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The U.S. government has passed new rules that seem destined to shake things up in the smartphone industry. While the rules may have been implemented with China’s Huawei in mind, they could also have consequences for Huawei’s competitors and suppliers. How this could all play out is what will be covered next.
How we got to this point
Huawei got put on the U.S. government’s Entity List back in May 2019, which restricted its ability to source supplies from U.S. companies, semiconductors in particular. Huawei response to these restrictions was to rely more on its own chip designs from its subsidiary HiSilicon and less on those from the U.S. But in order to do this, Huawei needed the assistance of foundries such as TSMC (TSM).
Foundries were therefore of special interest when the U.S. government made its sanctions even tougher in May 2020. Foundries rely heavily on semiconductor manufacturing equipment from U.S. companies like Applied Materials (AMAT), Lam Research (LRCX) and KLA Corporation (KLAC). The U.S. was able to use this dependency to force TSMC to stop doing business with Huawei. Restrictions were again made tougher last August.
The new rules went into effect last May and included a grace period of 120 days. This means that as of September 15, Huawei will no longer be able to source semiconductor chips from many of its suppliers. The new rules are so restrictive that quite a few people believe that the future of Huawei is in great peril due to a lack of access to sufficient chip supplies.
Why the Huawei restrictions could be bullish for the U.S. tech industry
The latest moves by the U.S. government have far-reaching implications for many companies in several industries. For instance, Huawei is currently ranked as the number one smartphone manufacturer in terms of market share. But Huawei may have trouble holding on to this position if it cannot secure new sources of chip supplies and manufacture enough quantities of new handsets to maintain its market share.
In theory, Huawei’s inability to manufacture new products could open up an opportunity for competitors to gain some market share. For instance, Apple (AAPL) and Samsung could be among the likely winners. Both could regain market share they lost to Huawei in previous years. But the gains for the latter could be offset by a drop in semiconductor sales to Huawei in the short term.
Another potential beneficiary could be Qualcomm (QCOM), the top supplier of smartphone SoCs. Qualcomm has seen shipments of Snapdragon chipsets slump in recent years. Partly as a result of a shrinking market for smartphones, but also as a result of stiff competition from Huawei. Huawei has its own line of Kirin chips, which compete against those from Qualcomm. In Huawei’s absence, OEMs such as Oppo, Vivo and Xiaomi could increase sales, giving sales at Qualcomm a boost since it supplies chips to all three of them.
Another company that could stand to benefit from Huawei’s predicament is Google (GOOG)(GOOGL). Huawei has been working on replacements for Google Mobile Services and Android in the form of Huawei Mobile Services and Harmony OS respectively. Google relies primarily on advertising for most of its revenue. Having access to as much of the global population as possible through its apps helps in this regard.
The removal or exclusion of its apps on smartphones is not a positive development for Google as is the case with recent smartphones from Huawei. The fewer Huawei smartphones there are, the better it is for Google. Not only does it open up room for Google’s Pixel smartphones in the market, but it ensures that Google’s software remains ubiquitous on mobile devices.
Why the Huawei restrictions may not be such a good thing
The general consensus is that Huawei is heading for challenging times, if it isn’t there already. But there’s some disagreement as to the severity of the situation Huawei finds itself in and the company’s ability to overcome the challenges it faces. Many analysts are fairly negative on Huawei’s future prospects. Some even go so far as to predict the demise of Huawei as a company. On the other hand, the viewpoint from China seems to be more optimistic. The predominant belief in China is that Huawei will be able to solve its supply chain issues, although it will take some time.
The latest round of sanctions from the U.S. focus primarily on semiconductor manufacturing equipment. It’s widely believed that U.S, equipment is essential for the manufacture of semiconductors, but not everyone from China seems to agree. As far as China is concerned, it’s possible to set up semiconductor production lines without using American equipment.
This issue has become of crucial importance for Huawei in light of recent events. If China is able to do this successfully, Huawei could get a life line for all intents and purposes. Not only would aforementioned companies not see the benefits of Huawei’s absence, but Huawei would become a more formidable competitor due to having access to a home-grown supply chain.
Source: Wikimedia Commons
Investor takeaways
It’s no longer business as usual for Huawei. The company can no longer count on the supply of semiconductors from its traditional suppliers as of September 15, unless they get approval from the U.S. government. The prospect of not having enough supplies spells trouble for Huawei and its ability to compete in the marketplace. Some people go so far as to predict the demise of Huawei as a viable entity.
A number of companies could benefit if Huawei is no longer able to compete. But whether or not that happens could be swayed by two issues. The first relates to how much chip inventory Huawei and related parties have access to. China’s imports of semiconductor chips has greatly increased in recent years, especially in the run-up to sanctions from the U.S. government. Some of it is very likely to have been used to increase inventories. A previous article covers this issue in greater detail.
Huawei could be sitting on enough inventory that could last for quite some time, although it’s a point of debate as to how much it really has access to. Nevertheless, Huawei will eventually run out of inventory unless it gets resupplied. It’s only a matter of when and not if. But what it does mean is that it may take a while before it becomes clear whether or not Huawei can produce enough products for the market. Companies may have to wait some time before they see a noticeable impact in the market.
The second issue is the more important one. China has to come up with its own production facilities for semiconductors without having to rely on the U.S. Having extra stocks of semiconductors gives you time to make alternative arrangements, but cannot be a permanent solution. Huawei needs access to new semiconductor production lines that do not include U.S. equipment. These would not fall under U.S. sanctions.
While the prevailing view is that U.S. semiconductor manufacturing equipment is essential, China does not seem to agree. China seems to believe that its domestic suppliers of polishing, lithography, etching, implantation, deposition, cleaning and inspection equipment have advanced to such a degree that they can fill the void to a certain extent, at least when it comes to DUV process nodes. More advanced processes, specifically those incorporating EUV, will take more time.
Which of these two opposing viewpoint turns out to be the correct one is likely to determine how effective the latest sanctions turn out to be. For Huawei, time is of the essence. Since it only has access to a finite amount of chips, alternate production lines need to be up and running before inventory runs out. Whether or not China is able to do this will shape the road ahead. If China fails, a number of U.S. tech companies stand to benefit greatly. But if China succeeds, a number of U.S. tech companies will have to face much tougher competition in the future.
It’s worth mentioning that Huawei itself has stayed unusually calm despite the recent turn of events, especially if one considers the very future of the company is on the line. Huawei could be pretending by putting on a brave face or the company knows something that most do not.
For instance, Huawei’s recent public events included roadmaps, which go into further details as to the company’s future plans. In it Huawei makes it clear that it intends to continue competing in the smartphone industry and has no intention of withdrawing as some have suggested. Job postings are another sign that Huawei is not only not taking a step back, but moving forward. Hiring new employees does not make sense if a company thinks it’s about to go out of business.
Bottom line, while there are quite a few industry watchers predicting the imminent demise of Huawei as a result of the latest U.S. sanctions, the final outcome has yet to be determined. Sanctions could turn out to work in favor of U.S. companies in the long run, but there’s no guarantee that is how it will play out. U.S. tech companies may not necessarily post gains at the expense of Huawei. Previous predictions concerning Huawei’s demise have shown to be premature.
Many did not expect Huawei to do well after it was put on the Entity List in May 2019, but the company still managed to become the number one OEM a year later. The fact that the U.S. government had to pass new restrictions is a tacit admission that the original set of sanctions did not achieve the desired results, contrary to expectations. It’s not out of the question that history could repeat itself. Huawei could not only survive, but emerge stronger than before.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.