Biden’s decree wipes out lucrative investments in China’s chip and artificial intelligence sectors

Biden's decree wipes out lucrative investments in China's chip and artificial intelligence sectors

China’s largest chip foundry, a key piece of the puzzle in Beijing’s efforts to achieve greater self-sufficiency in semiconductors, likely would not have been able to set up its first factory on the outskirts of Shanghai in the early 2000s without funding from the United States. United. Investors such as Walden International and Goldman Sachs.

Semiconductor Manufacturing International Corp (SMIC) is just one of many Chinese companies to receive US venture capital funding from investors looking for extraordinary returns from China’s economic take-off, and is a bold example of the marriage of homegrown technological ambition and US venture funds.

However, amid rising geopolitical tensions between the world’s two largest economies and the implementation of stringent restrictions on US investment, prospects for such cooperation in the future have dimmed, dealing a direct blow to China’s ambitions to become a global power in artificial intelligence. Industry insiders and analysts say the withdrawal of financial backing and technical expertise would be a game changer.

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“The damage is being done in the sense that a lot of people are going to be afraid of the Chinese market,” said Ben Harburg, managing partner at MSA Capital, a Beijing-based venture capital fund. “We will avoid sectors that we believe are at risk or may fall under current or future US sanctions,” Harburg said in a recent interview with The Washington Post.

MSA Capital manages US dollar funds with capital from sovereign wealth funds, international asset managers and pension funds, as well as Chinese entrepreneurs.

And with more investors like MSA Capital trying to dodge the sanctions bullet, backers of these funds will also have to rethink their strategies in China in light of the increasing geopolitical acrimony.

Elton Jiang, a founding partner at Shanghai-based Genilink Capital that backs chip startup Black Sesame Technologies, among others, said US investors would not only stop investing money in certain sectors, but might also abandon companies in existing portfolios. to comply with the new restrictions.

Jiang added that the biggest disadvantage caused by the new investment restrictions will be the deterrent factor for potential investors in China.

While US dollar limited partners (LPs)—investors who back investment funds without participating in day-to-day management—come from all over the world, including America, the Middle East, and Southeast Asia, “historically, limited partners from the US account have “The investment restrictions will make the limited companies think again about allocating any money to China.”

In August, the Biden administration unveiled an executive order aimed at restricting venture capital and US private equity investments in Chinese companies involved in semiconductors, microelectronics, quantum technologies, and artificial intelligence systems.

Washington’s move to scrutinize overseas investments came as US venture capital funds were already drying up in the Chinese market, according to analysts at the independent market research firm Rhodium Group. Its data shows that US support for startups in China fell to a 10-year low last year to $1.27 billion, a significant drop from a peak of $14.4 billion in 2018.

While the global investment community had largely expected tougher restrictions, practitioners said the announcement was the final nail in the coffin for investment in sanctioned sectors.

Some of the largest limited liability companies – such as private equity pension funds – have now completely pulled out of new investment in China, said Kaede Zhao, an analyst at investment data service Pitchbook.

A recent report from investment research firm Brecken showed that China-focused venture capital funds raised $2.7 billion in the April-June period, a drop of 54.2% from the previous quarter. Meanwhile, for sectors such as semiconductors, funding has long been migrating to local yuan funds, according to local industry experts.

The Chinese founder of the memory controller chip designer, who asked not to be identified due to the sensitivity of the matter, told the newspaper upon returning from a fundraising trip that several small Chinese chip startups aim to provide financial support to the state. Companies when their products are ready or going public on the mainland’s tech-heavy STAR market. In this case, he added, “taking American money would send a bad signal either way.”

An AI chip from Tongfu Microelectronics is shown during the World Semiconductor Congress in Nanjing, east China’s Jiangsu Province on July 19, 2023. Photo: AFP alt= An AI chip from Tongfu Microelectronics is displayed during the World Semiconductor Congress in Nanjing, east China’s Jiangsu Province at July 19, 2023. Photo: AFP>

This comment mirrors remarks made at the 2023 China Semiconductor Equipment Annual Conference (CSEAC) earlier this month, where an investor from venture capital fund Fountain Bridge Capital said they had long separated U.S. money from yuan money for the purposes of Investment in China’s semiconductor industry, with the latter currently the only way to invest in this sector.

The semiconductor sector has always represented a special case, as it enjoys long investment prospects and high risks due to the weight of its assets.

The sector was being shunned by private funds until China’s drive for self-sufficiency intensified due to rising tensions with Washington. Several Chinese private equity and venture capital funds were seen hounding CSEAC executives to talk about investment opportunities.

