When it comes to the chip industry chain, the most critical link might not be chip design but rather contract manufacturing at scale.

Chinese mainland companies have long designed high-tech chips; the most typical example is the Kirin chips designed by HiSilicon, a subsidiary of Huawei, for smartphones. However, they have always struggled to find contract manufacturers with the technological capability to produce these chips in large quantities. It wasn't until this year, with the launch of the Kirin 9000s on the Mate 60 series, that we saw the possibility of "light boats passing through ten thousand mountains."

Of course, it's still unclear who the contract manufacturer of this chip is. Huawei has been keeping a low profile, with no official response to even the most exaggerated online rumors, likely to protect the contract manufacturer and avoid causing trouble.

Undoubtedly, the "big gun" in the global chip contract manufacturing industry is Taiwan Semiconductor Manufacturing Company (TSMC) from Taiwan, China. Not only does it hold a market share of 60% of the entire industry, but more than half of its revenue comes from cutting-edge processes below 7 nanometers.

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There are many reasons why TSMC is so formidable, and one extremely important factor is its good relationship with the Dutch lithography equipment company ASML. It is said that when ASML was being suppressed by Japan's Nikon and Canon, TSMC advised ASML to change the medium of the lithography machine from air to water, which ultimately led to a successful trial and established ASML's unique technological advantage. ASML was the first to manufacture high-end DUV lithography machines and is currently the only company capable of manufacturing the most advanced EUV lithography machines.

There is no doubt that ASML's comeback is inseparable from TSMC. Therefore, TSMC never has to worry about not being able to buy high-end lithography machines, as the two companies jointly hold absolute authority in the field of semiconductor manufacturing.

Of course, for ASML, selling lithography machines only to TSMC is far from enough. Mainland China, South Korea, and the United States are also its main customers, especially our companies, which contributed half of ASML's lithography machine sales revenue in the third quarter of this year.

Recently, ASML announced its financial data for the third quarter of 2023. Amidst the current downturn in the global semiconductor industry, ASML's revenue, although slightly lower than market expectations, is still in a good overall condition. This is related to its technological monopoly, especially after cost reduction and efficiency improvement, ASML's gross margin in the third quarter has increased compared to before, resulting in a slight increase in profitability.

From July to September 2023, ASML achieved a total operating income of 6.7 billion euros, of which 5.3 billion euros were revenue from the sale of lithography machines, and 1.4 billion euros were service revenue. In terms of net profit, the third quarter profited 1.9 billion euros, a sequential decline for two consecutive months, but a year-on-year increase of 11.3%.

The biggest highlight of the third quarter was the revenue from Mainland China, which accounted for 46%, far ahead of other regions. The second-ranked revenue came from Taiwan, China, accounting for 24% of the total revenue in the third quarter. South Korean contract manufacturers contributed 20% of the revenue, and the United States accounted for 5%.As previously mentioned, the operating income from the sale of photolithography machines from July to September was 5.3 billion euros, which means that Mainland Chinese companies purchased photolithography machines worth 2.44 billion euros (5.3 billion * 46%) in the third quarter. Assuming that without this revenue, ASML's revenue would drop from 6.7 billion euros to 4.26 billion euros, a sequential decline of 38%.

What does this mean for ASML? In addition to a significant decline in operating performance, the stock price will suffer a heavy blow. Considering the impact of future adverse expectations and market irrational selling, it is possible for the stock price to fall by more than 50% in the short term.

It is worth noting that the revenue share from Mainland Chinese companies in the third quarter of this year is the highest in recent quarters.

In the second quarter of 2023, the revenue from photolithography machine sales in Mainland China accounted for 24% of the total revenue, while in the first quarter it was only 8%, and in the fourth and third quarters of last year, it was 9% and 15%, respectively. This may be related to the Dutch government's export control on high-end DUV photolithography machines.

There have been reports that under pressure from the United States, the Netherlands has strengthened export controls on ASML, and high-end photolithography machines need to be approved in advance for export to Mainland China, and can only be shipped out with an export license. In order not to breach the contract, ASML delivered the DUV photolithography machines ordered by Mainland Chinese companies before the export ban took effect, resulting in a large number of photolithography machines sold to us in the second and third quarters, especially the revenue in the third quarter, which almost accounted for half of the total revenue.

However, we have found that the Dutch government has "gone back on its word". According to foreign media reports, ASML has obtained permission to continue exporting photolithography machines to Mainland China in the fourth quarter, which means that ASML's three mainstream DUV photolithography machines NXT:1980Di, NXT:2000i, NXT:2050i will not be temporarily out of stock, and the revenue share from Mainland China in the fourth quarter this year is still likely to be high.

Why did ASML obtain an export license shortly after the ban took effect? I guess it may still be coveting China's huge semiconductor market.

ASML is an important enterprise in the Netherlands, creating a large amount of tax revenue and job opportunities every year, which is of great significance to the Dutch real economy. Both ASML and the Dutch government know what it means to lose the Chinese market and completely cut off supplies. On the surface, they comply with the United States' wishes and issue bans, but in actual operations, they constantly test the United States too much, and issue licenses as soon as there is a slight loosening, selling as much as possible and delaying as long as possible.

In addition, both the United States and the Netherlands are worried that a complete cut-off will force Mainland China to accelerate the development of high-end photolithography machines. Once the pearl on the industrial crown is quickly taken, there will be fewer and fewer restrictions on China's manufacturing industry transformation in the future. It has been proven that the more difficult the situation, the stronger China's resilience, and its potential can be quickly unleashed. In the end, it is found that the real sanction impact is on the sanctioner itself.

We should make good use of the dilemma faced by Western countries in the Chinese market, play the role of the large market well, and expand the inconsistency of interests between Western governments and enterprises, to strive for enough time and space for self-developed breakthroughs, which is one of the important strategies for the smooth transformation and upgrading of China's manufacturing industry. Using the market to exchange technology is never outdated.