The semiconductor industry is more dependent than most on free trade and open markets. Alexander Foltin, Treasurer at European chip maker Infineon, talks about his treasury priorities and how the industry thrives on a mix of cooperation and competition.
Semiconductors, the brains of all modern electronics from cars and phones to new technology like the IofT and strategic 5G networks, have rarely seen such demand. Yet surging demand, accelerated by the pandemic’s impact on digitisation trends, comes against the backdrop of the industry’s vulnerability to geopolitical risk, also on the rise. US/China tension has led to the US restricting Chinese companies’ ability to access foreign-built chips – when the US cracked down on Huawei in 2019, share prices in all the big chipmakers plunged. Elsewhere, the push to re-shore manufacturing in the US and Europe shows how geopolitics can muddy complex supply chains based around outsourced manufacturing capabilities to key factories or foundries in Taiwan and South Korea. When it comes to trade skirmishes, the industry that makes the tiny components essential to our digital lives and modern economies holds all the ingredients of a key battleground.
“Protectionism is the very opposite of what we at Infineon advocate,” says Alexander Foltin, Group Treasurer and Head of Investor Relations of German chip manufacturer Infineon, where navigating tight supply from contract manufacturers like Taiwan’s TSMC under its outsourced model alongside its own in-house manufacturing increasingly influences treasury strategy. “We favour a globalised industry with open markets, a level playing field of fair and free global trade.”
Semiconductors are particularly vulnerable to protectionism, explains Foltin, who oversees a highly centralised treasury, created from scratch when Infineon was carved out of Siemens 21 years ago. A complex manufacturing chain of specialist clusters (plus chips’ high value to weight ratio) mean chips are flown around the world with processes and value added on route before they wind up in an end device.
European manufacturers’ strength lies in areas like power semiconductors, security and sensor technology but also in manufacturing high-end wafer equipment, while in Asia and the US key competences are in leading-edge processors, memory components and electronic design tools. Today’s market thrives under co-opetition, the mix of cooperation and competition whereby companies share a common technology pool of opensource chip architecture, and standard and software agreements are interoperable for common benefit.
Liquidity
Keeping up with the competition and ensuring his treasury always has enough on hand to finance growth has put liquidity centre stage. “We have to be able to find the financial means of supporting our growth track,” says Foltin. “We would never bring cash down to bare operating levels. We want to have the financial freedom, especially through cycles and down phases, to proactively invest.” A reassuring nod to his belief that a certain portion of today’s tight supply is cyclical. The industry only tipped from a scarcity of demand to today’s scarcity of supply in less than 12 months, he says. “It was only a year ago that several semiconductor markets took a nose-dive.”
Infineon is increasingly discussing ways to make supply more resilient by sharing risks with its customers in the automotive and other industries. In part, this mirrors a trend already visible amongst Infineon’s own contract manufacturers, the first to ask for down payments from customers like Infineon. “There is an interest from foundries to share risk with their customers.”
Now Infineon is asking customers to commit ahead rather than rely on just-in-time delivery strategies based on their own fluctuations in demand. “We have capacity reservation agreements that we offer our customers,” he says, explaining that treasury is an integral part of these negotiations, brokering the deals, checking on the risk and most of all safeguarding the liquidity position. “If customers want to ensure against the risk of a lack of capacity, they can make capacity reservations and thus share the economic risks.”
Conversations with customers “aren’t easy,” but he says concerns around certainty of supply makes them constructive. “Delivery capability certainly has a value,” he explains. “If you are selling a US$40-50,000 car, to have a €4-5 component missing is frustrating. The most expensive chip is the one that halts your production.” The long lead times in chip production also means companies can’t make up the shortfall quickly. Production normally takes 12-14 weeks, but that becomes six-12 months if the firm needs to procure new machinery, assuming there is cleanroom space available. “Building new facilities is a multi-year endeavour,” he says. “In this sense, there is a certain understanding that burden sharing needs to be done.”
