While the Covid-19 pandemic rages, China and the United States continue to spar warily over national security, technology and deal-making. In this fight, the canary in the coal mine is Nvidia’s pending $6.9 billion acquisition of Mellanox. 

Nvidia, a U.S. company, agreed to acquire Mellanox, an Israeli company with U.S. operations, 13 months ago. Both are in the semiconductor industry, making high-end chips to power supercomputers and much of the cryptocurrency industry. For Nvidia, facing slowing growth, this is a must-do deal which would allow it to further penetrate the supercomputing arena and build on Mellanox’s artificial intelligence business.

This is key technology in a world where China and the U.S. are setting up champions to further economic competition. And because Nvidia is a U.S. company, this is a deal that would further build the U.S. lead in a critical area.

But China has a regulatory card up its sleeve. As with most global deals these days, the Mellanox acquisition by Nvidia requires the approval of the Chinese regulator, the State Administration for Market Regulation, otherwise known as SAMR. China set deliberately low thresholds for subjecting deals to review, and now the regulator has the power to approve or block almost all global transactions. The combined companies need only have $282 million in worldwide sales and about $56 million in Chinese sales to be required under Chinese law to clear a SAMR review. Both NVIDIA and Mellanox sell chips to China and meet the threshold.

The review is ostensibly for antitrust purposes. But the SAMR process has given the Chinese immense control over global deal-making and leverage in the great technology game. In prior years, SAMR (and its predecessor, the Ministry of Commerce) regularly demanded review of certain confidential technology to approve a transaction. SAMR would then leak this technology to Chinese competitors. SAMR has also been known to demand remedies that enhanced Chinese enterprises such as technology licenses or transfers.

SAMR has become a key weapon in China’s arsenal — especially in the semiconductor industry. It was SAMR that halted Qualcomm’s acquisition of NXP as the U.S.-China trade war heated up. SAMR did this even though the U.S. — to entice China to approve the transaction — lifted sanctions on ZTE, China’s largest telecom-equipment maker, for violating the U.S. embargoes on Iran and North Korea. China apparently felt the economic gain from blocking the transaction was too enticing to satisfy a quid pro quo.

Now the Mellanox/Nvidia deal has cleared all regulatory approvals but SAMR’s. Dealreporter reported in late March that the SAMR clearance was imminent, and in anticipation of completing the transaction, Nvidia raised $5 billion in debt financing at the end of March. It seems the market is predicting the deal will clear. On April 7, SAMR cleared another semiconductor deal, Infineon’s pending acquisition of Cypress Semiconductor. This wasn’t such a surprise as this is a German company acquiring a U.S. one, so the Chinese shouldn’t have had the same objections as they would to an American acquisition. The U.S. national security regime has also allowed this transaction to go forward. 

If China clears a U.S. acquisition of a semiconductor company, even an Israeli one, it would signal a thaw in the relationship after a semi-truce in the trade wars. It shows that at least in some cases China is not going to fight an all-out war on these grounds.

I’m not so sure that clearance the market is predicting will happen, however. Behind the struggle over semiconductors is a greater war over technology, one which will be exacerbated by the Covid-19 pandemic. The battle lines were already drawn over semiconductors and telecom technology. Five years ago China set a goal of producing 70 percent of integrated circuits it consumes internally by 2025, and has made little progress, with internal production perhaps reaching only about 16 percent now, despite having taken a heavy hand in attempting to import or sometimes to appropriate technology to gain a competitive advantage. It also provides tens of billions of dollars of state subsidies to its select national champions. 

Meanwhile, the U.S. is awakening. Washington has repeatedly blocked Chinese semiconductor or equipment acquisitions, including deals to buy Lattice Semiconductor and Xcerra. The industry has been a focal point of CFIUS, the Committee on Foreign Investment in the United States, which reviews overseas investment in the U.S. for national security issues. CFIUS also blocked Infineon’s attempted acquisition of Cree Inc. assets, and Broadcom’s acquisition of Qualcomm. And national security reviews are now de rigueur in almost any Chinese acquisition, as CFIUS expands its purview. In one example of its wider lens, CFIUS ordered that Beijing Kunlun Tech divest the LGBTQ dating app Grindr because of fears that it would allow the Chinese to access sensitive personal data of U.S. government officials.

There has been speculation that the tariff truce might let the Mellanox deal skate through, but recent rhetoric during the pandemic appears contrary. The Wall Street Journal recently reported that the U.S. is considering extending restrictions on the sale of semiconductor technology to Chinese tech giant Huawei to include semiconductors made on U.S.-designed equipment outside the United States. This would effectively deprive Huawei of its major supplier of chips — Taiwan Semiconductor Manufacturing Co. Eric Xu, Huawei’s rotating chairman, has responded furiously to this report, stating that “[t]he Chinese government would not sit there and watch Huawei being slaughtered. I believe there would be counter-measures . . .”

Dealreporter’s reporting thus appears to be a bit premature. So long as China has dependency on foreign semiconductor chips, it will view itself as having economic weakness. This, in turn, is going to lead China to act in its interest to attempt to slow U.S. development while making all efforts to catch up and establish a Chinese-based supply chain.

This battle is only going to be compounded as we emerge from the Covid-19 pandemic, which has further exposed the perils of global supply chains. In particular, the U.S. is recognizing its dependency on Chinese and Indian manufacturers for drugs, China for masks, and the worldwide supply chain for ventilators. The main manufacturer of swabs used in viral testing is located in Northern Italy. In a post-Covid-19 world, expect to see a reshuffling of global supply chains as the U.S. will seek to rebuild its independent medical and pharmaceutical technology, including biotechnology. Also expect the U.S. to focus on medical supplies and biotechnology, according them the same urgency as the battle over semiconductors.

Other countries will also act. Australia adopted emergency rules in the last week of March requiring all foreign investment be approved for national security reasons.

In the meantime, we are on hold for this bigger readjustment as we fight the pandemic.  But the skirmish over chips is continuing. Watch what China does with Mellanox to see if it is going to be an all-out semiconductor war as we emerge from the current crisis.

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