. Under the Obama administration report, if China does not adhere to these agreed-upon norms, one way that the U.S. could respond would be to allow China's policy to affect national security threat assessments of Chinese acquisitions. "On its face it seems as if the report's goals would be aligned with President Trump's, but certain recommendations in the report are not necessarily a blueprint for action. These recommendations rely on norms agreed to by the two countries," Salladin said. "That process could take time to put in place and would not immediately apply higher scrutiny to deals."
Nevertheless, Trump would be wise to seek some sort of formal framework in order to make clear that most in-bound investment is still welcome. Otherwise, overseas investors may believe their efforts are better directed elsewhere, Salladin said.
President Trump "seems to be a dealmaker, and I don't think he wants to shut off the spigot" of capital investment from overseas.
