The Tech Cold War between China and America is ratcheting up…
On Tuesday, the U.S. Commerce Department announced new rules to close loopholes on exports of advanced semiconductors – aka chips – to China.
This comes roughly a year after the U.S. government first launched export controls on chips the ruling Chinese Communist Party can use for military purposes.
And it could tip the balance of power toward China and away from the U.S. and its allies.
According to a recent review by Australian defense experts, “China’s military build-up is now the largest and most ambitious of any country since the end of the Second World War.”
And the Chinese are putting a strong emphasis on AI-assisted weapons systems.
These include autonomous aerial- and ground-based drones. The Chinese military can use these for reconnaissance, surveillance, and combat missions.
China is also investing in AI to jam enemy radar and communications systems… as well as to augment its offensive and defensive cyberwarfare capabilities.
Estimates put the Chinese government’s AI spending at $150 billion by 2025.
The new measures will close loopholes the Chinese have exploited. And shockingly, they’ve done it with the help of leading U.S. chipmaker Nvidia.
Its shares are up 188% this year. But Nvidia has played fast and loose with America’s national security interests. Now, this threatens to send its shares plummeting.
Washington’s initial export ban was intended to stop China from accessing high-end chips, including Nvidia’s H100 chip.
It’s the AI-ready chip OpenAI uses to power ChatGPT. And it’s the premier AI chip on the market today.
But after Washington put export controls in place last year, Chinese tech firms found workarounds… with Nvidia’s help.
To get around the export ban, the California-based company created a China-specific chip – the A800.
It’s based on the same architecture as the H100. But it complied with U.S. export rules and still provided ample AI computing power.
And Chinese tech companies snapped them up.
In August, Chinese tech giants – including Bytedance, which owns TikTok, Baidu, Alibaba, and Tencent – scooped up $5 billion worth of A800 chips.
The Commerce Department aims to put an end to these workarounds with the new restrictions announced this week.
They ban exporting all high-performance AI chips that exceed certain processing speed and density thresholds, regardless of model or brand.
Nvidia tried to downplay the financial consequences, saying that the restrictions would not immediately affect earnings.
But I’m not buying it. And neither should you.
Sure, none of this will matter when Nvidia reports its third-quarter earnings in November.
But to fully grasp how the ban on sales to China will impact Nvidia, you must understand the accounting tricks the company uses.
Nvidia is a “fabless” semiconductor company. It designs its chips. But Taiwan Semiconductor Manufacturing Company (TSMC) makes them.
TSMC is the world’s largest chipmaker. It has a client list a mile long – including Apple, Google, Intel, AMD, and Tesla.
TSMC must secure the raw materials and equipment to make the chips its customers order. This requires Nvidia and other customers to make binding commitments to buy a specific amount of chips.
As demand for Nvidia’s AI chips has surged, it needs to make larger commitments to TSMC.
Nvidia calls these “future purchase commitments” on its financial statements.
To give you an idea of how much the company has upped these commitments, look at just the past three quarters…
January 29, 2023 – $4.92 billion
April 30, 2023 – $7.27 billion
July 30, 2023 – $11.15 billion
That’s a 126% leap since the start of the year.
And we won’t know its latest commitments until Nvidia reports earnings in November.
Critically, these are what are known as “off-balance-sheet” commitments. Nvidia has to disclose the commitment. But it can book sales and profits as though these commitments don’t exist.
When sales are strong, it’s not a problem for Nvidia.
But that hasn’t always been the case.
In 2020 and 2021, Nvidia made large commitments to TSMC to make chips for gaming and crypto mining.
When demand plummeted in 2022, Nvidia tried to back out of these commitments.
But TSMC didn’t budge.
And shares of Nvidia plummeted nearly 50% in 2022, in part because it misjudged demand.
Sure, Nvidia will pivot supply to the U.S. and other countries in 2024 as the new export rules choke off its supply of chips to China…
But as I showed you on Monday, it’s made poor decisions with its domestic sales, too.
Instead of allocating its chips to Amazon, Google, Microsoft, and other major players, it chose to send a chunk of that supply to startups it’s taken a stake in.
That led these tech giants to roll out their own custom chips to reduce their reliance on Nvidia’s chips.
Without China buying up extra supply of Nvidia’s silicon… and with competition closing in from well-resourced Big Tech companies… Nvidia is playing a dangerous game.
One it already lost when the crypto mining bubble burst just a few years ago.
This is why I recommend you avoid Nvidia stock.
As regular readers will know, I believe Nvidia is priced for perfection.
It’s so richly valued that the slightest disappointment in sales and earnings results will send shares tumbling.
Today, investors are willing to spend three times as much for each dollar of Nvidia’s earnings compared with its peers.
And with sales of its A800 chips to China no longer an option… and many of its Big Tech clients making their own rival chips… it will be hard to achieve perfection.
But this is great news for folks who own shares in a rival chipmaker set to become the leader in the industry.
It trades at a future price-to-sales ratio of 30 versus Nvidia’s price-to-earnings ratio of 100.
Its new AI chip outperforms Nvidia’s H100.
It’s all in the new presentation I’ve put together for you and your fellow readers.
As I show, this smaller company will power the next wave of AI profits.
And it’s caught the eye of legendary trader Ken Griffin… hedge fund billionaire David Tepper… and value investor David Einhorn.
It’s only a matter of time before everyone starts piling in… because this company is about to unveil the most powerful AI chip in history.
To get ahead of the pack go here to find out more.
Regards,
Colin Tedards
Editor, The Bleeding Edge
The Bleeding Edge is the only free newsletter that delivers daily insights and information from the high-tech world as well as topics and trends relevant to investments.
The Bleeding Edge is the only free newsletter that delivers daily insights and information from the high-tech world as well as topics and trends relevant to investments.
