IT Spending Growth Persisted Despite Tumultuous U.S.-China Trade Risks

The U.S. has long alleged China's unfair trade practices concerning technology transfer and intellectual property (IP) theft is threatening U.S. businesses and workers domestically and abroad. The trade tension simmered to a boil under President Trump in 2018 with tariffs imposed on many imported goods from China. Both countries responded with retaliatory tariffs, export trade restrictions, and regulatory scrutiny on cross-border mergers and acquisitions (M&As) that are still ongoing.

During the tumultuous eight years (2017-2024) that saw trade skirmishes dominate headlines and require businesses to swiftly adapt to new business rules and practices, global IT spending grew to $3.23 trillion in 2023 from $2.1 trillion in 2017, (about a 7% compound annual growth rate) according to research and consulting firm Gartner. This period also included the unexpected and highly disruptive COVID-19 global pandemic that significantly affected supply chains and price behaviors. It speaks to the growing importance of the tech sector to the global economy.

Worsening Trade Tensions Could Hamper Tech Growth

However, the global pandemic and trade tension with China also highlighted the global tech sector's vulnerabilities, most notably its reliance on China as a significant tech consumer and as a factory for the world for increasingly higher value-added products such as semiconductors and electric vehicles.

U.S.-based semiconductor manufacturing capacity was about 12% of total global capacity in 2023, down from 37% in 1990, according to the Semiconductor Industry Association. U.S. chipmakers fare worse in advanced chip manufacturing, which is dominated by Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), which has an estimated over 90% market share and about 80%-90% of its manufacturing based in Taiwan.

Despite TSMC's plans for new fab buildouts in the U.S., Europe, and Japan, S&P Global Ratings believes the high concentration of the advanced chip supply-chain will remain a risk for years to come. In addition, China currently represents about 11% of global IT spending and over 20% of global semiconductor spending, both growing figures that underestimate the country's influence if including manufacturing and IT spending for intermediate goods.

Geopolitical risks are rising and the U.S.-China trade tensions will likely persist irrespective of the outcome of the upcoming U.S. presidential election. A strict trade policy with China appears to be a strategy of both U.S. political parties. If tensions worsen further between the two largest economies or intensify the technology race, we believe this would impede supply chains and disrupt investment and capital flows for both countries.

Therefore, we view the companies with the most China end-consumer and supply-chain exposure as the most at risk and their ability to rapidly manage or mitigate such risks will be key to their business prospects.

Efforts To Diminish Tech Supply-Chain Concentration In China Will Be Long And Arduous

U.S. tech companies have long understood and accepted the geopolitical risks associated with the concentration of manufacturing and assembly of tech goods in Asia, and more specifically in China. Since the late 1970s, China's economic policies have promoted increased productivity, low labor costs, and logistical efficiencies due to its close proximity to component manufacturers, assembly suppliers, and customers both within China and across Asia-Pacific. This has led to substantial foreign investment by tech original equipment manufacturers (OEMs) to establish a significant and expanding manufacturing base in China to meet the growing global demand for tech products.

As global IT spending continued to increase, China's comparative advantage as a global tech manufacturing hub widened; as China became a growing consumer of tech products, U.S. tech companies' revenues and supply-chain presence in China increased.

Former president Trump made prominent in his 2016 presidential campaign his desire to end certain trade practices such as technology transfers and IP theft experienced by foreign firms operating in China. In August 2017, the Trump administration initiated an investigation (under Section 301), and in 2018 it imposed multiple rounds of tariffs (10%-25%) on certain Chinese imports, including tech final goods and components.

In August 2019, the Trump administration also placed Huawei and many of its affiliates on the "entity list," choking off Huawei's technology supply lines from U.S. firms. Huawei is a major provider of telecom infrastructure and services, networking equipment, servers, storage systems, surveillance systems, smartphones, PCs, and wearable devices globally. The move targeted Huawei's competitiveness but also harmed many U.S. tech firms that had a varying degree of sales exposure to Huawei.

The U.S. Commerce Department in October 2022, under the Biden administration, also introduced export controls of certain advanced chips and semiconductor equipment to China in an effort to curb China's access to critical technologies that could be used in military applications, breakthroughs in AI, or threaten U.S. national security.

