Chip makers are changing the dynamics in the Artificial Intelligence market

Artificial intelligence and the technology needed to develop it remains one of the hottest investment topics for this year but with some caveats. Results from Dutch chip making equipment manufacturer ASML and a tweak in the US policy on selling said equipment to China have made it a less straight forward bet than it was six to 12 months ago.

So rather than park an investment into Artificial Intelligence related technology and forget about it for a few years – which would have been possible only a year ago – these changes will require keeping a closer eye on AI-related investment.

Pushing the boundaries of AI programming

This week ASML, the company that is the maker of equipment for chip making, reported a net profit of EUR 1.9 billion in the three months to the end of September. ASML sits in the centre of the chip making chain, companies making chips use ASML equipment as a critical manufacturing component.

The difference between ASML and competitors is that the Dutch firm’s equipment is of unmatched precision and can be used to created superior computers capable of pushing the boundaries of AI programming. Samsung, Intel and other chip makes use ASML in their production. ASML’s sales next year are set to rise to around EUR 28.5 billion from EUR 27.2 billion in 2023.

The firm’s third quarter profit, while still phenomenal, was slightly less than expected earlier in the year as higher interest rates stifled global growth. End buyers of phones, television sets and computers are more strapped for cash then they were a year ago and sales numbers are stalling – as are purchase orders for chip makers.

For this to change the Fed would need to commit to decreasing rates, a scenario that is not likely to come into play until early next year. Economic numbers in the UK and Europe are also looking less promising and retail buyers are likely to remain cautious at least for another quarter.

The chip supply chain, however, is far more complicated than that, with end buyers being far more diverse than just retail. Chips produced using ASML machines are in almost everything: industrial equipment, factory robotics, cars and digital medicine equipment.

While retail demand depends heavily on economic growth in specific regions, demand for computer equipment capable of producing next generation artificial intelligence is in a different league. The race to create next gen AI is more akin to an arms race; money is almost no object because whoever develops the dominant AI will have a phenomenal advantage.

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Which brings us to the China chip making export rules

In October last year the US brought in regulation with a very narrow scope, restricting the export of advanced computer chips for AI applications to China. The export rules also included the Netherlands and Japan.

According to the Center for Strategic and International Studies, “the three countries are working together in a way that challenges China’s ambitions across nearly every segment of the semiconductor value chain. The export control targets China across design, design software, fabrication, materials, chemicals and manufacturing equipment. Within equipment the combination of US, Dutch and Japanese controls covers nearly every type of advanced chip-making equipment.”

The outcome for Western companies is not straightforward. As much as China depends on foreign chips and equipment, Western companies’ sales are heavily dependent on sales to China. The upshot of the export restrictions introduced in October last year and the updated version tweaked for gaps released this week is not only that major relevant manufacturers’ sales into China will decline but also that China will eventually build itself up to be more self-sufficient in other aspects of chip making.

The Beijing government has waved through heavy investment in domestic research and development and although China is still a good few years away from being high-level chip self-sufficient, current efforts will eventually create a different supply-demand dynamic in which Western technology companies will be slightly edged out.

There are too many moving parts to make a clear prediction on this one so the recommendation will have to be – keep an eye out for changing dynamics.

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