Although trade finance is low risk and short-term, profits are low making scale important – difficult against the backdrop of dimmed growth.
Gianluca Romeo, Director, Banks, EMEA, Fitch Ratings
Credit rating
Against the backdrop of tight supply and uncertain geopolitics, his other treasury failsafe is easy access to the financial markets and a strong investment grade credit rating. Arranging the financing for the company’s 2019 €9bn purchase of US rival Cypress Semiconductor proved its worth.
Financing came via a final mix of one third equity and two thirds debt spanning two straight capital raises, a hybrid bond placement, a jumbo euro bond and one US private placement in a strategy carefully choreographed to keep the rating agency (S&P Global) happy, despite the unprecedented size of the deal – half of Infineon’s market cap. “We spent a lot of time with the rating agency upfront, presenting financing scenarios to ensure our target equity debt mix would safeguard the company as investment grade.”
Although the rating slipped from BBB flat to BBB – when the deal closed, it was still investment grade. Since then, S&P has bestowed a positive outlook on the company, indicating a road to a potential return to BBB flat. This has ensured the door was always left open to the right kind of investors at the right price, he says. “If you are sub investment grade you run the risk of markets being closed or unavailable. We have funded ourselves up to 2033.” It also meant the company could access the ECB’s bond buying programme, set up to support investment grade companies with stable funding through the pandemic.
The process also marked another coming of age in today’s volatile and challenging semiconductor market. Prior to the Cypress deal, Infineon didn’t have an established set of core banks providing an RCF. In a quid pro quo, the group of banks advising on the deal committed funding lines in return for the M&A advisory mandate. “They had to chip in and put their money where their mouth was, guaranteeing to underwrite the initial transaction,” he said.
Since then, the company has syndicated out to 20 national and global institutions, initially providing committed financing across a short-term bridge facility as well as term loans out to 2024. Take-out transactions were all allocated competitively. “Normally you have initial underwriters who take the largest piece of cake, then financing is pre-allocated according to ticket sizes in the syndication,” he explains. “Following the syndication, we had all our banks on an equal footing so that whenever a refinancing came up, they could compete equally.” Although the process is more laborious for banks and treasury, it assures Infineon gets “the best service” from “highly motivated banks,” giving them a chance to “prove their worth.”
It’s just the kind of competitive, level playing field that plays to banks’ individual strengths that he wants in the global chip market. And one of the reasons he questions if investing billions in more manufacturing capabilities in Europe to reduce dependency on highly skilled Asian contract manufacturers would ultimately benefit. The EU has earmarked a portion of its €750bn COVID-19 recovery fund to strengthen Europe’s semiconductor design and manufacturing capabilities. Elsewhere Bosch recently received €140m in European subsidies for its new €1bn semiconductor factory. In the US, leading the re-shoring drive, plans to beef up the domestic industry have been enshrined into a new bill “Creating Helpful Incentives to Produce Semiconductors for America Act,” or CHIPS outlining plans to create a US$10bn federal grant, investment tax credits and a variety of research and development funds. Yet Foltin isn’t convinced that getting into a spending race is viable, questioning if the EU can match government incentives elsewhere. “We welcome support for a road map for the European industry, but we need sensible, intermediate steps on route to getting there.” In the meantime, it makes the arguments for free trade even more compelling.
Flip side
Semiconductors is one industry particularly vulnerable to souring US/China relations. But the flip side of a tougher US stance on China is better US/EU trade terms, an entente recently evident at the G7 gathering in Cornwall. For example, the US and EU have just announced a five-year truce on aircraft subsidies to Airbus and Boeing which has led to billions of tariffs on their respective exports over the last 17 years. The reason, says Robert Silverman, a partner at New York law firm GDLSK which specialises in international trade and customs, reflects the new administration’s effort to work more closely with its key trading partners. It also reflects a united response to the emergence of China’s Commercial Aircraft Corp (Comac), a competitor to the two plane makers.