NVIDIA Corp. was most affected because it will no longer be able to export several high-end AI chips to China. To a lesser degree, Advanced Micro Devices Inc. and Intel Corp. are similarly restricted from exporting their advanced chips used in data centers, particularly for AI.

Although the export restrictions are clearly a negative for these semiconductor firms' near-term performance, we believe the longer-term growth prospects are even more damaging, considering China's sizable market for such chips. Earlier this year, Nvidia's CEO warned that the U.S. export restrictions will likely increase the rate at which local Chinese firms develop alternative rival chips. The company also expects its China sales, which made up 20%-25% of its data center segment revenue, to decrease significantly due to these rules.

Despite these trade restrictions and tariffs, many U.S. tech companies' revenue exposure to China remains high, albeit lower than in 2017. This is notwithstanding the weak economic demand currently observed in China. Certain companies, such as semiconductor equipment manufacturers Applied Materials Inc., Lam Research Corp., and KLA Corp., have even seen their China revenue exposure grow, demonstrating the importance of U.S. technology to China's ambitions in semiconductors and its industrial policies.

Besides China's desire to become self-sufficient in technology and aggressively invest to close its technological gap with the U.S., it is also possible that the significant spending on semiconductor manufacturing by Chinese firms witnessed recently includes front running in anticipation of tighter export restrictions ahead.

While many tech companies plan to manufacture more of their products in emerging markets such as India, Vietnam, Malaysia, and Indonesia--mainly to diversify their manufacturing base and develop a strategic presence in markets with strong growth prospects--it would be difficult for companies to reallocate much of their manufacturing production from China over a short period without compromising execution. The U.S., Mexico, Europe, or other western regions are also viable options for reallocation because they are close to end customers, but higher operating costs are major drawbacks.

Just as it is difficult and lengthy to diversify revenue exposure away from China, it will also take years or maybe even decades for the tech supply chain to reduce its reliance on China as a manufacturing and assembly hub, in our view. It's time consuming to establish a new supply-chain network and to adapt to new regulatory environments.

Recent Developments On Rated Issuers

Apple Inc.

Apple Inc.'s main contract manufacturers, including Hon Hai Precision Industry Co. Ltd., also known as Foxconn (iPhone), Luxshare and Goertek (AirPods), and BYD (iPad) have expanded their production capacity in India and Vietnam. Last year, Hon Hai began assembling the iPhone 15 and iPhone 15 Plus models in India and China. According to Bloomberg, Hon Hai will assemble the new iPhone 16 Pro and iPhone Pro Max for Apple in India this year. Apple's suppliers' growing footprint in India and Southeast Asia does not necessarily equate to a reduced reliance on China because these contract manufacturers are either China- or Taiwan-based companies.

Dell Technologies Inc.

In January 2023, Dell Technologies Inc. announced plans to phase-out China-made chips by 2024 and told suppliers to reduce the other made-in-China components in its products amid concerns over U.S.-China tensions, according to Nikkei Asia.

According to Taiwan's Commercial Times, Dell is also planning to move 50% of its production out of China by 2025 and remove all reliance on Chinese manufacturing by 2027. After Dell announced its plan to phase-out China-made chips, its shipments of desktops and notebooks in China plunged by 44% in 2023, higher than the PC market decline of 17%, according to research firm Canalys. Its share in China's PC market shrank to 8% in 2023, compared to 11% in 2022.

Dell currently owns manufacturing facilities in China, the U.S., Brazil, Ireland, Malaysia, India, and Poland. It also utilizes contract manufacturers throughout the world to manufacture or assemble products.

HP Inc.

In August 2024, HP Inc. indicated its intention to build PC production sites in more countries while reaffirming China's importance as a key partner in manufacturing, engineering, and innovation.

Hewlett Packard Enterprise Co.

In May 2024, Hewlett Packard Enterprise Co. (HPE) announced it will sell 30% of the total issued shares of H3C (a China-based joint venture with Huawei) to Chinese IT provider Unisplendour Corp. for $2.1 billion. HPE has an option to sell the remaining 19% of total issued shares it owns for $1.4 billion to Unisplendour at a later date. The sale helps generate proceeds for its planned acquisition of Juniper Networks Inc. but lowers its ownership in H3C, which allows HPE a presence in the local enterprise IT market.

