Hermes: Opportunity strikes – A postcard from Taiwan

Jun 27, 2019
On a recent research trip to Taiwan, Kunjal Gala found the country to be in a potential sweet spot between the US crackdown on Huawei and rivalry with China

As tensions between the US and China continue to escalate, Taiwan has found itself – more so than other economies – with some delicate decisions to make. The Taiwanese economy relies heavily on global trade, and the US and China are its top two trading partners.

We see two trends emerging, both of which are promising for the island nation:

– The US will increase its dependence on Taiwan. To avoid tariffs, US companies will move their production or supply chains out of China to Taiwan-based firms. Already, several suppliers have facilities in Taiwan – such as Accton, Advantech and Delta

– Similarly, China will become more reliant on Taiwan as the US denies China access to critical technology supplies. Some of these technologies are available in Taiwan. For Taiwanese companies that export to China, there is a risk Taiwan could give in to American political pressure and ban exports of certain technologies to the mainland. But TMSC, the world’s largest contract chipmaker, has suggested it is business as usual and expresses confidence that it is complying with the export control regime.

Opportunistically, the Taiwanese government started an Invest Taiwan campaign last year in an attempt to attract companies to the country amid escalating US-China trade tensions.

Huawei fallout: Crisis or opportunity?

The Trump administration’s assault on Huawei has further impacted the investment landscape in Taiwan. Taiwanese companies continue to supply components to Huawei – as far as they are concerned, it is business as usual but they are monitoring the situation. Two points to consider:

1. Huawei has a roughly 40 percent share of the telecommunications equipment market in China. While ZTE is still reeling from the export ban the US imposed and subsequently rescinded in 2018, other local players such as Fiber@Home remain active. Huawei’s Chinese competitors – such as smartphone makers Oppo, Vivo and Xiaomi – are keen to regain lost market share, while Samsung, Ericsson and Nokia will also aim to advance their interests. As such, the rollout of 5G should continue regardless of whether Huawei survives the US blacklisting

2. The majority of Taiwanese companies have diversified customer bases and therefore do not face existential crises on the back of the Huawei ban. Most are confident of being able to shift to Huawei’s competitors due to existing supply relationships. The only risk here is if Huawei digests inventory before demand from new buyers ramps up.

Several Taiwanese suppliers are not heavily dependent on China for their revenues and generate substantial income from overseas operations including those in the US and Europe. A number of companies in Taiwan possess critical technologies, such as silicon photonics (LandMark), gold bumping and chip-on film (Chipbond), advanced logic nodes (TSMC) and switching technology (Accton) that are difficult to replicate. This puts them in a strong position, as they also benefit from long-term secular drivers such as cloud computing, 5G, artificial intelligence and high-performance computing.

In demand: Taiwanese tech

Amid the poor sentiment caused by the Huawei crisis, short-term volatility in the Taiwanese market is inevitable. From a medium-term perspective, however, the challenges faced by its technology companies are not insurmountable. 

Some firms are moving up the value chain by focusing on solutions, platforms and software applications rather than components alone. In many cases, Taiwanese technology is unique, and in other cases is of equal quality to that produced in Japan. In a few cases, it can substitute US technology – MediaTek Mobile’s system-on-a-chip can likely be used instead of Qualcomm for 4G and 5G applications, for example. 

The Chinese have achieved expertise in back-end testing and memory but lack cutting-edge semiconductor equipment and manufacturing capabilities – making Taiwan a critical source of supply in the current geopolitical climate.

Kunjal Gala is global emerging markets co-portfolio manager at Hermes Investment Management

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