On May 17, Huahong Semiconductor's debut meeting took place at the Shanghai Stock Exchange, marking a significant milestone for the Chinese semiconductor industryFollowing the launch of the leading player SMIC and the third-ranking company Jinghe Integrated, Huahong Semiconductor, the second-largest player in China's chip foundry sector, is poised to make its entrance on the Sci-Tech Innovation Board.

Historically, Huahong's progress towards its public listing appears to be ahead of market expectationsIn 2020, SMIC achieved rapid momentum with an 18-day approval process and a subsequent listing in just 45 daysSimilarly, Jinghe Integrated managed to get listed in under two months in 2021. Today, Huahong appears set to follow in their footsteps.

The establishment and growth of Huahong Semiconductor encapsulate a significant chapter in the story of China's self-sufficient semiconductor industry

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Initiated by a national initiative in 1996, the 909 Project sought to invest 10 billion yuan in creating an 8-inch wafer production line with a 0.5-micron process technologyThis monumental investment became the largest semiconductor project in Chinese history, surpassing total investments in the sector since the founding of the People's Republic.

The determination encapsulated in the mantra “no stone left unturned” reflects the country’s commitment to prioritize semiconductor industry development, a sentiment echoed strongly at the timeThe company tasked with executing this ambitious plan was none other than Huahong Group, with notable individuals such as Hu Qili, the then-Minister of Electronics, taking the helm as its chairman, underscoring the project's high stature.

In 1997, Huahong Group established a joint venture with Japanese semiconductor giant NEC, creating Shanghai Huahong NEC, aimed at leveraging its technology to accelerate development

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However, as the global semiconductor landscape shifted and Japan's dominance waned, the joint venture gradually pivoted to self-reliance, heralding a new beginning for China's semiconductor innovation.

Huahong NEC adopted a practical approach, focusing on chips tailored to Chinese market needs, characterized by relatively easier design requirements, thus establishing a foothold in the competitive fieldTheir initial product development emphasized IC card chips and communication chips, eventually cutting a niche through strategic alignment with domestic demand.

In January 2013, Huahong NEC merged with Hongli Semiconductor, forming Shanghai Huahong Hongli Semiconductor Manufacturing Co., LtdA year later, the company went public on the Hong Kong Stock Exchange, raising 2.573 billion HKD, which laid the foundation for what would now be known as Huahong Semiconductor.

From an ownership perspective, Huahong Semiconductor stands as a key player embodying national interests

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In addition to its controlling shareholder, Huahong Group, the State Integrated Circuit Investment Fund possesses 178 million shares, amounting to a significant 13.74% stake in the company, making it one of the largest shareholders of the national fund.

The most compelling factor driving Huahong's return to A-shares is undoubtedly the allure of higher valuationsComparing market metrics, Huahong Semiconductor commands a meager price-to-earnings (P/E) ratio of just 8.7 times in the Hong Kong market, whereas SMIC's A-share valuation soars to an impressive 39 times, highlighting the former's vast undervaluation.

Indeed, the fundraising target for Huahong Semiconductor on the Sci-Tech Innovation Board reaches a staggering 18 billion yuan, only trailing behind SMIC and BeiGene, with their offering market capitalization soaring to 72 billion RMB, overshadowing its current Hong Kong market valuation of 33.5 billion HKD.

In the landscape of the semiconductor foundry business, the “Matthew Effect” is notably pronounced, presenting a highly consolidated industry

In 2022, the top five global foundry powerhouses commanded nearly 90% of market share, led by TSMC, which alone accounted for an astonishing 63.14%. Among Chinese firms, only SMIC and Huahong Group broke into the global top five, ranking second and fifth with respective shares of 6.01% and 3.58%.

Despite being dubbed the “twin stars” of Chinese chip foundries, Huahong Group's strategic outlook diverges significantly from SMIC's pursuitAs China's largest and most recognized foundry, SMIC concentrates on the advancement of cutting-edge technology, endeavoring to catch up with TSMC and other industry giants in wafer fabrication.

This pathway demands immense R&D investment and technical expertise, continuously refining transistor line widths in line with Moore's Law, thereby serving high-performance computing and other high-end sectors

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By 2021, advanced nodes of 65nm and below had become the main revenue drivers for SMIC, contributing to approximately 59.3% of its total sales.

Conversely, the earlier established Huahong Group pursues a dual development strategyOne limb consists of the pre-IPO Shanghai Huahong, akin to SMIC, committed to cutting-edge logic technology, with the most sophisticated processes targeting 28nmThe other limb, the current Huahong Hongli, centers its attention on specialty processes aiming to become the comprehensive champion of the specialty wafer foundry domain.

