11 Jul

Alexa, Tech Companies Are Leaving China: Where Will They Go?

WRITTEN BY Mike Sonnenberg

Tech companies are shifting from China

Last week, the Nikkei Asia Review said that global consumer tech companies are looking to move out of China amid the still unresolved trade war. While Donald Trump and Xi Jinping announced a trade truce, the tariffs on $300 billion worth of Chinese goods are still in place. Moreover, there might already be some cracks emerging in the trade truce.

The Nikkei article reported that HP (HPQ), Dell (DEL), Microsoft (MSFT), and Amazon (AMZN) are thinking of moving significant production out of China to escape from the tariffs, uncertainties, and rising costs in China.

HP and Dell are the largest and third-largest manufacturers of personal computers, respectively. These companies together control about 40% of the global market. 40% of HP’s shipments and 47% of Dell’s shipments from China head to the US.

Amazon (AMZN) is looking to shift the production of the Kindle ebook reader and echo smart speaker away from China. While Kindle and echo command a small fraction of Amazon’s revenues, the latter is a fast growing segment.

Apple (AAPL) is gauging the cost impact of shifting 30% of its smartphone production out of China. Foxconn and Megatron assemble the majority of the iPhones sold worldwide in Shenzhen, China.

Alexa, where are you going?

Last month, we discussed which companies may benefit from the trade war. This article is an extension of that analysis where we’ll focus solely on the tech sector.

President Trump’s tweet on May 13 said, “Many Tariffed companies will be leaving China for Vietnam and other such countries in Asia.” Thus, we’ll keep the focus on South East Asian economies. India is the only wild card we are considering in this analysis apart from the ASEAN group countries, owing to the fact that only India can come close to China’s scale in Asia.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Vietnam: the biggest beneficiary

As per the Nikkei article, Amazon (AMZN) is looking to produce Kindle and echo devices in Vietnam. Vietnam’s VinGroup has also signed a deal to manufacture 5G smartphones with Qualcomm (QCOM) and a unit of Japan’s Fujitsu. Qualcomm derives two-thirds of its revenues from China. Working with a new partner should help Qualcomm to diversify its revenue sources. Dell (DELL) has already started pilot production of notebooks in Vietnam.

Nomura expects Vietnam to be the biggest beneficiary of trade diversion with gains of 7.9% of its GDP. Although Vietnam wouldn’t be the biggest beneficiary of the short-term import substitution by the US or China, it will benefit from production relocation.

Vietnam already seems to be benefitting from the trade war. During the first five months of 2019, Vietnam’s exports to the US came in at $25.8 billion, a 35% jump over the same period last year. The foreign direct investment (or FDI), the funds that go into building factories, are up too. In the first five months of 2019, Vietnam received FDI of $16.7 billion, a whopping 69% jump over the previous year. The surge was primarily driven by the US-China trade war as Chinese and Hong Kong investors have put their money in Vietnam to avoid trade friction.

Other economic parameters are looking good too. While most countries’ manufacturing sectors are struggling due to the trade war, Vietnam’s manufacturing PMI came in at 52.5 in June, higher than May’s 52.0. During the same period, global manufacturing PMI dropped from 49.8 to 49.4, indicating contraction. The first quarter unemployment rate was at 2.17%, lower than America’s. The economy grew at a healthy rate of 6.7% in Q2 2019, surpassing China’s growth rate.

With a young workforce, a vibrant and growing economy, and improving relations with the US, Vietnam is poised to attract more manufacturers to its soil. 32% of Vietnam’s total exports come from electrical and electronic equipment. Most of it was focused on assembling the equipment. The country will have to upskill its labor to take on more high-tech manufacturing. However, with the young workforce at hand, Vietnam seems to be at an advantage.

The VanEck Vectors Vietnam ETF (VNM) offers an opportunity to get exposure to Vietnamese equities. The technology sector accounts for 15% of the ETF’s total portfolio. So far in 2019, the ETF has returned 8.1%.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Malaysia: The semiconductor factory

Malaysia is the region’s export powerhouse with exports accounting for 71.5% of the country’s GDP. The country derives 22% of its GDP from manufacturing, higher than the global average of 19%. What’s more, 38% of Malaysia’s exports are in electrical and electronic components, particularly semiconductors. Thus, Malaysia could benefit vastly from tech companies leaving China.

