China's Subsidized Silicon Strategy

The competitive threat to U.S. and European semiconductor firms is underestimated.

While the recent cyclical downturn experienced by semiconductor companies like Texas Instruments, ADI, Microchip, ON Semiconductor, and NXP exhibits characteristics of a typical cyclical slowdown, it also signals a deeper shift in the competitive landscape. Although there is ample attention to the growing long term competitive threat from China, the full magnitude of this challenge remains underestimated.

Backed by government subsidies and China’s debt-fueled industrial policy, Chinese semiconductor firms are aggressively expanding capacity, escalating competition while playing by a different set of rules. This subsidized competition distorts market dynamics, undercuts foreign firms through non-market pricing, and threatens U.S. and European companies.

The U.S. can no longer remain passive as Chinese firms gain ground through unfair competitive advantages. The Trump administration must continue advancing reciprocal policies to safeguard U.S. economic and corporate interests, including stronger trade enforcement and targeted investment incentives to counter China’s state-backed expansion.

Management teams that underestimate this threat do so at their peril. Across industries, Chinese firms have consistently exceeded expectations, leveraging aggressive pricing and steady product improvement to move up the value chain. In industrial, automotive, and consumer electronics, Chinese semiconductor suppliers don’t need components that outperform foreign competitors—being "good enough" is sufficient to gain market share as Chinese buyers align with national semiconductor industry goals.

Even as U.S. export restrictions limit China’s access to advanced semiconductor production equipment, Chinese companies are investing in mature manufacturing technology nodes, targeting analog, microcontroller, and power semiconductors, that are the backbone of the auto and industrial markets.

Quantifying the scale of China’s semiconductor capacity expansion and the risk of overcapacity is challenging due to gaps in data on fab output, utilization rates, and production yields. However, semiconductor equipment sales growth to China serve as a reliable proxy, indicating a production base expanding well beyond end-market growth.

This expansion persists despite weak global demand. The analog, microcontroller, and power semiconductor markets likely already suffer from overcapacity, even accounting for suppliers currently under-shipping relative to end-market demand. Rising on-balance-sheet inventories further signal supply-demand imbalances. Texas Instruments, an industry bellwether, saw inventory grow from $2.4 billion in Q3 2022 when the company’s quarterly revenue peaked to $4.5 billion by the end of 2024—equivalent to an increase from 133 days of sales to 241 days.

Across industries, China has consistently pursued national strategic goals, resulting in overcapacity and long-term industry disruption. Even if most of China’s semiconductor capacity remains domestically focused, its impact on global competition will be significant.

With China as the world’s largest semiconductor market, even a gradual displacement of foreign suppliers will erode China-sourced revenue for Western firms, triggering a ripple effect beyond China. As companies seek to offset lost revenue, competition will intensify, further pressuring market dynamics worldwide.

China Inc.’s Debt Driven Growth Model

China’s semiconductor industry is following a familiar pattern seen across its domestic industries: a debt-fueled, state-backed growth model where profitability and cash flow take a back seat to strategic objectives. China aggressive pursuit of self-sufficiency in semiconductors, is using state subsidies and strategic credit allocation to accelerate the expansion of domestic production, rapidly scale operations, and undercut foreign competitors.

The control of credit is critical to the Chinese Communist Party's (CCP) grip on the economy, with government-controlled non-bank financial firms, local government finance vehicles (LGFVs), and state-owned banks serving as the primary channels for policy-directed lending. Corporate credit growth is essential to sustaining China's economic growth, leading to an increasingly leveraged economy. Total corporate and LGFV debt is more than 170% of GDP, more than twice that of the U.S., with total debt (total social financing) to GDP reaching 303% in 2024.

China’s economic model systematically uses debt as a substitute for cash flow. This feature of China’s growth model has resulted in a continuous decline in the productivity of credit as a greater portion of loans are allocated to cover existing interest payments and uneconomic investment projects. Consequently, China requires an increasing amount of credit to generate a unit of GDP growth. Using China’s broader measure of credit, total social financing (TSF), the ratio of credit required to generate one unit of GDP has increased from 2.66 in 2017 to 5.52 in 2024.

The collapse of China's residential real estate market is a prime example highlighting the risks and fragility of its Ponzi scheme-like industry structures driven by debt fueled growth and speculative investment activity reliant on continuous credit expansion.

China's Semiconductor Sector: A Subsidy-Fueled Push

This growth model is now being applied in China’s semiconductor sector. Competition, in principle, is a catalyst for operational efficiency and product innovation. Yet, China's semiconductor industry is not competing under traditional market-based principles. Western firms face not only competition but also state-backed industrial policy, financing structures, and subsidies that distort fair competition.

While many players in China’s semiconductor industry are private, making it difficult to get a complete financial picture, the financial performance of publicly listed Semiconductor Manufacturing International Corporation (SMIC) offers some insight.

The implicit guarantee of government support allows SMIC and its Chinese peers to operate and gain share using anticompetitive and non-market means. SMIC’s financials differ drastically from those of U.S. peers or its Taiwanese counterpart, TSMC. While TSMC and U.S. firms are highly cash generative, SMIC continues to burn cash, driven by a capital expenditure binge aimed at meeting national strategic goals.

