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Introduction
China’s growth in the past two decades has been impressive. Economic growth seemed like it would never end, and American semiconductor companies grew along with China’s tech-hungry economy, leaving these companies heavily exposed to China.
Unfortunately, growth in China is coming to an end. At least for the foreseeable future. I firmly believe China is on the brink of a massive economic recession if it is not already, leaving semiconductor companies with heavy exposure to China with grave risks.
China is in a messy situation involving real estate. Years of leverage and greed in the name of growth are starting to show signs of cracks. A perfect storm is forming, which will likely be powerful enough to engulf not only the Chinese economy but also American semiconductor companies relying on China’s growth. Therefore, I believe Qualcomm (NASDAQ:QCOM), one of the most heavily exposed American semiconductor companies to China, is a sell in a storm beyond the company’s control.
Qualcomm and China
Qualcomm is one of the companies that are most exposed to China. As such, a massive economic slowdown in China will lead to problems.
Qualcomm, as the management team said, has “a significant portion of [the] business [that] is concentrated in China.” In 2021, Qualcomm reported full-year revenue of $33.5 billion, but $22.5 billion came from China, representing about 67.4% of total revenue exposed to China.
Further, Qualcomm has estimated that there were about 7 billion 3G/4G/5G connections globally as of September 2021, and by 2025, Qualcomm estimates the connections to increase 20% to 8.4 billion. This information was given to investors to show the growth potential of the company; however, the growth rate of mobile connections is heavily reliant on China. About 86% of the new connections are expected to come only from China, meaning that any meaningful slowdown in the Chinese economy may alter Qualcomm’s growth goals as it is likely for the Chinese consumers to cut back on spending in times of economic hardship. Compounding from this risk, there are already more active smartphones than people in China. In times of economic weakness, consumers can easily hold back their new smartphone purchase. Therefore, slowdown in China will be catastrophic for Qualcomm.
China’s Economic Problem
China has a serious economic problem, and real estate is at the root of all the problems. For past decades, real estate in China only rose, which played a critical part in creating two unique cultures.
One, Chinese people religiously believed that real estate investment is not only safe but necessary in their lives, leading about 70% of the household wealth to be tied up in the real estate asset. Further, because people bought houses thinking that the price will only go up, about a fifth of all houses in China are empty. Investors simply believed that real estate was a good investment even if their property was vacant. In fact, some properties are completely vacant, leaving ghost towns and cities. Thus, the obsession and belief in real estate have created an extreme housing oversupply.
Two, because real estate only rose for years, pre-sale, buying a property before the developer finishes building it, became immensely popular. For example, if a household has to wait 2 more years for the developer to complete the apartment, the price of that real estate would most likely be more expensive, so the households wishing to purchase real estate would purchase houses that have not even been built yet. Developers, on the other hand, used the fund from selling pre-sale homes to not finish that particular project but start numerous other projects to collect more pre-sale funds. Using this leverage, developers relied on continuous pre-sale funds to grow and finish existing projects. The Ponzi scheme-like actions were tolerated as the belief in real estate was strong, which grew the bubble in the market.
For years, a single factor has been supporting this massive real estate bubble: trust. However, trust in the real estate market is finally deteriorating because over-leveraged Evergrande and numerous other developers failed to leave all pre-sale customers with halted real estate projects, economic growth is slowing, geopolitical tensions are choking trade, and zero-Covid policy is pressuring economic stability. Thus, a single factor that has been supporting and growing the real estate market is deteriorating leaving over-leveraged real estate developers unable to sell more pre-sales, leading to a significant number of housing projects being halted. Ponzi scheme only works well if there is continuously increasing demand for its product. As such, today, it is estimated that at least 91 cities are seeing households boycotting mortgage payments on a housing project that is not being completed in time spreading the real estate risk to not only households and developers but to banks and companies that are tied to real estate development including raw materials and industrial equipment companies.
The economic risks do not end here. Local governments rely on land sales for about 30% of their income since you can only lease land from the government in China. As such, local governments are struggling as well. Up until 2015, China did not allow the local governments to bond financing, which created about $7 trillion in off-balance sheet debt. For years, China has been growing on debt, and the current slowdown in its economy is finally putting a brake on debt-driven growth.
It’s Not Only Qualcomm
Although I believe risks in China create the biggest hurdles for Qualcomm, other U.S. semiconductor companies such as Micron (MU), AMD (AMD), Nvidia (NVDA), and Texas Instruments (TXN) are exposed to risks from China as well. China consumes 60% of the world’s semiconductors. The slowdown in this massive economy will certainly have repercussions. Further, the slowdown in China’s economy can create a chain reaction causing other foreign economies to slow down. Thus, the above semiconductor companies should be avoided until the dust settles. There is nothing these companies can do. Why risk investing in times of potential trouble?
Summary
Qualcomm’s execution and performance do not matter. No matter the innovation, risks are beyond the company’s control. Qualcomm is heavily exposed to China and relies on China’s growth for its own. However, the Chinese economy may be entering a recession due to the real estate bubble. A perfect storm is forming, and I believe it is wiser for investors to seek shelter until the storm winds down. Therefore, Semiconductor companies should be avoided, especially Qualcomm.
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