Lawrence Person's BattleSwarm Blog

I’ve written about China’s semi-illusory semiconductor businesses before: “In China the question is always how much of that investment is real, and how much is illusion. A lot of those ‘under construction’ fabs never materialize, either unable to attract investors or having their funds magically siphoned off to some other enterprise.” While researching yesterday’s piece on the current semiconductor shortage, I came across this Emily Feng NPR piece on more multi-million dollar shenanigans in that space:

In 2019, the U.S. sanctioned two major Chinese telecom firms, temporarily cutting them off from a vital supply of semiconductor chips — bits of silicon wafer and microscopic circuitry that help run nearly all our electronic devices.

Wuhan Hongxin Semiconductor Manufacturing Co. promised a way out, toward self-reliance in the face of increasingly tough U.S. curbs on this technology. The private company once boasted on its website that it would raise a total of $20 billion to churn out 60,000 leading-edge chips a year.

None of that would come to pass.

Hongxin’s unfinished plant in the port city of Wuhan now stands abandoned. Its founders have vanished, despite owing contractors and investors billions of yuan.

The company is one of six multibillion-dollar chip projects to fail in the last two years. Their rise and fall is a cautionary tale in an industry that is flush with state cash but still scarce on expertise — and a preview of the expensive and winding road China will have to take toward semiconductor self-sufficiency, now a national security priority.

Hongxin Semiconductor began in November 2017 as a joint venture between Wuhan’s Dongxihu district government and a company called Beijing Guangliang Lantu Technology.

The venture got off to a good start — on paper — but a closer look shows there were a number of issues. One of the co-founders of Guangliang had only finished elementary school and was allegedly using false credentials and a different identity, Cao Shan, according to 36Kr, a Chinese tech news outlet. Another co-founder, Li Xueyen, dabbled in selling Chinese traditional medicine, alcohol and tobacco before starting Hongxin, according to corporate records reviewed by NPR.

These are not the profiles you look for in semiconductor startup founders.

The two could not be reached for comment.

Yeah, I bet.

To balance out their lack of technical know-how, the Hongxin founders lured in one of Taiwan’s most famous semiconductor engineers, Chiang Shangyi, to serve as director. He left the company in 2020 to become the deputy chairman of China’s Semiconductor Manufacturing International Corp., telling Hong Kong paper South China Morning Post that his time at Hongxin was “a nightmare.” Chiang did not respond to NPR requests for comment.

Hongxin made headlines in December 2019 when it managed to buy an older model lithography machine made by Dutch company ASML, despite American lobbying to prevent its sale to the Chinese chipmakers.

OK, on the face of it that sounds pretty impressive. If you want to have a cutting edge fab, you have to have one of ASML’s top of the line Extreme Ultraviolet (EUV) steppers. In almost every other segment in the semiconductor equipment market, there’s competition between the three big players (Applied Materials, LAM Research and Tokyo Electron) and occasionally other companies (like Axcelis for ion implanters). But while you might be able to get away with lesser Deep Ultraviolet (DUV) lithography machines from Nikon or Canon for some tasks, for the smallest features on cutting edge 7 and 5nm nodes, you simply can’t do without an ASML EUV stepper. (More background here.)

Well, guess what? The vaunted ASML tool Hongxin bought is apparently an older 1980 model (presumably this one, which dates from 2015, not 1980) which is DUV, not EUV.

Back to the NPR piece.

ASML sold the multimillion dollar piece of equipment — used to etch semiconductors — because of Jiang’s top-notch reputation, according to two people familiar with the sale who were not authorized to speak publicly about it. ASML declined to comment.

Feng (or her editors) goofed here. ASML makes lithography machines, not etch tools.

Hongxin’s timing was opportune. Chinese chip companies still rely heavily on European, American and Japanese technology — much of which, in turn, relies on American intellectual property, which the U.S. appears determined to keep out of Chinese hands. China’s semiconductor demand continues to surge beyond what it can supply itself; trade data show that in 2019, Beijing imported around $350 billion worth in chips.

Given that reliance, China’s central and local governments have been pumping money into the sector to accelerate domestic chip design and manufacturing. The country’s latest five-year economic planning document released in March identifies integrated circuits — semiconductors — as a priority sector for research and development funding.

When governments starts pumping big money into private companies, you can be sure multiple scams are never far behind.

The all-out approach has notched achievements. Successful chip design companies such as Cambricon and Huawei’s HiSilicon have allowed Huawei to replace some of its U.S.-designed chips in its mobile phones.

Cambricon and HiSilicon are both fabless design houses, and both get their chips fabbed at foundries like TSMC. Huawei is one of the largest electronics companies in the world, with over $100 billion in annual sales, and they don’t own their own fab.

Not far from Hongxin is Yangtze Memory Technologies Co. (YMTC), a partially state-owned company that plans to double its output of memory chips to overtake South Korea’s Samsung and SK Hynix, which currently dominate production.

