Huawei is threatening to take a slice out of Apple’s (US:AAPL) phone business after getting around sanctions to make a high-performance new 5G smartphone. The surprise for Huawei’s competitors is that the company has made it past a trade block on the manufacturing equipment needed to make the best microchips, resulting in the better performance of its new phone, called the Mate 60 Pro. 

The semiconductor industry is a key battleground in the US/China trade war, alongside the electric vehicle market.

This breakthrough is some years in the making. In 2019, the US convinced the Netherlands government to ban ASML (NL:ASML) from exporting its newest EUV lithography machines to Chinese companies. These are used to “to create the highly complex foundation layers of the most advanced microchips”, in the words of ASML. Consultancy TechInsights said Huawei’s new phone had a seven-nanometre (nm) chip inside, called the Kirin 9000s, an advanced piece of kit made by Chinese company Semiconductor Manufacturing International Corporation (SMIC). 

Apple comes into the picture because China is a key market. In 2020, Apple made $40bn (£33bn) from China, equivalent to 15 per cent of this revenue. By 2022, Chinese revenue had almost doubled to $74.2bn and was up to 19 per cent of the total. 

A large part of Apple’s tailwind in China was driven by the US government’s sanctions on Huawei. These crippled Huawei’s ability to make high-end smartphones by preventing US chip suppliers, such as Qualcomm (US:QCOM), from selling it 5G chips, as well as limiting local production. When this ban was imposed, Huawei’s revenue collapsed, falling 29 per cent between 2020 and 2021. 

While the Kirin 9000s is being hailed as a win for the Chinese semiconductor business. Apple is still ahead of Huawei in terms of chip technology. Last week, Apple released its new iPhone 15 Pro, which is powered by a new A17 3nm chip. It is designed by Apple and manufactured by TSMC (TW:2330) using ASML’s EUV lithography machine. This is the most advanced chip used in an iPhone and will significantly advance its gaming ability, for example. 

Despite the fact Apple’s technology is still ahead, it is likely to lose some of its Chinese market share to the Mate 60. There is a strong sense of pride among the Chinese population in the success of domestic companies. “For the majority of consumers, the difference in performance won’t be noticeable between the iPhone and Mate 60,” explained Jefferies analyst Edison Lee.

The problem for Apple is smartphone growth was already slowing. In the quarter ending 1 July, iPhone revenue slipped 2 per cent year on year and it now faces a new headwind in its third largest market. “If it starts losing a third of its China revenue it will have a meaningful impact on earnings,” said Jefferies tech analyst Andrew Uerkwitz.

More sanctions 

There is also some concern amongst analysts that the US government will respond by tightening sanctions further. A possible move would be to further increase restrictions on equipment manufacturers, such as ASML. However, it appears easier for the US to target artificial intelligence chip designers instead. “It took extensive negotiation for the US to convince the Netherlands to ban the EUV machines and the US will have to wait some time to re-enter negotiations,” said Lee.

The AI chips are mostly designed by US company Nvidia (US:NVDA), which makes them easier to sanction. Nvidia has already been banned from exporting its most advanced H100 GPUs, but it has less powerful A800s, which it has been selling to Chinese customers. In the 12 months to January, Nvidia made $5.8bn of revenue from China, equivalent to 21 per cent of its total.

The belief is that with the less advanced LUV machines, SMIC will be able to get to 5nm (down two from the chip used in the new Huawei phone) but won’t be able to get down to the 3nm without the most advanced EUV lithography machines. However, the yield with the 5nm chips will be even lower than it was with the 7nm. “The Chinese don’t really care how efficient the process is, the government will happily subsidise it in order to improve over time,” said Lee.

Apple is fighting an increasingly uphill battle in China. Earlier this month, the government banned its employees from using iPhones. This won’t materially impact Apple sales, but it shows the direction of travel: away from US companies.