The Nomura report ranks Malaysia as the biggest beneficiary of the import substitution by the US or China. In short, a substantial part of the high-tech stuff that the US imports from China will now carry the made-in-Malaysia tag if the trade war persists. China would also go for Malaysian products instead of American products.

However, what matters more is the benefits Malaysia will accrue in case of production relocation. Here, Malaysia is expected to be right behind Vietnam in welcoming companies to set up factories there. In fact, major American tech companies already have a sizable presence in Malaysia. Intel (INTC) has been operating in Malaysia since 1972. Out of Intel’s total workforce of 107,000, about 9,000 are based in Malaysia.

Malaysia wouldn’t just benefit from American companies leaving China. Chinese companies are also expected to source components from Malaysia instead of the US if the trade war continues. Thus, Malaysia may win business from both the trade-warring sides.

With its expertise in semiconductor manufacturing, Malaysia may snatch tech companies leaving China. Malaysia’s younger workforce with a median age of 27 years may also prove to be a boon. Investors who want to bet on Malaysia’s economy can consider the iShares MSCI Malaysia ETF (EWM). The ETF invests in Malaysian equities. However, tech companies don’t feature prominently in the ETF’s holdings.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Philippines: The emerging player

Unlike its ASEAN peers, the Philippines is not exactly an export powerhouse. However, it has proven experience in exporting semiconductors and other tech products. Semiconductors accounted for over half of the country’s total exports in 2018, bringing in 12% of the GDP.

While only 13% of the Philippines’ total exports go to the US, there is room for growth. In fact, during the first five months of 2019, the US has imported an additional $200 million worth of products from the Philippines over the same period in 2018. Dell (DELL) is also running a pilot production of notebooks in the Philippines.

The Philippines’ economic indicators are also painting a rosy picture at a time when the global economy is struggling. The Philippines’ manufacturing PMI came in at 51.3 in June, a second straight gain. A PMI reading above 50 indicates expansion. Rising PMI signaled that the Philippines’ manufacturing sector is expanding at a faster pace. Since semiconductors account for a large part of the Philippines’ manufacturing sector, it is safe to assume that the Philippines is benefitting from the trade war.

With a young workforce, experience in manufacturing hi-tech products, and a strategic location, the Philippines is poised to benefit from production relocation in case of a prolonged trade war. How President Duterte manages to balance relations with the US and China will decide on how much his nation can benefit.

For those interested in investing in the Philippines’ growth story, the iShares MSCI Philippines ETF (EPHE) provides exposure to the country. EPHE has returned 12.9% so far in 2019.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Thailand is the reigning economy

Thailand is another export powerhouse in the region with exports accounting for 68% of the country’s GDP. Some of Thailand’s and China’s exports—especially office machine parts and integrated circuits—also overlap.

Thailand has proven capabilities in electronics assembly. Companies like Microsoft (MSFT) and HP (HP) are targeting Thailand for production relocation. The Nikkei report adds that Microsoft (MSFT) said it had no active plans to withdraw any manufacturing from China.

Thailand is a long-time ally of the United States, which could help Thailand win some business from companies looking for a safer place to manufacture tech products meant to be sold in the US. However, certain demographic factors threaten Thailand’s chances to benefit big from the trade chaos. Thailand’s median age of 37.8 is higher than China’s, which also makes Thailand’s workforce the second oldest in ASEAN region after Singapore. Worse, Thailand’s population growth rate of a mere 0.18% (world average of 1.07%) means the population will continue to get older.

For investors interested in gaining exposure to Thailand, the iShares MSCI Thailand ETF (THD) is a passive option. The ETF invests in Thai equities and has returned 15.6% so far in 2019.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Singapore: The superstar

Semiconductor exports have been the foundation of Singapore’s economy ever since the country came into existence in 1965 after splitting from Malaysia. Tiny Singapore account’s for an 11% share of the semiconductor wafer output. HP (HP) and Texas Instruments (TI) have invested heavily in Singapore so far. Apart from semiconductors, Singapore accounts for 25% of the world production of printers.

Singapore’s strategic location makes it a trading powerhouse. Its exports stood at a whopping 173% of GDP against China’s 19.8% and the world average of 29% in 2017. A large part of these exports is re-exports, as Singapore acts as a trading hub between the east and the west.