Elsewhere, he notes a pause in the threat from European countries to impose digital taxes on US tech giants and less talk of reciprocal US threats of duties on European products. “The current administration wants to be on better trade terms with the EU,” he says, adding that duties on steel products into the US from the EU imposed under Section 232 are also likely to be softened.
In contrast, Chinese companies importing into the US remain out in the cold, particularly vulnerable to anti-dumping duties. He estimates around two thirds of all products from China into the US are subject to 301 tariffs which are either 7.5% or 25% (depending on the commodity) and will stay in place for a while yet. “Democrats and Republicans have divergent views on many issues, but everyone wants to be tough on China,” he says. All the while China is forming its own alliances through the BRI and, more recently, via the 2020 extended Regional Comprehensive Economic Partnership, widened to include an additional ten countries but not the US or EU. “This is a sign that points to the potential increase in tensions between the US and China,” warns Gianluca Romeo, Director, Banks, EMEA at Fitch Ratings.
In a ripple effect, Silverman says he notices more companies shifting their supply chain from China to reduce the assessment of duties. “We are seeing some movement to some of the European countries where it is less expensive to manufacture products like Poland or Turkey. But it has to be done the right way to make sure you are not still subject to additional China duties,” he says. “The pandemic hasn’t dimmed the number of US custom audits and penalty cases, and potentially high duty rate items are at the top of the list.”
In another trend, companies are looking more closely at their tariff classifications under harmonised tariff schedules. “Tariff provision ‘A’ might be subject to additional duties, or dumping duties, and tariff provision ‘B’ may not,” he explains. “Companies are taking time to ensure that a product is being classified in the right way.” US Customs is also on the lookout for items where duties have been avoided because of misclassification. He also notes about the possibility of valuation reductions. Most duties in the US are set at a percentage of dutiable value resulting in companies increasingly trying to lower their dutiable value. “If an importer buys from a trading company who then buys from a factory, the factory price is usually lower than the trading company price. In the US, if the transactions are set up the right way, dutiable value can be based on the factory price not the trading company price,” he says, explaining that furniture imports from China are a good example of this process in action. Duty-free up until 2018, they are now subject to a 25% rate. “Furniture importers didn’t care what the customs value was because there was no duty. Now they want to lower the dutiable value – 25% of a smaller number is less duty.”
Mind the gap
Protectionism and its impact on global trade is also one of the culprits behind crimped availability of trade finance. In 2020 a raft of important trade finance banks including ING and Natixis exited or reduced their trade finance offering. And although other players are filling the gap created by their exit, Fitch’s Romeo says demand still exceeds supply. “The free space resulting from banks exiting the market isn’t being absorbed. The consequence is reduced access to trade finance especially for SMEs; large corporates remain a target for trade finance banks.” Although trade finance is low risk and short-term, profits are low making scale important – difficult against the backdrop of dimmed growth, he says. “Protectionism is a major risk for banks with trade finance programmes. It is a main driver for banks deciding to expand their business – or disengage.”
Labour
Of course, protectionism isn’t just a consequence of souring US China relations. Witness how labour unions recently complained that Mexico breached USMCA (the free trade agreement between Canada, Mexico and the US that replaced NAFTA) over labour rights in its manufacturing processes. Protectionism also includes sanctions. Russia and Iran, which together account for a large slice of the global population, are both excluded from free trade agreements. Elsewhere, protectionism is a consequence of nationalism. Brexit jettisoned bilateral agreements and has led to new duties and costly customs paperwork for fraught UK companies exporting to Northern Ireland – within their own country. The global and freewheeling semiconductor industry is both particularly vulnerable to protectionism, and because of its strategic importance, in danger of feeling its wrath. Any change to the backdrop of free trade and open boarders that have allowed the industry to flourish would be detrimental. “When you reduce protectionism you have GDP gains, less corruption and improved competition,” concludes Romeo.
