Weekend Long Read: Local Losses Are a Price Worth Paying to Consolidate China’s Chip Industry

China’s semiconductor industry has long discussed consolidation, but substantial action remains limited due to complex entanglements with state-owned assets and government reluctance to realize losses on investments. Mergers and acquisitions (M&A) efforts commonly stall when state investors — often local government-backed funds or state enterprises — resist marking down assets amid declining industry valuations, leading to failed negotiations. Most M&A targets are underperforming projects, and buyers seek reduced prices, but government officials are hesitant to record official losses on these state-owned assets, effectively impeding consolidation.[para. 1]

The surge of state-backed investment began in 2014 when China established the China Integrated Circuit Industry Investment Fund (“the Big Fund”), spurring a nationwide wave of similar funds for semiconductor projects. However, rapid changes in the industry and the underperformance of many projects have made the disposition of state-owned assets a pressing issue for facilitating M&A. With significant investments at stake and projects increasingly languishing, policies to allow value preservation while disposing of assets are urgently needed to minimize broader economic losses.[para. 2][para. 7]

A persistent vicious cycle underpins industry woes: underperforming projects lead to lowered valuations in consolidation discussions. Yet, government investors, especially at the local level, refuse to acknowledge or formalize losses, fearing accountability and penalties tied to asset devaluation. Unlike high-level, large-scale industry consolidations — such as in the automotive sector — many semiconductor investments are overseen by smaller, local government stakeholders who lack both the central government’s mandate and the operational flexibility of private enterprises. Consequently, progress on consolidations slows or stalls altogether.[para. 3][para. 4]

Officers assigned to manage or “rescue” failing projects assume significant personal risk due to strict asset preservation rules; large semiconductor investments typically span billions of yuan, heightening stakes. Even when buyers exist, continuous declines in valuation deter deals, as holding out to avoid a formal loss can ultimately worsen depreciation and financial drag if action is further delayed.[para. 5][para. 6][para. 7]

While clearing out poor-performing assets was once less urgent amid a healthier economy, economic slowdown has shifted focus, making the removal of bad assets central to national economic recovery efforts. China has prior experience in managing large-scale bad assets, notably in its mid-1990s banking reforms, and recent years have seen supportive central government policies and accountability measures targeted at hidden local government debts and improved fiscal management. Occasionally, national authorities step in to drive consolidation, as seen in 2024 with directives for major carmakers and real estate developers, indicating the type of intervention that could be extended to semiconductors if necessary.[para. 8][para. 9][para. 10][para. 11]

Policy solutions proposed to facilitate semiconductor industry M&A and asset cleanup include four key measures: 1) employing bankruptcy restructuring to address debt and enable new buyers to maximize asset value, 2) embracing market-based pricing and allowing limited depreciation of state assets for legitimate projects, setting fair reference prices through auctions, 3) using debt-to-equity swaps to stabilize companies with future potential and protect creditors, and 4) injecting high-quality upstream and downstream assets to balance returns and enhance economic impact assessments at the industry chain level. Timely adoption of these recommendations is critical to minimizing losses; delaying action risks leaving valuable projects to wither and liquidate for minimal returns.[para. 15][para. 16][para. 17][para. 18][para. 19][para. 20][para. 21][para. 22]