IBM

In August 2024, International Business Machines Corp. (IBM) announced plans to relocate its hardware research and development team in China to other overseas facilities, including India. The closure is estimated to affect more than 1,000 employees.

TSMC

TSMC has plans to actively diversify its fab capacity outside of Taiwan to mitigate geopolitical risks. The company currently has plans for seven new plants, including three in the U.S. (Arizona), one in Japan (Kumamoto), one in Germany (Dresden), and two in Taiwan (Kaohsiung). Due to higher costs of power, labor, materials, and operations, TSMC plans to charge a premium for chips produced outside of Taiwan, according to its CEO. According to TrendForce, despite its efforts to diversify its wafer production capacity away from Taiwan, TSMC's share of capacity in Taiwan will only drop to 87% by 2027 from 90% in 2024.

Changing Competitive Landscape Ahead Even In Best-Case Scenario

In a best-case scenario, if geopolitical conflicts are subdued, we believe tech firms can invest in new production capacity outside of China and gradually reduce their reliance on the country, rather than "lifting-and-shifting" their existing facilities overseas. This path is preferred because it would be less likely to jeopardize access to a large and growing China market and alienate its customers. However, any sudden flare-up in geopolitical tension involving China could mean expediting this process and likely evoke costly supply-chain and business disruptions.

In the meantime, Chinese firms are also aggressively boosting their technological capabilities and production capacities to meet their localization push. Research firm International Data Corporation (IDC) predicts that by 2030, China's mature semiconductor process market (more than 22 nanometers) will grow significantly, reaching nearly 40% market share (up from 30% in 2023) through government policies and subsidies, coupled with the support of China's sizable domestic market.

China aims to reduce reliance on foreign technology imports and continues to provide financial and policy support to cultivate its "national champions"--Huawei (diversified technology), Semiconductor Manufacturing International Corp. (SMIC; foundry), Yangtze Memory Technologies (YMTC; NAND memory), and ChangXin Memory Technologies (CXMT; DRAM memory)--to satisfy its domestic demand and also meet its global tech leadership ambitions.

We anticipate plenty of opportunities and obstacles ahead for China. We note that challenges remain for China's advanced semiconductor process market (smaller than 7 nanometers) and semiconductor equipment manufacturers due to lack of IP. At the same time, we expect its captive China consumption will also provide significant demand and opportunities to close its technology gap with the U.S.

What Might The Next Four Years Bring?

The potential effects of the upcoming U.S. presidential election remain difficult to assess. The next U.S. president will most likely have a direct impact on the tech sector, but whether there is political party alignment and control between the White House and Congress will be even more consequential to the likelihood of policy actions.

In addition, it's unclear if the policy preferences communicated by the presidential candidates thus far are merely campaign rhetoric or close to what will eventually be their official policy platforms. Therefore, we find it prudent to assess the potential impact of these publicly communicated policy preferences with caution. Furthermore, we believe it is premature to consider any policies as solid base-case assumptions for the next few years.

Despite the many differences between the presidential candidates' policy preferences, there are also many commonalities that are relevant to the U.S. tech sector. A tough stance against China is the most obvious one.

Here, we outline the policy areas most important to the tech sector--trade and supply chain, taxes, and M&A and regulations--and provide our latest views on each.

Trade and Supply Chain

Trade restrictions, especially those levied against Chinese imports, have been in place since the Trump administration. These measures have received bipartisan support, and it is reasonable to expect they will remain or even expand.

The export ban of advanced semiconductor chips and manufacturing equipment to China, which was enacted to stifle technology innovation and thwart threats to U.S. national security interests, has had a negative effect on several U.S. tech companies' growth over the past few years.

These export restrictions involve working with allied countries such as Japan and the Netherlands to prohibit access to the most advanced chipmaking equipment by China. It is unclear whether any of the existing export chip ban will be renewed or expanded further and, therefore, become more onerous as technology advances.

