BEIJING -- Chinese chip concern Semiconductor Manufacturing International ( SMI) announced a resumption of hostilities with arch-rival Taiwan Semiconductor ( TSM) on Wednesday, disputing charges that it spilled trade secrets. Semiconductor Manufacturing International (SMIC) also launched its own legal claim in response to the lawsuit that Taiwan Semiconductor (TSMC) filed against it two weeks ago. In a statement sure to raise hackles in Taiwan, SMIC said it will tell a California court why its "leading role in mainland China poses a substantial threat to competitors like
TSMC ." In reality SMIC looks somewhat less than fearsome. The money-losing company has seen its shares drift steadily downward ever since it went public two and a half years ago, losing more than half their value in that time. Shares in New York closed Thursday at $6.67 vs. a close of $15.52 on its first day of trading in March 2004. The latest round of tit-for-tatting highlights SMIC's ambitions -- and its role as a thorn in the side of TSMC. Six-year-old SMIC has devoted itself to grabbing share from the two top Taiwanese companies that dominate the foundry business: TSMC and United Microelectronics ( UMC). Foundries outsource chipmaking for semiconductor companies, many of which have left the chip manufacturing business because of the multibillion-dollar investment it requires. SMIC's longstanding fight with TSMC got under way in 2003, when the Taiwanese foundry accused SMIC of patent infringement and theft of trade secrets. The matter dragged on until January 2005 when SMIC agreed to pay $175 million over six years to settle.
But the dispute revived again in late August. TSMC filed a lawsuit in California that accused SMIC of misappropriating trade secrets and breaking the 2005 agreement. In the countersuit announced Wednesday, SMIC griped that TSMC "did not voice any complaint for a period of over 17 months, until July 2006, after SMIC succeeded in meeting a number of major business and technical milestones." J.H. Tzeng, public relations manager for Taiwan Semi responds: "TSMC's legal actions against SMIC have been aimed at protecting our intellectual property and protecting shareholder value as well and for no other reason." Tzeng says the company is currently reviewing and analyzing SMIC's latest filing. This week, analysts brushed off the short-term implications of the dueling lawsuits, pointing out that SMIC shares haven't lost any more ground on the news. "Near term, I think
the lawsuits will have no impact," says Pranab Kumar Sarmah, a Hong Kong-based analyst at Daiwa Institute of Research. But the more interesting long-term question is, could SMIC conceivably pose a future threat to the industry leaders? Headed by 20-year Texas Instruments ( TXN) veteran Richard Chang, SMIC is one of a breed of Chinese companies hoping to secure a place in the ranks of global tech leaders. In 2004, it raised $1.7 billion in separate listings on the New York and Hong Kong stock exchanges. At the time of the IPO, money managers and other tech analysts were skeptical about SMIC's prospects , pointing out that TSMC in particular had a major head start in key technologies.
While it still lags industry leaders, last year SMIC unveiled China's first 12-inch fab at a site in Beijing. (The choice of location is something less than ideal, since fabs depend on ultra-clean conditions, and China's capital is notorious for dust storms that sweep in from the Gobi Desert. SMIC acknowledged in an SEC filing it may have to spend extra cash figuring out how to seal out the ambient dirt.) In any case, SMIC has managed to secure respectable share of the global foundry market -- around 6.4% last year, according to Gartner Dataquest -- after only four years of operation, ranking it in third place worldwide. Its annual sales grew 20% to $1.2 billion in 2005, compared with 7% growth at TSMC. Granted, with revenue of $8.1 billion and market share of 44.8%, the Taiwanese company easily clinches the global lead. But SMIC has also lined up big-name customers such as Broadcom ( BRCM) and Texas Instruments. Its employee rolls have surged from 122 in 2000 to over 9,000 last year. SMIC is also spending heavily to build and expand its chipmaking fabs. The company expects to follow its $903 million capital expenditures in 2005 with another $1.1 billion in spending this year. For investors, the downside of all that capex spending is that heavy depreciation has weighed on profits. SMIC posted a $112 million loss in 2005.
Most Wall Street analysts are steering clear of the shares for now. "I don't see too much in the way of near-term positives. Investors need to see sustained profitability before they become excited about it again," said one analyst in Hong Kong. But others are more sanguine. Daiwa's Sarmah has an outperform rating on SMIC. "I'm expecting them in 2007 to turn a profit," he says. One of the main reasons is that the depreciation burden will start to decrease. Another point in SMIC's favor, he adds, is its low valuation. SMIC has traded at an average enterprise value to EBITDA ratio of 6.2 times since it listed in March 2004. Investors assign a much higher premium to TSMC, which has a historical average EV/EBITDA of 10 times over the past five years. That valuation gap spells out just how little Wall Street expects from SMIC, which looks like a long shot to get anywhere against powerhouse TSMC. That said, SMIC is nothing if not ambitious. A few years out, it's likely to be a test case for whether China's technology upstarts manage to live up to their promise.