Over the past 5 years SMIC had an estimated US$14 billion in negative free cash flow, with its capital expenditures equivalent to approximately 100% of revenue during this period. In 2024 alone, SMIC’s capital expenditures were 2.3 times its depreciation expense. These metrics reflect an unsustainable level spending without government support.

SMIC’s gross margin of about 20% is also significantly lower than TSMC’s average gross margin of 55% over the past two years. While a heavy depreciation expense burden contributes to this, it also suggests that SMIC is aggressively pricing its services, lowering the cost for its customers that compete with foreign semiconductor players.

China’s domestic demand from industries like electric vehicles (EVs) further contributes to this distorted industry structure. Although EVs remains a critical auto semiconductor growth driver, this demand is propped up by an industry reliant on unprofitable players. While China leads in EV production, this growth is built on a weak financial foundation, with the majority of China's EV OEMs operating at a loss.

Enabling China's Semiconductor Ambitions

China’s push for semiconductor self-sufficiency has been supported by U.S., Japanese, and Dutch semiconductor equipment suppliers, which have significantly increased sales to the region. Before COVID, China accounted for around 30% of total sales for many of these companies, including a substantial share to non-Chinese semiconductor firms operating within China.

In recent years, however, this exposure grew to over 40% in some quarters, with the majority of sales now directed to Chinese companies. For instance, Applied Materials’ China sales reached $10.1 billion in FY24, up from $4.2 billion in FY19. In FY24, China revenue accounted for 37% of Applied Materials total sales, with China revenues above 40% on a quarterly basis in two of the four quarters. The implementation of export restrictions has tempered these figures but still leaves China as a critical market.

The Downturn and Chinese Competition

The analog, microcontroller, and power semiconductor markets have experienced a severe downturn and are now searching for a bottom and path to recovery. Company revenues have declined significantly, with quarterly peak-to-trough declines averaging over 30%. NXP sales has been relatively resilient, declining nearly 20%, while Microchip has suffered a 50%+ drop. Corporate margin trends also remain weak, reflect rising pressure from declining utilization rates, the unwinding of prior price increases, and likely intensifying price competition in China.

Leading analog, MCU, and power semiconductor firms have China sales exposure ranging from approximately 20% to 35%, but China’s importance extends beyond revenue share. Its rapid adoption of EVs and advance driver assistance systems has outperformed other regions, making it a key market for auto semiconductor growth.

While demand in China has been more resilient, this strength is relative to weaker regions and largely driven by strong demand from electric vehicles with high semiconductor content. However, this provides false reassurance, as China’s EV market is ripe for Chinese semiconductor suppliers to gain market share.

For example, BYD, China’s EV national champion, recently developed EV electrification system illustrates the company’s ongoing efforts to reduce its reliance on foreign suppliers. As China accounts for over 50% of global EV sales, its increased sourcing of domestic chips will reshape the automotive semiconductor landscape, forcing non-Chinese suppliers to more aggressively pursue other markets to offset lost revenue.

Simultaneously, Chinese auto OEMs continue to gain domestic market share, impacting foreign semiconductor suppliers that supply Western auto OEMs in China. Currently, Chinese-produced chips account for only an estimated 15% of domestic demand, indicating that Chinese suppliers’ market share gains are still in their early stages. As China’s self-sufficiency push advances, market share erosion for Western firms will only intensify.

Stock Valuations at Risk

A competitive shift is underway in the analog, microcontroller, and power semiconductor markets, yet some stock valuations fail to reflect this changing landscape. While there are signs of improved cyclical dynamics for select companies, the prospect of a strong, broad-based recovery in the near term remains muted. Rising Chinese competition further clouds the long-term outlook, with the risk of market share losses and pricing pressure threatening longer-term earnings estimates, potentially leading to a derating of some stocks as terminal value multiples compress.

Texas Instruments stands out as particularly vulnerable, trading at 34x 2025 earnings, a premium to the broader market. With rising competitive pressures and potential pricing headwinds, this valuation is increasingly difficult to justify.

Analog Devices remains the best-in-class among this group, yet even ADI in the long term is not immune to the evolving landscape. Trading at 31x forward earnings, its valuation premium is also at risk as Chinese competitors gradually advance in analog markets. NXP Semiconductor remains at risk due to its above-average China exposure, making it more susceptible to China competition.

ON Semiconductor is less well positioned to withstand this competitive shift. However, ON and Microchip—as the most fundamentally depressed U.S. names—could see a more significant snapback in their stock prices when demand improves. However, sustained competitive pressure from China will challenge their longer-term fundamentals.

U.S. Policy Response and Strategy

China plays by a different set of rules, often disregarding traditional market-based principles. The shifting competitive landscape in China’s semiconductor market and the growing threat to U.S. and European suppliers is part of a larger challenge that must be addressed. The Trump administration must stay on course with policies that incentivize domestic manufacturing and enforce local content requirements to build a more secure and resilient supply chain across industries.

Just as China pursues policies that favor its domestic companies, the U.S. can respond in kind, not through heavy-handed intervention, but with a more market-based approach that fosters stronger economic growth and greater innovation. Beyond semiconductor policy, the U.S. and EU must pursue a broad economic and trade policy agenda that creates and enforces a policy regime to prevent China from flooding global markets with excess production at artificially low prices. Without firm trade policies to counteract industrial overcapacity and predatory pricing, China’s ability to undercut U.S. and European firms will continue to threaten U.S. industries.