Along with tariffs on electronic goods, restrictive or protectionist trade policies have been damaging to the U.S. tech sectors, which has high sales and supply-chain exposure to China. Higher tariffs on Chinese imports could result in inflationary cost pressures for companies that would negatively affect profit margins, hamper market access, and encourage expediting the efforts to gradually diversify away from China as a supply-chain hub.

Protectionist trade policies would also likely raise prices for consumers. During the pandemic, when supply disruptions compounded the issue of tariffs, tech hardware and semiconductor companies were able to pass along higher costs to consumers. But with demand largely returning to normal, we think it would be tougher for companies to pass along higher prices to consumers.

The main objective of the U.S. CHIPs and Science Act, enacted in August 2022 and administered by the U.S. Department of Commerce, is to improve resiliency of the tech supply chain. The Act provides incentives for both the U.S. and foreign tech firms with the aim to bolster domestic semiconductor manufacturing and research capabilities in the U.S.

The higher cost to build and operate semiconductor fabs and tech manufacturing factories away from China and Taiwan has been prohibitive for decades. Without financial incentives to help companies bridge the cost gap during the early stages of supply-chain diversification, we do not believe the private sector would be motivated or financially capable of establishing a resilient tech supply chain to minimize disruptions from unforeseen events such as geopolitical uncertainties, natural disasters, and economic crises.

As electronic content becomes even more ubiquitous and essential to areas such as defense, auto, medical devices, and critical infrastructure, we believe continued support by the U.S. government to mitigate national security concerns would be well-received and necessary.

We currently expect the diversification of the supply chain to be gradual. However, our base-case expectation could be challenged if escalating geopolitical tensions lead to unexpectedly sharp cost inflation and the need for higher inventory levels.

We would expect more geopolitical headline volatility and trade and tariff uncertainties under a Trump Administration. Former President Trump had suggested that he would be in favor of a 10%-20% tariff levied on all U.S. imports and a 60% or more tariff on all goods from China. In our view, the 10%-20% universal tariff would prevent re-routing of trade and would be more effective in protecting the price competitiveness of U.S. domestically produced goods. The restrictiveness of these trade measures would likely accelerate the pace of supply-chain diversification efforts away from China as a manufacturing hub under a Trump administration.

Taxes

Corporate tax policy is one area where the two presidential candidates have opposing views. Vice President Harris indicated that her revenue-raising policy proposal would be to increase the corporate tax rate to 28% from 21%. This aligns with President Biden's budget for the fiscal year ending September 2025, submitted in March 2024. This increase would also represent a partial rollback of the Tax Cuts and Jobs Act (TCJA) put in place by the Trump administration in 2017, in which the corporate tax rate fell to a flat 21% rate from a top tier of 35%.

President Biden's budget also outlined new tax proposals such as raising the corporate minimum tax rate to 21% (from 15%), increasing the global intangible low-taxed income (GILTI) tax to 21% (from 10.5%), and repealing the reduced tax rate on foreign-derived intangible income (FDII). Democratic Presidential nominee Harris recently indicated she would be in favor of new tax proposals, including raising the corporate minimum tax to 21% from 15% and increasing the stock buyback excise tax to 4% from 1%.

Former President Trump's tax policies could be more positive for companies. The expiry of the TCJA at the end of 2025 opens the possibility for changes in taxation, but the former president has indicated that, if elected, he would be in favor of extending or making permanent the TCJA legislation he signed in 2017. His proposal also includes lowering the corporate tax rate marginally to 15% from 21%.

A higher corporate tax rate would be an adverse development for rated tech issuers' earnings and cash flow generation. However, we view the negative impact from corporate tax rule changes to be manageable and would mostly affect rated issuers' share buybacks rather than their credit quality. Given most tech companies' shareholder return policies, we view any negative impact from corporate tax rule changes to mostly affect rated issuers' shareholder returns rather than their credit quality.

M&A and Regulations

On the M&A front, we believe the U.S. technology sector has turned the page on a period of depressed activity since the spring of 2022. We view the M&A environment more favorably following the close of Microsoft/Activision and Broadcom/VMware M&As in late 2023. The depressed tech M&A activity observed since mid-2022 was due to a confluence of possible recession concerns, a rising rate environment, and heightened regulatory approval concerns.

