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%.
     

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