(Bloomberg)– Just as the market’s love for the FANG stocks turns to angst, the U.S. government is looking to ban Chinese investments in its technologies. That’s a bigger problem for the country’s expensive chipmakers than their would-be Asian acquirers.
The Philadelpha Semiconductor Index is 8 percent below its mid-March peak
Semiconductors and 5G wireless communications are among areas that would be placed off-limits under plans to invoke a law reserved for national emergencies, Andrew Mayeda, Saleha Mohsin and David McLaughlin of Bloomberg News reported Wednesday in Asia. The restrictions would be the latest step in President Donald Trump’s plan to punish China for what he sees as violations of American intellectual property rights.
A ban will hardly raise eyebrows in China. Companies there are already stepping away from overseas acquisitions: Homegrown is the new buzzword in technology.
China is trying to open its $8 trillion stock market to unicorns, as startups with a value of more than $1 billion are known. Concrete moves include fast-tracking the IPO application of Terry Gou’s Foxconn Industrial Internet Co. and luring U.S.-listed domestic firms to return home via the issuance of Chinese depository receipts.
Technology companies have a real urgency to go public because of the sweet valuation premium that scarcity confers. Of 3,400 listed firms in China, only 59 are in semiconductors. As a result, they trade at an average 80 times historical earnings on a market-cap weighted basis. Even the median firm commands a 47-times multiple.
But there’s a caveat. China is cracking down on companies that have too many intangible assets, having learned a bitter lesson from Leshi Internet Information & Technology Corp., a one-time high-flyer that helped to sink the entire Shenzhen stock market.
Securities regulations require that any firm planning to list on the main board can’t have intangibles exceeding 20 percent of net assets. An average firm on the Philadelphia Stock Exchange Semiconductor Index trades at 4.7 times book.
That means that a good 80 percent of any takeover price, based on a back-of-the-envelope calculation, will be booked as goodwill. In other words, China Inc. has one more reason not to climb the technology ladder via acquisitions — whatever the U.S. does.
There’s evidence that China’s securities watchdog is actively looking out for intangible violators. Mindray Medical International Ltd., a medical device maker that was taken private in a $2 billion deal in 2015, withdrew its listing application last month. The company has a large amount of goodwill after a series of overseas acquisitions, according to Caixin.
Wuxi AppTec Co., also taken private in 2015 in a $3.3 billion deal, got the exact opposite treatment this week. The China Securities Regulatory Commission approved its $2.9 billion IPO, only 50 days after the company’s filing. Unlike Mindray, Wuxi AppTec didn’t use acquisitions to grow.
The company, China’s biggest contract medical researcher, employs the country’s army of biotech graduates to help U.S. pharmaceutical firms develop drugs.
What does this mean for U.S. semiconductor firms, a “crowded” field to use the investor jargon? Over the past three years, a dozen ETFs tracking tech firms received at least $1 billion in new investments, according to data compiled by Bloomberg. Many among them, such as London-listed iShares Automation & Robotics UCITS ETF and First Trust Nasdaq-100-Technology Sector Index, have invested heavily in semiconductors.
A Crowded Trade
Over the past three years, a dozen tech ETFs received net inflows of at least $1 billion. Many have large exposure to the semiconductor industry
Despite the recent sell-off, the U.S. sector is still trading at 20.6 times earnings. To justify this investor enthusiasm, companies must produce strong earnings reports (the street sees only 7.5 percent growth this year), buy back shares in a meaningful way, or become acquisition targets. Trump’s emergency law will shut down the last option.
Chinese technology firms won’t lose any sleep. Their focus now is on going public, fast.