In this realm, success hinges not on the advanced nature of the processes but on yield rates, product quality, distinctive traits, and response timeCurrently, Huahong Hongli is focused on providing specialty wafer foundry services for both 8-inch and 12-inch wafersThe former predominantly operates within the 0.35µm to 90nm process nodes, while the latter covers 90nm to 55nm.

Analyzing the product structure, Huahong Hongli still primarily generates revenue from nodes larger than 0.35µm, with this segment accounting for over 43% of revenue in 2021, while contributions from 55nm and 65nm nodes remained relatively modest at just 9.7%.

Although not a leader in advanced processes, Huahong Hongli has excelled within its chosen niche, establishing itself as a formidable competitor

By the end of 2022, the company operated three 8-inch fabs alongside one 12-inch facility, with annual production capacities growing at a compound rate of approximately 24.67% over the past three years.

According to data released by TrendForce, in the specialty wafer foundry domain, particularly in the IGBT and MOSFET sectors, Huahong Semiconductor ranks first globallyIts products find extensive applications within industries including home appliances, renewable energy, and energy storage.

Additionally, Huahong has emerged as the largest intelligent IC card foundry in the world and holds the title of China's leading MCU foundry, showcasing its dominance in the realm of embedded non-volatile memory technologies, catering to crucial markets such as SIM cards, bank IC cards, second-generation ID cards, and social security cards.

The underestimation of Huahong's position has far-reaching implications, especially when discussing the evolution of China's semiconductor sector

The prevalent focus on advanced logic processes often leads to neglect of the significance held by mature specialty processes.

Strikingly, China reigns as the world's largest semiconductor market, accounting for one-third of the global share; nonetheless, its chip foundry takings signify a mere 15% of the international pieTo assert true independence and control, China's chip industry requires breakthroughs in advanced techniques to tackle high-end chip challenges and a dominant market position in mature specialty processes to meet diverse demands satisfactorily.

A telling example lies in the pre-Huahong era, wherein China exclusively depended on imported SIM cards, averaging 82 yuan eachOnce domestic production commenced, the price plunged to 8.1 yuan, effectively severing a longstanding foreign monopoly.

Moreover, the emergence of sectors such as photovoltaics, wind power, energy storage, and electric vehicles has opened vast growth opportunities for China's mature specialty process chips, a trend also reinforced by Huahong's financial metrics

Between 2020 to 2022, Huahong's revenue surged from 6.737 billion to nearly 17 billion yuan, with net profits tripling from under 700 million to approximately 3 billion yuan, reflecting sustained growth exceeding 50% over two consecutive years.

As the first quarter of this year unfolded, global semiconductor entities faced monumental losses and revenue declines; however, Huahong's chip foundry business retained its growth and profitability, generating $631 million in revenue (up 6.09% year-on-year) and $152 million in net profits (a remarkable 47.88% increase).

Evidently, shifts in downstream demand and resultant adjustments towards product structures have been both observable and pronouncedSince 2019, the company strategically regulated its 8-inch production capabilities while advancing its 12-inch production linesSales from 12-inch wafers leapt from $519 million in 2019 to $3.1 billion by 2021.

In the fiscal year 2022, 55nm and 65nm 12-inch wafers emerged as the fastest-growing technical nodes, witnessing an incredible year-on-year increase of 125%, collectively contributing to a growing share in total revenue, which climbed from 9.7% in 2021 to 14.3% in 2022.

The resurgence of robust market demand has led to capacity constraints, instigating a dilemma in development

Of the 18 billion raised, 12.5 billion will be allocated to expanding the 12-inch production line in Wuxi, with expectations to incrementally elevate monthly output to 95,000 by the end of the year, which will account for over 30% of the company's total capacity.

To the naked eye, Huahong's modest production processes may seem like laborious endeavors; however, the implications regarding profitability reveal a contrasting trend, showcasing promising gross margins that have consistently increasedFrom 2020 to 2022, Huahong Semiconductor maintained a gross margin of 18.46%, climbing to 28.09% in 2021, ultimately reaching 34.1% in 2022, with margins in the last quarter peaking at 38.2%.

In comparison, SMIC’s concurrent gross margins were recorded at 23.78%, 29.31%, and 38.3%, indicating diminishing disparityThe takeaway remains clear: delivering quality, distinctive products leads to substantial market rewards.

As the listed platform under Huahong Group, Huahong Semiconductor presents substantial upward potential as it anticipates strategic asset injections