Now, the expectation for continued economic growth, albeit moderating, and the start of a rate-cutting cycle over the near term seem to have pushed aside recession concerns and fear of higher rates as a headwind to M&A valuations. We believe tech companies view inorganic growth as an essential part of their growth strategy and would continually evaluate opportunities to: bolster their product, IP, and services portfolio; obtain top talent; and benefit from scale efficiencies.

In 2024, there has been sizable M&A announcements: Hewlett Packard Enterprise (acquiring Juniper Networks for about $14 billion), Synopsys Inc. (Ansys, about $35 billion), IBM (HashiCorp, $6.4 billion) and, most recently, Advanced Micro Devices (ZT Systems, $4.9 billion). The fast-evolving tech landscape favors M&A as a critical consideration to gain a competitive edge or remain viable. The slow M&A activity since mid-2022 created pent-up demand for over a year for deals because the tech evolution backdrop has only accelerated and AI burst onto the scene.

While strategic buyers have been actively scouring for M&A targets, noticeably missing are leveraged buyouts (LBOs). Although tech-focused private equity firms have raised substantial sums over the past few years, we haven't seen the typical volume of financial sponsor-to-sponsor portfolio exits or IPOs given the still high interest rate environment. While a lower interest rate environment will certainly be more conducive to LBOs, we believe clarity and stability of longer-term rate expectations would be sufficient for potential buyers and sellers to start engaging in deal talks.

Regulatory scrutiny, however, remains a challenge to M&A activity. Tech M&As that require approval from China's antitrust regulator, the State Administration of Market Regulation (SAMR), will likely be subjected to a lengthy regulatory approval process. In August 2023, Intel Corp. abandoned its $5.4 billion deal to acquire Israeli foundry chip manufacturer Tower Semiconductors after the merger agreement expired without regulatory approval from China.

For M&A transactions that require China SAMR approval, the threshold for review is low, at approximately $116 million in China revenues for each entity and combined global revenue of about $1.74 billion, based on 2023 thresholds. In our view, while not prohibitive, this environment would discourage many potential suitors from engaging in the process because of their apprehension for an extended regulatory evaluation, business disruptions that could occur during the period, and the potential for incurring M&A termination fees.

It is also unclear what a Harris or Trump administration would mean for Big Tech antitrust regulation.

The Biden-Harris administration has focused on limiting corporate dominance and aimed to create a more competitive business environment. The administration seemed to place particular emphasis on M&A by large tech companies, which include Alphabet Inc., Amazon.com Inc., Apple Inc., and Meta Platforms Inc.

Ongoing lawsuits and investigations are unlikely to resolve anytime soon. This includes the FTC's cases against Amazon (for exclusionary conduct in online marketplace) and Meta (accumulated monopoly power via anticompetitive mergers with Instagram and WhatsApp), as well as the Department of Justice's lawsuits against Apple (app store) and Alphabet (default search engine).

On Aug. 5, 2024, a U.S. district judge ruled that Google struck anticompetitive deals with Apple and other companies for default search engines. This represents a major setback for Alphabet (Google's parent) and has potential ramifications, including whether Apple's estimated $20 billion a year payment in 2022 for Google to be its default search engine for Safari on iPhone, iPad, and Mac will be allowed. We expect Alphabet will argue that its products are superior, which resulted in its higher market share in search. We also anticipate Alphabet will appeal the ruling, and the process could take years to resolve.

Although a Trump administration is generally viewed as business-friendly, we do not view this as similar to M&A-friendly, as evidenced by the administration blocking Broadcom's $117 billion planned takeover of Qualcomm in 2019 due to national security concerns, specifically leadership in 5G wireless technology.

The next frontier in tech regulation is in AI. How to regulate this new technology is controversial; too stringent regulation could stunt growth, while lax intervention could lead to development of an anticompetitive marketplace. Big Tech companies are already leaders in AI infrastructure and large language model development. How AI will be regulated in the U.S. and abroad will have a significant impact on its growth trajectory and whether competition will broaden to include the most innovative new entrants into the AI scene.

China Retaliation Against U.S. Tech An Increasing Risk

We view China as more ready, if not more willing, to retaliate against the U.S. tech sector than it was in the first bout of trade tension with the U.S. during the Trump administration in 2016-2020.

