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The US Commerce Department has placed Huawei Technologies Co Ltd and 68 of its affiliates on its Entity List, a move that restricts Huawei’s ability to purchase critical components from US firms to manufacture its products.

US companies that wish to conduct business with companies on the Entity List are required to obtain a special licence before doing so.

This comes after US President Donald Trump signed an executive order barring US companies from using telecoms equipment manufactured by Huawei, citing national security risks.

There are concerns that hardware manufactured by Huawei could possibly be used for spying, although evidence has yet to be found.

The effect of the ban is far-reaching, as even non-US companies, such as Panasonic Corp and ARM, announced they will be suspending business relations with the embattled Chinese firm.

Huawei is the world’s largest networking gear maker and is widely considered to be the leading player in 5G networking solutions.

Besides its reliable and cheap networking equipment, Huawei also produces a variety of products ranging from smartphones, to fitness trackers. As a major producer of electronic goods, the success of Huawei largely depends on its ability to procure semiconductors, the backbone of all electronic devices.

China currently does not possess the capability to produce high-performance chips required for modern electronics.

Much of that capability resides with US firms, most of which are goliaths in the global semiconductor industry.

Huawei and most of its peers are heavily reliant on the US chipmakers for their chip supply.

It is estimated Huawei purchases roughly 20% of its chips from US-based firms each year, while the remainder is sourced from mainland China and other markets such as South Korea and Taiwan.

Huawei’s supply chain is so closely intertwined with US chipmakers, it is not surprising the ban had a negative impact on its share prices.

The VanEck Vectors Semiconductor Exchange-traded Fund, which tracks 25 US-listed semiconductor companies, has tumbled by almost 9% as of May 27, 2019, since the ban was implemented.

Among the world’s top 10 semiconductor companies by market capitalisation, six are listed on the Nasdaq exchange.

Out of the six companies, three companies have a more than 5% revenue exposure to Huawei, the largest being Micron Technology Inc at 13%, followed by Taiwan Semiconductor Manufacturing Co Ltd (TSMC) at 6.42% and Broadcom Inc, 5.34%.

Intel Corp, the company with the largest market cap of the lot, has an exposure of just 0.17%. While it remains unclear if TSMC — a non-US company — is affected by the US ban, the company has said it will maintain supplies to Huawei for the time being.

As such, we think the Huawei ban should have limited impact on TSMC’s earnings in the near term.

Since most of the semiconductor companies do not have significant revenue exposure to Huawei, we believe the recent sell-off may be a knee jerk reaction.

The restrictions on Huawei, as well as those placed on ZTE Corp in 2018, revealed just how vulnerable China is to the production of semiconductors.

The decision to ban US companies from doing business with ZTE nearly bankrupted the company, until Trump stepped in to strike a last-minute deal.

Although Huawei may be in a better shape compared to ZTE due to its extensive efforts to develop its own semiconductors, it is still far from being completely self-sufficient.

Hence, China will most likely double down on its efforts to develop its own domestic semiconductor supply chain, so as to reduce its reliance on the US.

If successful, this will certainly threaten the long-term competitiveness of US semiconductor firms — another market concern weighing on the share prices of US chipmakers.

While such concerns are legitimate, it is worth noting semiconductors are some of the most complex products to design and fabricate in the world and the success of US-based firms in semiconductor manufacturing is not something that can be replicated overnight.

It is the fruit of thousands of hours and billions of dollars spent on research and development over decades. It could take China several years or even decades just to be on par with the US. Until that happens, Chinese electronics manufacturers like Huawei will have no choice but to rely on the US for their supply of chips.

While we remain hopeful of a breakthrough in the US-China trade negotiations, the long-term growth story of semiconductors remains intact.

Global semiconductor sales are still well on track to hit a record high of US$500 billion (RM2.08 trillion) by 2020 driven by the widespread demand for semiconductors, which are essential components of all electronic devices, including future applications such as 5G and the Internet of Things.

As technology advances with each passing day, manufacturers need to constantly source for cutting-edge chips that can meet the lofty requirements of modern-day technology.

Until China gets up to speed with its semiconductor technology, the US lead in semiconductors could bode well for the US semiconductor industry.