In terms of manufacturing, Singapore is well known for manufacturing semiconductors and circuit boards, which could help it become the preferred destination for high-tech goods manufacturers looking to shift away from China. Nomura believes that Singapore could be the third-largest beneficiary of production relocation away from China.

Just like Thailand, demographics and higher wages may stop companies from moving big into Singapore. At 40.8 years, Singapore’s median age is the highest in the ASEAN region. Singapore’s population is also growing at a minuscule pace of 0.1%. On top of that, Singapore’s wages are the highest in South East Asia and among the highest in the APAC region.

In spite of the demographic challenges, the government of Singapore is eyeing a bigger market in the global electronics and electrical equipment sector. For investors who want exposure to Singapore equities, the iShares MSCI Singapore ETF (EWS) is an option. The ETF has returned 12% so far in 2019.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

Indonesia: The underdog

With a large local market to cater to and abundant natural resources at hand, Indonesia’s exports have largely been limited to commodities. Unlike some of its ASEAN peers, Indonesia’s component exports remain minuscule. With a population of 264 million and a young workforce with a median age of 30.8 years, Indonesia is in a position to change that.

The challenge is upskilling and reskilling. Indonesia doesn’t have any high-tech manufacturing capabilities as of now. To take full advantage of the demographics and the global situation, Indonesia needs to have policies that could develop its workforce. In spite of the challenges, Microsoft (MSFT) is eying Indonesia to relocate its production from China.

Indonesia’s exports primarily include commodities such as oils, rubber, coal, and textiles. Only a fraction of its total exports of $189 billion in 2017 had overlap with China’s exports to the US. Indonesia’s exports stood at 20% of its GDP in 2017, much lower than the global average of 29%. To make it worse, exports to China account for 15% of Indonesia’s total exports, making China its biggest trading partner. Thus, the prolonged trade war and in turn slowing China can hurt Indonesia more than it can benefit the archipelago.

The iShares MSCI Indonesia ETF (EIDO) is an option for investors looking who want exposure to Indonesia. The ETF invests in Indonesian equities and has returned 6.9% so far in 2019.

Alexa, Tech Companies Are Leaving China: Where Will They Go?

India: The elephant

India doesn’t belong to the group of above-discussed economies. It’s not a part of ASEAN. It’s not in Southeast Asia and it’s not an export-driven country. We are only including India here because of the sheer scale the country offers. In terms of the size of the workforce and economy, only India can put up a fight of its own against China in terms of scale.

With a 1.3 billion population and the median age of 29 years, India’s workforce is second only to China’s. If India could get millions of more women to work, it could surpass China in the next decade or two. However, India needs to reskill and upskill its workforce to take advantage of tech companies planning to move out of China.

The government has recently published a draft of its new education policy to tackle some of these challenges. However, a lot needs to be done to be a high-tech hub beyond the software hub that it is right now.

At the G20 Summit last month, India’s prime minister, Modi, and President Trump discussed 5G and Huawei. The expectation is that some of the 5G manufacturers may shift to India.

Over the last five years, Modi has emphasized the “Make in India” initiative. The related policies have even pushed Amazon (AMZN) and Walmart-owned Flipkart (WMT) to produce locally. Some phone manufacturers have also set up factories in India. The annual production of smartphone devices has skyrocketed from 3 million in 2014 to 11 million in 2017, clocking 11% of world smartphone output. That puts India right behind China in smartphone manufacturing. India may be able to leverage on that. In fact, Apple (AAPL) is expected to mass-produce iPhones in Foxconn’s facilities in India.

Beyond Asia

While most winners from the trade war are in Asia, that’s not the only place they belong to. Latin American countries including China, Argentina, and Mexico are expected to benefit from the trade war. However, they may not be able to attract much hi-tech manufacturing. Data center builders like Quanta Computer, Inventec, and Foxconn (all Taiwanese) have moved some production out of China to Mexico and the Czech Republic.

What’s next?

Deal or no deal, the global manufacturing map is poised to be altered as companies look beyond China. Technology companies will be the frontrunners in the shift as the issue with Huawei, rising costs in China, and the tariffs hamper them the most. Along with Southeast Asia, India is poised to become the world’s new manufacturing hub.

The ability of countries to attract the tech factories moving out of China will depend on how fast their governments react to the changing landscape.

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