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China Gets Semi-Enthusiastic. Watch Where the Money Goes

|Includes: AXT Inc (AXTI), NTP, TSM
I have been waiting patiently for China to drop the other shoe. Finally a few days ago it happened. Beijing has at last revealed where its big money will be going to (and coming from) in the next nine years.

You may remember that phrase "pillar industries." This is a uniquely Chinese phrase that cropped up late last year during the creation of the country's next Five-Year Plan. Titles like that may sound mind-numbing and bureaucratic. But in China they have meaning. And real money behind the meaning.

In this case: one-point-five-trillion dollars of investment.

Investors got some idea of China's future pillar-industries last year. But since then, Beijing has been coy about releasing actionable details.

There wasn't a lot of guidance investors could use in China's first statement about its strategic goals. The Communist Party declared, in a general way, that the future of the country lay in "new-generation information technology, energy-saving and environment protection, new energy, biology, high-end equipment manufacturing, new materials and new-energy cars."

Since then I've been waiting for details. Now I have them.

Chinese Pillar Revealed

In a little-noticed report, Beijing declared that China will boost the integrated circuit (IC) sector at a "state strategy" level over the next five years (through 2015). As if to minimize western attention, Yang Xueshan, the vice minister of industry and information technology used the old fashioned term "integrated circuit."

We all know these complex circuits as microchips. They are the heart of every portable electronic device on the planet. Microchips can hold billions of pieces of information or process millions of operations a second. And right now China is far behind in this crucial field.

China's global sales of chips made up less than nine percent of the worldwide market last year. Amazingly, China can meet only 20 percent of its internal demand.

China loves to export, but when it comes to electronic chips, China must import more than $156 billion worth annually. Right now Chinese industry simply doesn't have the expertise or the high-tech machinery it needs to build the most modern chips.

That is going to change. And believe me, when Beijing resolves to push its way into a certain industry, amazing things do happen. Look out Intel!

That's Where the Money Goes

It takes big money to build small chips. Just designing a modern chip will cost China $40 million. Building a single production line similar to an Intel factory will cost $2.5 billion.

But money and special treatment are about to be delivered to China's chip-makers by the shovel-full. Just look back at what was promised when China announced it would establish these pillar industries.

The state pledged tax and fiscal policies to support business innovation and the industrialization of scientific research. That means big tax breaks and grants.

Beijing's plan said it would guide mergers and acquisitions to increase manufacturing industry concentration. That means the government will be arranging mergers and buy-outs in the chip industry in order to create one or more national giants like Intel.

Is financing a problem with new research? No problem.

Beijing says it will encourage financial institutions to finance the growth of these industries. It will also ask venture capital firms and private equity funds to provide new funding.

Trouble getting the permits for new plant construction? Don't worry. The government will "adjust tax and pricing systems for land, water and electricity to drive growth in the sector."

In China's relatively splintered chip-making field it will be hard to pick the big winner in chip making – the kind of company that the Chinese like to call a "national champion" at this early point.

One interesting bet is a company that provides the basic materials for chip-building, AXT Inc. (AXT) is a developer and producer of compound and single element semiconductor substrates. (These are the discs that chips are built on.) They include platforms made from exotic semi-conductors including gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge).

Another possible beneficiary is Nam Tai Electronics, Inc. (NTE) The company is an electronics manufacturing and design services provider to original electronic manufacturers of telecommunications and consumer electronic products.

Another big contender is headquartered in Taiwan, but does much of its manufacturing on the mainland. Taiwan Semiconductor Manufacturing (NYSE:TSM) is a highly profitable company involved in the research, development, and manufacturing of integrated circuits. It is considered to be the world's largest chip foundry.

TSM is already a huge company with a market cap topping $65 billion and a dividend yield of more than 3.7 percent.

We may have to wait a while to see who emerges as China's national champion. Meanwhile, I'm betting tentatively that a rising tide will lift most boats in this economically strategic sector.

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