SMIC scores mainland China’s biggest IPO in a decade

Zhou Ziqing, a 27-year-old who works in the PR department of a law firm, has put aside Rmb100,000 ($14,310) for the biggest IPO on the Chinese mainland in a decade.

On Thursday morning, she plans to join the millions of investors scrambling to buy shares in SMIC, the giant Chinese chipmaker that is returning home to list on Shanghai’s Star board. “I was born ready for this day,” she said.

SMIC, valued at $31bn on Wednesday, will become one of the China’s top 50 most valuable public companies after the listing. It has already sold roughly half its placement to institutions, raising Rmb53.2bn ($7.6bn), but plans to sell the rest to retail investors like Ms Zhou.

Ahead of the listing, Ms Zhou was confident that SMIC, as one of China’s national champions, is a safe bet. “SMIC is China’s best chipmaker and the industry enjoys a lot of policy support,” noted Ms Zhou, who said she would hang on to at least half the shares she plans to buy for the long term.

A senior official at the Shanghai stock exchange noted that the government plans to use its domestic capital markets to raise money towards China’s goal of technological self-sufficiency. “SMIC is benefiting from US-China tensions,” the official said, adding: “We hope to compete with Nasdaq for Chinese tech companies.”

Column chart of Capital spending (US$bn) showing SMIC plans to hike its equipment purchases this year

As well as China’s government funds, Singapore’s sovereign wealth fund and the Abu Dhabi Investment Authority are among the institutions backing the IPO.

SMIC’s first week of trading is likely to be dramatic. The Shanghai Star board is the only exchange on the mainland with no limit on stock price movements in the first five days, after which there is a 20 per cent up-or-down limit, compared to 10 per cent elsewhere.

The company acknowledges that it is charging a high price, compared to its peers. At its target price of Rmb27.46, SMIC’s valuation will be 113 times last year’s earnings. By the company’s own reckoning, that is at least four times higher than its domestic rivals. TSMC, the Taiwanese industry leader, trades at 27 times earnings.

Line chart of Semiconductor Manufacturing International Corporation share price since IPO (HK$) showing Before SMIC's A-share debut, prices were disappointing

Historically, SMIC has not been a good buy. Its Hong Kong shares traded at below their 2004 opening price of HK$24 until around three weeks ago, when they rallied on expectations that the Hong Kong share price will be dragged up by the price on the mainland. SMIC has now delisted from the New York Stock Exchange, where it also listed in 2004, raising $1.7bn.

Nevertheless, domestic analysts have felt pressure to be positive about SMIC’s prospects, and foreign analysts agree that it will benefit from the macro-trend of China needing to boost its domestic chip industry.

“But investors will need to keep their enthusiasm, given a long period of investment required to get to strong earnings and cash flows. It could take over five years, with some foundries never getting there,” said Randy Abrams, an analyst at Credit Suisse in Taipei.

Mark Li, at Bernstein, was less optimistic. “SMIC has been tasked to do the most difficult tasks in the semiconductor supply chain, at the cutting edge, which is typically money-losing,” he said.

SMIC's R&D is rising, but falls far behind Taiwan's TSMC

“Korea, Japan, Taiwan tried to reduce their dependency on US equipment in the past 30 years. Even though they’re very strong in manufacturing semis, all of them failed. I don’t think China can overcome this,” Mr Li added.

In the short term, intensifying US pressure could deal SMIC a heavy blow as soon as September, when new sanctions will stop any company using US technology from supplying Huawei, the Chinese telecoms company that is SMIC’s biggest customer and responsible for almost a fifth of its revenues.

Like other major chipmakers, SMIC relies on US technology and notes that this is a major risk, but that the finer legal details have yet to be ironed out.

SMIC had planned to use 40 per cent of its IPO proceeds to invest in a production node for 14nm chips. But demand from Huawei accounts for about 70 per cent of that node’s capacity, according to estimates from Bernstein.

US hostility is also blocking SMIC from buying the equipment it needs to make the leap to the ever-smaller chips that are essential to high-end smartphones and 5G base stations.

SMIC lags behind in the global race to shrink semiconductors

After buying a cutting edge, extreme ultra violet (EUV) lithography machine from ASML, which has a monopoly on the devices, SMIC has seen its $150m purchase languish in the Netherlands for two years as the US puts pressure on the Dutch government to block the order.

Analysts at Bernstein believe SMIC is preparing for a future where it is cut off from US supply chains, and has already raised $2.9bn from government funds this year, as well as $2.6bn in debt, to put alongside its IPO proceeds. This dry powder will help it stockpile equipment before further sanctions hit.

But these future concerns are unlikely to weigh too heavily on retail investors such as Ms Zhou. In turn, her confidence in the government’s support for SMIC will encourage institutions, said Xiao Lei, a Beijing-based financial commentator.

“Retail investors are very important: institutions will not invest if the retail investors are not interested. Some would call it fleecing the flock, but China has a strong demand for chips and you will make money on the top companies,” Mr Xiao said.