Japan's strong-armed $21 bln chip bet is low risk

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    (The author is a Reuters Breakingviews columnist.  The
opinions expressed are her own.)
    By Robyn Mak
       HONG KONG, Oct 22 (Reuters Breakingviews) - Being
bullied into a $21 billion deal is hardly ideal but that's the
situation Tokyo finds itself in after agreeing to fund up to two
new chip factories in the US. It falls under a $550 billion
investment pact it struck last year with Washington in return
for lower US tariffs on Japanese imports and as a way of dealing
with President Donald Trump. At least for this venture, the
risks look as low as the returns. 
    The biggest winner is $26 billion GlobalFoundries  GFS.O ,
owned by Abu Dhabi sovereign fund Mubadala. The contract
chipmaker will construct and operate the first $10 billion
factory without having to commit a single dollar of capital. In
return, it will receive technology, construction and operating
fees, as well as an undisclosed share of EBITDA after 2030, when
the facility is due to start production.
    All together, GlobalFoundries executives reckon that will
amount to $3 billion in cumulative adjusted free cash flow over
the first 10 years. A second $11 billion factory is also under
consideration, presumably with the same arrangement.
    It means Japan is bearing all of the risk. Per the wider
terms of the 2025 agreement, Tokyo will also share half of
available cash flows from the project with the US until it
recoups its investment amount plus interest payments, after
which 90% of profits will go to the US.
    Assuming a 5% discount rate, roughly the yield on 30-year US
Treasuries, one analysis estimates projects would need to
generate annual returns of at least 13% for Japan just to break
even, reflecting the large share of profits that go to the US.
Washington will also more than double its stake in
GlobalFoundries to 7% as part of the deal, allowing it to
capture more of the gains. 
    Hitting that returns hurdle will be hard. GlobalFoundries
specialises in churning out commoditised chips used in cars and
smartphones. It had an average pre-tax return on invested
capital of just 10.4% over the past five years, according to
Visible Alpha, far below the roughly 50% at Taiwan's TSMC, which
dominates in higher-margin cutting-edge processors.
    Tokyo can salvage some value elsewhere. The US factory can
use Japanese equipment and components, boosting suppliers like
Tokyo Electron. Moreover, Renesas, which designs semiconductors
for auto giants like Toyota, can also benefit from diversifying
manufacturing towards the new GlobalFoundries fabs and away from
Taiwan, a democratically ruled island that Beijing claims as its
own. And there are worse partners for Tokyo than Abu Dhabi.
Perhaps the rich Gulf emirate will ultimately find a way to
repay Japan in other ways. 
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    CONTEXT NEWS
    GlobalFoundries on October 15 said it will operate two new
semiconductor manufacturing facilities at its New York site. As
part of the agreement, Japan will initially invest approximately
$10 billion for the first factory that will begin construction
by the end of 2026, and potentially another $11 billion in the
future. GlobalFoundries, which is owned by Abu Dhabi's sovereign
fund Mubadala, will provide technology as well as operating and
construction expertise, and receive fees and eventually a share
of earnings.
    The project falls under a US-Japan pact struck last year for
Japan to invest $550 billion in the US in return for Washington
lowering import trade tariffs. Per the arrangement with the US,
Trump selects projects to be funded ​by Japan. Available free
cash flow from investments will be split evenly between the two
countries until Japan recoups an agreed-upon amount, after which
90% will go to the ​US.
    In a separate agreement, the US Department of Commerce will
receive equity in GlobalFoundries of approximately 4%.
     

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    (Editing by Una Galani; Production by Eileen Soreng)
((For previous columns by the author, Reuters customers can
click on  MAK/   mailto:robyn.mak@thomsonreuters.com))