In April 2024, China's Ministry of Industry and Information Technology (CMIIT) directed its country's largest telecom carriers to phase out foreign processors that are core to their networks by 2027, a move that would impair U.S. chip companies Intel Corp. and Advanced Micro Devices Inc.'s (AMD) sales to Chinese telecom firms such as China Mobile, China Unicom, and China Telecom.

In May 2023, the Cyberspace Administration of China launched a cybersecurity probe into U.S. memory chipmaker Micron Technology Inc. and ordered the country's critical infrastructure operations to halt procurement of Micron's products. These actions by China's regulatory bodies could be perceived as retaliation for U.S.' actions restricting China's access to advanced semiconductor technologies.

If U.S.-China trade relations deteriorate further, leading to either an expansion of the U.S. bans on chip exports to China or more tightly enforcing existing restrictions, it is conceivable to expect more retaliatory actions directly against U.S. tech firms. While the current trade restrictions and investigations appear to center on the semiconductor industry, they could spill into other parts of the tech sector.

We're aware that China could leverage its global supply chain dominance and effective control of many critical minerals that are raw materials for advanced tech products. On Aug. 21, 2024, China's Ministry of Commerce announced export controls on antimony, a critical raw material for weapons used in the defense and electronics industry, particularly for ammunition, sensors, precision optics, semiconductors, cables, and batteries.

According to the Center for Strategic and International Studies, China accounts for 48% of global production and 63% of U.S. antimony imports. According to S&P Global Market Intelligence's data, China also accounts for more than 71% of the U.S. imports of lithium-ion batteries in 2023, 70% of natural graphite, and about half of permanent magnets. These raw materials are inputs in many tech goods and also electric vehicles. In addition, countries that appear to replace China's position in U.S. imports may themselves be materially reliant on China, making it complicated to assess the true dependence on China.

It could be more damaging to alienate China as an important customer for U.S. tech companies. Currently, China represents about 11% of global IT spending and over 20% in global semiconductor spending. While it is sensible for U.S. tech companies to diversify their supply chain and for the U.S. to support domestic manufacturing to protect its national security interests, it might also encourage China to adopt anti-U.S. behaviors when it comes to domestic consumption and inspire further determination to promote homegrown tech innovation and become more self-reliant, ultimately at the expense of U.S. tech demand.

Semiconductor Firms Most Exposed To Supply-Chain And Trade-Related Disruptions

Escalation of the U.S.-China tensions has had limited ratings impact over the past decade. Retaliatory actions between the two countries have targeted certain subsectors within the IT industry, such as an export ban on leading-edge wafer fab equipment. However, it has not led to negative rating actions for Applied Materials, Lam Research, or KLA Corp. because their revenues remain strong due to China's imports of mature node semiconductor manufacturing equipment in the near term.

Export restrictions on certain NVIDIA chips and a Chinese import ban on certain Micron products were noteworthy but shielded by the more remarkable AI and memory industry growth trends, and therefore did not affect our ratings on the companies. In fact, we can say the U.S. tech sector has been somewhat "de-risked" over the past decade as U.S. tech companies' overall China revenue exposure has declined, though it is still significant (see table 1). Even the China-reliant supply chain, while difficult to track, is slowly diversifying based on various company announcements.

However, a deepening of the U.S. and China divide underlies the growing risk for the tech industry at large. Bifurcation of the global tech ecosystem is already under way. China wants the IP to the most advanced logic and memory chips and semiconductor manufacturing equipment in the U.S. and elsewhere, and it will continue to invest heavily to build a self-sufficient IT supply chain.

Given this backdrop, we anticipate trade tension between the two countries will likely continue to worsen. Even in the unlikely scenario that a new U.S. administration takes a more dovish stance toward China, both superpowers will continue to pursue a dual path--one in which they continue to trade with one another while separately fortifying their own IT ecosystem.

U.S. technology firms looking to diversify their supply chain beyond China will face higher costs and reduced efficiencies because these firms must manage a more dispersed supply chain and operate in regions with underdeveloped infrastructure, higher labor costs, or more limited options of local suppliers. We estimate, for example, that the operating expenses of TSMC will be 40% higher at a planned Arizona facility, versus a plant in its home market.

