China’s chip consolidation accelerates with SMIC, Hua Hong buyouts

Two of the country’s leading fabs announced buyouts of government partners in their non-wholly owned subsidiaries last week

Key Takeaways:

• SMIC and Hua Hong are consolidating ownership of their assets by buying out their government investors, eliminating profit-sharing and internal fab competition
• China’s government chip investment strategy has produced mixed results, including lucrative exits alongside massive failures like the collapse of Wuhan Hongxin

By Hugh Chen

What do you do when your semiconductor industry has too many players, inefficient capital deployment, and mounting pressures to compete with global giants?

If you’re China, the answer is that you consolidate. The clearest signal of such intent came last week, when leading chipmakers SMIC (0981.HK; 688981.SH) and Hua Hong (1347.HK), which collectively account for over 7% of global foundry capacity, nearly simultaneously announced they would buy out minority stakes held by government investment funds in their key subsidiaries.

Both deals involve buyouts of the same minority investor: China’s National IC Fund, also known as the “Big Fund,” alongside various other local government investment vehicles. The close timing of two similar announcements appears to be more than coincidental. These state-backed funds need to recoup some of their capital for new investments, as the industry itself has become crowded with a wide range of players.

This investment cycle of government funds backing new ventures, then exiting once they mature, is precisely the playbook Beijing has used to build its semiconductor industry. The SMIC and Hua Hong transactions showcase the model at its best: early state capital helps establish domestic champions, then withdraws at higher valuations to pocket big profits to fund the next generation of technology.

Both SMIC and Hua Hong have histories that date back before the strategy began in earnest, and things haven’t always worked so smoothly in the era of highly targeted chip investment. China’s chip sector is also plagued with massive losses from failed projects and stranded investments in lackluster companies — complications that help explain why consolidation has become urgent. We’ll explore these challenges shortly. But first, let’s examine the SMIC and Hua Hong deals in more detail and what’s driving them.

The SMIC deal, announced last Monday, centers on SMIC Beijing, a subsidiary operating a fab using cutting-edge 12-inch wafer technology. SMIC will acquire the remaining 49% stake in SMIC Beijing for 40.6 billion yuan ($5.81 billion) from multiple sellers, including the Big Fund and two Beijing municipal investment vehicles, according to a company announcement.

The Hua Hong deal, announced two days later, follows a similar pattern. Hua Hong will acquire an additional 38.4% stake in Shanghai Huali Microelectronics, which operates two 12-inch wafer fabs in Shanghai. The transaction, which involves shares in one of these facilities, values the stake at 8.3 billion yuan. It involves four sellers, including Shanghai IC Fund, China IC Fund Phase II, and Guotou IC Fund.

Unlike many companies in China’s chip sector, both SMIC and Hua Hong can afford such buyouts due to their relatively maturity – both have around two decades of history – and strong cash flow and access to credit and capital markets. 

Uneven results

Both SMIC and Hua Hong plan to fund their acquisitions primarily through issuing new shares, an approach that makes sense given their stocks are trading near multi-year highs. For the exiting investors, the transactions almost certainly offer handsome returns.

For SMIC and Hua Hong, the transactions are strategic for different reasons. SMIC’s case is about profit consolidation. While SMIC Beijing was already contributing revenue to the parent, nearly half of the subsidiary’s profits were flowing to minority shareholders. By acquiring the remaining 49%, SMIC will now capture 100% of the earnings from one of the most profitable facilities among its 10 fabs.

Hua Hong’s rationale differs slightly. The asset being acquired has been competing directly with Hua Hong’s own major Shanghai fab. The consolidation eliminates this internal competition while also bringing Huali’s revenue fully onto Hua Hong’s books — a move that should produce a significant revenue jump and better profitability.

This brings us back to Beijing’s strategy of using government funds to promote industrial development. The logic is sound enough. Wafer fabs require massive investment and face heavy depreciation in their early years, making government financing a sensible way to support them in their early stages.

However, the track record reveals such a strategy can also lead to big waste as ill-conceived projects line up alongside the better ones, all in search of big government handouts. One of the most notorious in the former group is Wuhan Hongxin Semiconductor, which aimed to become one of China’s most advanced foundries at its launch. Instead, the project collapsed into bankruptcy in 2020 after burning through more than 15 billion yuan without ever producing a single commercial chip.

More recent cases suggest such failures aren’t uncommon, though they receive less publicity. Wusheng Electronics, a Shanghai project launched in 2019, initially planned total investment exceeding 18 billion yuan with a five-year construction timeline. Less than three years later, the project stalled completely, and the company filed for bankruptcy last year without ever beginning meaningful production.

For the broader Chinese semiconductor industry, years of government-fueled expansion have created conditions ripe for consolidation among surviving companies. The “Big Fund,” established in 2014, has been the primary catalyst, raising 138.7 billion yuan in its first phase, 200 billion yuan in its second, and 344 billion yuan in its third phase in 2024.

Now, consolidation is sweeping through every segment, not just chip production, but also chip design, materials, equipment manufacturing, and EDA tools.

Last September, major wafer manufacturer National Silicon Industry Group (688126.SH) announced plans to fully acquire three of its subsidiaries. Three months earlier, semiconductor equipment leader Naura (002371.SZ) bought 17.9% of rival Kingsemi’s shares from two state-backed investors for 31 billion yuan.

The pace of consolidation is accelerating. According to data analytics firm IT Juzi, China recorded 93 semiconductor M&A transactions last year through September — a 33% increase from 70 deals in the year-ago period. The total transaction value of those deals reached an estimated 54.9 billion yuan, up nearly 50% year-over-year.

Government fingerprints are visible across these deals. State-backed funds that invested during the expansion phase are now facing strong pressure to exit and recycle capital into new government priorities.

However, not all consolidation attempts succeed. A prominent example is the failed merger between AI chip and CPU maker Hygon and server manufacturer Sugon. Announced last June, the deal was later abandoned by December, with the companies citing the transaction’s large scale and the complexity of coordinating multiple stakeholders.

Despite such setbacks, we can almost certainly expect more consolidation this year. The wave represents a necessary evolution as Beijing pursues self-sufficiency across the semiconductor value chain amid intensifying U.S.-China technology competition. The question is no longer whether consolidation will happen, but who will emerge as the primary consolidators, positioned to become China’s answers to global giants like Taiwan’s TSMC (2330.TW; TSM.US), South Korea’s Samsung (005930.KS) and U.S. giant Qualcomm (QCOM.US).

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