Semiconductor companies caught in the middle of a U.S.-China trade war want to avoid taking sides in a political battle, but the longer the schism lasts, the more it will weigh on the outlook of companies like Intel Corp. and Qualcomm Inc., analysts said.

As the two countries negotiate in hopes of heading off tariff increases that could resume in March, U.S. companies want to see the loosening of restrictions on doing business in China as well as better protections for intellectual property. In addition to stopping tariffs, a new trade resolution could lead to a concurrent loosening of policies on the import and export of semiconductor technologies, which would be beneficial to the industry.

While semiconductor companies only started feeling the impact of the tariffs around the fourth quarter of 2018, the chip industry has experienced rising tensions between the U.S. and China for years, with the U.S. government accusing both the Chinese government and specific Chinese companies of unfair trade practices. U.S. government officials have specifically targeted Chinese chipmakers Huawei Technologies Co. Ltd. and ZTE Corp. for alleged violations of trade bans and theft of intellectual property. The U.S. also has criticized China's massive investment in its domestic semiconductor industry, saying the effort keeps Chinese semiconductor prices artificially low and impacts prices across the global supply chain.

Market matters

Semiconductors are important because they stand to play a major role in helping countries transition to more advanced economies in the digital age, said Dan Hutcheson, CEO of VLSI Research. For example, chips enable artificial intelligence, 5G, electrification of automobiles and automation in the industrial sector.

The trade barriers enacted last year have created uncertainty in the semiconductor market and adjacent sectors, which is not good at any level, Hutcheson said, adding that the trade issues have sapped the economic outlook for China, a big market for U.S. chipmakers.

"Chipmakers don't want to be getting into a political debate. They don't want to be taking sides between U.S. or China. Eliminating the uncertainty at one level would be one of the best things to do." Hutcheson said.

Factoring in tariffs and other issues, VLSI Research is projecting total semiconductor sales to drop to $481 billion in 2019 from $486 billion in 2018.

From design through the manufacturing process, chips typically cross borders multiple times before reaching a finished product. Semiconductors are fabricated mostly in countries like the U.S., Taiwan or South Korea, and in a majority of cases, ultimately pass through China, which is the largest packager of chips and devices.

"Something like 60% to 70% of integrated circuits end up in China before they get assembled into products," Hutcheson said. "We're talking about a huge disruption in the supply chain."

The tariffs on semiconductors seems to be having the intended effect on the U.S. and China, according to data analysis from Panjiva, a division of S&P Global. China's gross trade of semiconductors, including imports and exports, recorded a 12.5% drop in December 2018 versus a year earlier. That compared to a rise of 14.8% in the past three months and 2018 growth of 21.2%. U.S. semiconductor imports from China fell by 38.7% in October 2018 compared to the same month in the previous year, Panjiva found. That followed a 44.3% jump in the previous three months as suppliers ramped up purchases to beat the announced U.S. tariffs.

Trade talks

To some extent, the trade negotiations could be an opportunity to clear up some long-standing issues. Even before tariffs, it was difficult for U.S. chip and data center companies to do business in China. Advanced Micro Devices Inc., Qualcomm, Hewlett Packard Enterprise Co. and others all entered joint ventures to conduct business, with a Chinese entity owning a majority in the domestic entity.

"That's how China gets the expertise in building servers or chips that they wouldn't otherwise. The tax is you need to give them your intellectual property," said Jack Gold, principal analyst at J. Gold Associates.

The trade negotiations also could lead to an easing of some ownership and intellectual property-related issues, Gold said.

China has years of catching up to do with the U.S. on technology, and the trade war could harden its resolve to pursue its own microprocessors and components, said Dan Olds, partner at OrionX, a technology consulting firm.

China still relies heavily on outside technology, and resolving outstanding trade issues with the U.S. will be a tricky negotiation, Olds said. Removal of trade issues could resolve economic issues and help China advance faster in areas like chip manufacturing, where it is behind the U.S. and other countries. But China is advancing quickly in other aspects on semiconductors, having made some of the world's fastest supercomputers.

"China has been working for years to come up with their own CPUs, compute accelerators, and other tech in order to end their reliance on western companies for these products," Olds said.

This is the second article in a two-part series on the impact of trade tensions between the U.S. and China on the semiconductor market. Read part one here.