Growing government support for local semiconductor industries could also lead to excess in global semiconductor capacity over the next several years. Such oversupply could be particularly meaningful for mature chip production. In the past year, the U.S. and EU separately announced legislation that will provide up to $53 billion and €43 billion, respectively, to support domestic semiconductor research and chip production over the next 10 years. Japan also announced plans to triple the sale of domestically produced semiconductors to more than $113 billion by 2030.

If there is a sudden trade escalation with the new administration, leading to higher tariffs for U.S. imports or a Chinese ban on certain U.S. products, companies with large China exposures will feel the immediate pain. For example, Qualcomm continues to face meaningful credit risk, with China revenues accounting for 62% of fiscal 2023 revenues. Apple's Greater China revenue exposure is more modest at 19%, but its dependence in this region extends beyond revenue and into supply-chain concentration, lower manufacturing costs, and availability of skilled labor.

Leading logic semiconductor providers, including NVIDIA, AMD, and Intel, whose China revenue exposure ranges from 15%–27% in their latest fiscal year, will have to navigate the increasingly complex web of U.S. regulatory restrictions on chip exports to China to meet U.S. objectives on limiting China's access to high-performance computing capabilities, particularly for AI.

We believe Intel, based on recent underperformance and its 27% exposure to China, would be most at risk of a downgrade given its limited ratings headroom. Further sales restriction to China beyond leading-edge equipment would harm semiconductor equipment makers such as Applied Materials, Lam Research, and KLA because they would face a flatter revenue growth trajectory and a smaller total addressable market.

China reportedly spent $26 billion on semiconductor manufacturing equipment through the first seven months of 2024, which would represent about 40%-50% of total spending globally, according to a recent Bloomberg article. That said, these companies also maintain solid balance sheets, which we believe will shield them from near-term ratings pressure if there are any further sales restrictions.

Providers of electronic and mechanical components (such as TE Connectivity Ltd., Amphenol Corp., TTM Technologies Inc., Vishay Intertechnology Inc.) and outsourced semiconductor assembly and test services (Amkor Technology Inc.) are asset-intensive and rely on a high number of skilled workers in relatively low-cost countries. Therefore, we expect these tech companies will have a tougher time weaning off their reliance on China. Their business models require high volumes to justify their steep fixed costs. For this reason, they prefer to centralize production with suppliers and be in close proximity of customers and a skilled workforce. Few geographies match China for these features.

Financial incentives from foreign governments to relocate or build new factories and train a new labor force will be necessary to ease the significant startup costs. Additionally, OEMs will likely need to provide business assurances, such as longer-term commitments or subsidized tooling, in order for many electronic manufacturing services firms to expand outside of China and help themselves mitigate supply-chain risks.

Tech Ecosystem And Long-Term Ratings Could Suffer Under Prolonged Geopolitical Tension

Although we believe U.S. tech firms will face increasing geopolitical and trade uncertainties, we expect the credit impact on most U.S. tech firms will be manageable at the current ratings. However, the longer-term rating trajectory on these companies is more uncertain.

As China's IT industry matures, not only will it become more self-reliant and able to serve its lucrative domestic market, it will also be even more competitive in battling with the U.S. for market share in tech products and services. There could be higher risk of overproduction of hardware and semiconductors, leading to pricing pressure and reduced overall IT industry growth. Different technology standards could also emerge if China and the U.S. pursue closed ecosystems, again leading to lower profits for all participants.

The International Monetary Fund estimates that reduced technology trade across rival blocs (U.S. aligned, China aligned and nonaligned countries) could cost as much as 1.2% of global GDP annually. Over time, this will likely lead to reduced revenue and margin opportunities for rated issuers. We believe highly rated issuers with strong balance sheets will have sufficient time to adjust to the new, more dangerous industry conditions. Those with less financial flexibility or that compete in industries with high volatility (memory chips for example), will have less room to maneuver under a bifurcated ecosystem.

S&P Global Ratings believes there exists potential for the global IT industry to continue to outpace overall global GDP. However, this path will be rocky if the two heavyweights continue to bicker.

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