Memory is a tough business. SK Hynix exists because Hyundai and LG (aka Lucky Goldstar), two huge Korean chaebols who hate each other only slightly less than rival Samsung, found the sledding too tough to go alone and had to combine their respective semiconductor operations to survive. Memory makes money hand-over-fist in boom times, but barely breaks even during busts. It’s less technically demanding than some other semiconductor segments, so China could conceivably make some headway there.

YMTC is a subsidiary of Tsinghua Unigroup, a wholly owned business unit of Tsinghua University. Hu Haifeng, Communist Party secretary of Tsinghua Holdings, is the son of Hu Jintao, former CCP General Secretary and President of the People’s Republic of China.

Hongxin sought to capitalize on this momentum. It rented a discreet office on the 25th floor of Wuhan’s Dongxihu district government headquarters.

“Cao” and his partners promised to pitch in 1.8 billion yuan ($276 million) in investment on top of 200 million yuan ($30.7 million) in starting funds from Dongxihu district.

Wuhan’s city government was, around the same time, also beginning construction on a cybersecurity park to provide office and residential space for technology businesses, and it was looking for a flagship company to anchor the complex. In 2018 and 2019, the city named Hongxin its most important “critical construction project” and the company began building its factory next door.

As early as late 2019, even while Hongxin was being lauded by Chinese media for securing an ASML machine, several Wuhan-based construction crews were scrambling to get paid for millions of dollars of work for Hongxin.

“Four months ago, [Hongxin’s] payments to us started to be short, and now we are missing 18 million yuan [$2.76 million],” one contractor, Lu Haitao told another, Wang Liyun in December 2019, according to phone recordings NPR obtained. Wang confirmed the authenticity of the recordings when reached by phone. Lu did not respond to several texts and calls from NPR. Wuhan’s municipal government did not respond to a request for comment.

Meanwhile, two other semiconductor companies — Tacoma Semiconductor Technology Co. Ltd. and Dehuai Semiconductor Technology Co. Ltd. — were also running out of cash.

Tacoma was over 350 miles from Hongxin along the Yangtze river, in the port city of Nanjing. There, the Taiwanese entrepreneur Joseph Lee had initially found a welcome harbor for his own ambitions, starting Tacoma in the city in 2015. He pledged to raise $3 billion to make wafer chips, with consultation from Israeli company Tower Semiconductor (formerly TowerJazz). Tower declined to comment for this story.

Lee continued pitching other local governments. In 2016, he co-founded a second company in Jiangsu province’s Huai’an city, named Dehuai Semiconductor. (Lee sold his stake the same year, citing a clash in vision with the firm’s other managers.)

In 2017, Lee invited Chinese media to tour Tacoma’s facilities, declaring the company had somehow scored 200 million yuan ($30.7 million) in sales. Tacoma had yet to even finish construction on its manufacturing facilities.

Lee initially agreed to an NPR interview for this story but later retracted it, citing state pressure. “Officials have told me not to talk to the media,” he said by text.

Yeah, I bet.

By 2018, Tacoma’s employees were blasting an online forum run by the Nanjing mayor’s office with complaints about unpaid salaries. Chinese corporate records show at least 50 legal complaints have been filed against Tacoma in provincial court, all seeking to recoup construction costs or unpaid wages. Lee disputes owing employees 20 million yuan in unpaid wages.

“Real or fake, the truth is in the hearts of the people,” Lee wrote shortly after these allegations, on Wechat, the Chinese messaging app, and cited a verse from the New Testament: “Now faith is the certainty of things hoped for, a proof of things not seen.”

Citing bible verse when rumbled for his scam. Classic.

Hongxin, Tacoma and Dehuai were able to secure billions of yuan in state funding on the condition they would match that with investment of their own — a commitment that never materialized. Tacoma eventually raised only a fraction — 250 million out of 2.5 billion yuan — of what it promised.

“We never imagined that when our cash flow dried up, we would not be able to find new [cash flow sources], that we would get in so deep,” he told Japanese broadcaster NHK this March.

And this is the problem with doing business in China in general: it’s shell games all the way down. At lot of times, loans and investments are siphoned through four or five different entities from the purposes for which they were originally obtained. Everyone’s trying to get rich, and they hope to survive on smoke and mirrors long enough to get profitable. Imagine if Kleiner Perkins invested $25 million in a software startup, only to find that money was spent on a noodle shop, a used car dealership and a golf club manufacturer.

Sometimes it works. You can build a company on margin, get profitable quickly, and be paying off investors and contractors before anyone realizes how shaky the entire enterprise is.

But you can’t do that with semiconductor manufacturing. The startup costs are simply too high, easily in the billions. Very, very few companies can afford to be in a game that expensive. China’s two biggest semiconductor manufacturing success stories, SMIC and Tsinghua Unigroup, all have have CCP direct government investment.

In this game, little hucksters working the margins have no chance.