Until now, the state-backed China Integrated Circuit Industry Investment Fund, also known as the Big Fund, has been the main vehicle for the Chinese government to inject money into the chip sector. The first phase of the fund raised 19.7 billion US dollars, while the second phase raised about 30 billion US dollars, and it has made several bets on Chinese semiconductor companies since its inception in September 2014.

It is difficult to estimate the total support package offered by Beijing and local governments to the domestic chip industry, as many forms of grants are not necessarily given in cash.

The founder of the memory control chip said that the city government of Zhengzhou, the capital of central Henan Province, wants to have a role in the game by providing cheap plots of land, factory facilities and even by paying for some equipment rather than through direct investments, as is the case with some of its companies. . Financial instruments have been affected by the unstable economy in China.

However, for some industry practitioners, yuan domestic financing can never make up for the loss of US dollar funds, which usually have a long investment maturity period and high risk tolerance.

One Shanghai-based investor, who also asked not to be identified due to the sensitivity of the matter, said the strength of US dollar funds lies in their ability to support high-risk projects, which distinguishes them from many yuan funds that take money from the so-called government. Routing funds, which are usually more risk averse. The investor added that local currency funds are less likely to invest in early projects without income.

In a recent roundtable discussion, Duan Kuang Zipeng, co-founder and managing partner of China-based Keming Venture Partners, said that US dollar funds favor risky projects that have the potential to generate large returns.

“Using GPUs as an example, RMB money will not bet on GPU projects until the world’s first running GPU (its potential) is validated,” Kuang said in an interview with Yang Xiaoli, CEO of Domestic Investment. Intelligence Service China Venture, according to An condition published by the company.

Kuang also said that despite the current ChatGPT craze in China — which has seen local companies rush to compete with OpenAI’s innovative AI product, RMB money would never have supported a research lab like OpenAI in the first place. He said this is because the yuan’s money will not take risks if the development pattern and growth path are not already clear.

With much tighter restrictions on investment in the US now in place, this poses a particular problem for those Chinese start-ups looking to replicate or exceed the success of OpenAI with their ChatGPT chatbot, which can provide human-like responses to user questions.

The Shanghai-based investor said that although the hype surrounding China’s generative AI sector is still gathering steam, there are fundamental hurdles to turning a potential ChatGPT competitor into a profitable business.

The latest batch of Chinese AI giants, such as SenseTime and Megvii, have enjoyed a large share of revenue coming from government requests or subsidies. But the Chinese government hasn’t shown equal love for the generative AI sector, which will also be subject to the country’s strict internet censorship regime.

So far, all home-grown AI chatbots are still in the public testing phase, and no company has been given the green light to go public on a commercial basis.

On the business side, companies have been beta-testing their AI robots in traditional industries to improve efficiency and reduce costs. But the financial condition has not yet been established.

iFlyTek, a Chinese AI company that said it surpassed OpenAI’s ChatGPT capability in October, saw its net income drop 74 percent in the first half from a year earlier. The revenue drop came months after the company, which is based in Anhui Province, Hefei Province, launched its ChatGPT-like SparkDesk bot in early May, touting its integration into a wide range of traditional industries.

Baidu, which unveiled its Ernie bot earlier this year, had a strong second quarter with revenue growing 15 per cent, but financial details of its generative AI efforts are scant.

Co-founder, Chairman and CEO Robin Li Yanhong said at the earnings conference that generative AI “has tremendous transformative power in many industries, providing a huge market opportunity” for the company, without disclosing how much revenue it generated from the service.

Despite the uncertain financial conditions, generative AI remains a hot sector for investors.

“The leaders in AI are mainly in China and the US…that’s where technologies are mostly created and the leading companies will be,” said Jeffrey Towson, partner at research firm TechMoat Consulting. “There is a lot of capital in the world. But there are only two big AI centers.”

But as the geopolitical storm continues to draw American investors into China, it seems increasingly likely that they will turn away.

Longtime SMIC investor Walden International saw the foundry delisted from the New York Stock Exchange in 2019 after 15 years of trading, and went public in Shanghai the following year.

The big fund and domestic companies such as Datang Telecom Technology as well as China Information and Communication Technology Group, among other state-owned companies, have since emerged as some of SMIC’s biggest backers, according to the company’s latest annual report.

Meanwhile, the San Francisco-based company has just received a letter from the House Select Committee on the Communist Party of China expressing “grave concern” and investigating its investments in Chinese tech start-ups.

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