No. 17


The conflict risk in South Korea is no longer near zero
Prudent investors should look at potential impact
A brief look at semiconductor infrastructure risk
Way back in 1996, we wrote a research report looking at the risks to the PC ecosystem when a belligerent China was lobbing missiles over the runaway nation state of Taiwan.
Some things never change...Just the names of the players...21 years later...
Today the risk comes from North Korea with the technologically driven South Korea in the potential crosshairs

In our view the risk to the technology ecosystem centered in South Korea cannot be ignored given the increasingly confrontational tone on both sides.  
Much of todays technology originates or passes through Korea much as Taiwan dominated the PC industry in 1996. 
Concentration brings risk and the interconnected nature of todays supply chain spreads that risk well outside the borders of Korea.

The risk is to South Korea not the US

While many may think that the North Korean risk is that of an ICBM launched from North Korea towards Los Angles, the real risk is much more pedestrian. North Korea has thousands of pieces of old fashioned artillery near the border with South Korea dug into granite mountains. Along with rocket propelled munitions it puts Seoul and much of South Korea well within range.
If the US were to launch a strike against the North and its nuclear ambitions the most likely and easiest retaliation from North Korea would be against South Korea through simple but very effective artillery.
In the past random artillery shells have hit South Korea. The north could either send a rainstorm of shells down on Seoul and civilians or a more measured action with a few specifically aimed rounds.
If North Korea military planners wanted to make an "impact" on South Korea and therefore the US without killing a lot of people (not that they care...but it could start a real war) they might target high value industrial targets. The highest value most economically damaging single target owned by the largest "flagship" company in Korea, Samsung, would be one of their fabs. Given that the most profitable part of the biggest company in South Korea is the semiconductor division, a couple of artillery rounds lobbed into a fab could shut it down for 6 months to a year very easily, and do hundreds of millions if not billions of damage perhaps without triggering a broader war.

Highway to the danger zone

Looking at the above map, a number of fabs and other high tech manufacturing is in the "danger zone", from Samsung, SK Hynix as well as many, many other companies. The danger zone is essentially all of South Korea as it is well known that North Korea has teams of saboteurs & infiltrators in waiting.......

De-Risking a Portfolio

Long Micron-Short SK Hynix

In the world of NAND and DRAM, the supply demand balance is already tight with prices high. If SK's memory operations were damaged, Micron is a clear beneficiary as Boise Idaho is pretty safe (and boring...). With memory supply taken off the market if a fab had a problem, prices would skyrocket and Micron would certainly benefit.  Even Microns international operations are in relatively safe locations.

Long Apple-Short Samsung.....Maybe and maybe not

While on first blush this "pair trade" seems to make sense, that Apple would benefit at Samsung's misfortunes, thats only assuming that Apple could still make phones to replace lost Samsung sales.  What happens if a key component, like a display, is made in Korea for Apple? Most Apple components are made outside Korea but is that the case for the Iphone 8?  Maybe Apple would be a short along with Samsung and the Chinese phone maker Xaomi is the real winner....an interesting outcome...

Go long TSMC

We want to be long TSMC anyway as we think they are great but taking out Samsung foundry operations would leave only TSMC standing with bleeding edge technology. GloFo would benefit but there is no public equity to buy. Samsung still has its fab in safe Texas but its way not enough.

Intel is Safe and maybe benefits

We don't know of significant exposure that Intel has in Korea.  Maybe Intel's alleged foundry business could see some customers, but the lead time is long. We don't see significant other benefit so Intel is likely neutral

Semiconductor Equipment- Short term horrible- longer term good- overall negative...

All semiconductor equipment makers have significant exposure to Korea and all would be hurt. Perhaps LRCX and ASML have the highest exposure as AMAT and KLAC have higher exposure to TSMC.  
The short term would likely be like driving off a cliff without skid marks as shipments to Korea would likely be halted. It could be several quarters of zero business in Korea and loss making.  In the longer run, when things would be safe again, obviously business would be off the charts to make up for lost shipments and any damaged tools. The disruption would be difficult as what do you do with finished inventory and do you keep making tools for a customer you can't ship to? It would be a mess.....

What about the Korean semi equipment industry?

There are a significant number of Korean equipment companies and sub-suppliers to the semiconductor industry.  Most of them have the majority of their business in Korea and tend to serve Samsung and SK but there could be disturbance to US manufacturers as Samsung has been on a long term process to "buy Korean" and incorporate parts made in Korea into US tools. US alternatives could benefit.

A long string of dominoes...

Obviously many, many things made in Korea are at risk and too many for us to analyze; cars, TVs and displays, kimchee, soju etc, etc. However we are just trying to stimulate thought on investment and business risks.
A large scale conflict in Korea would obviously impact the entire stock market in many countries but smaller, more limited actions might only impact certain companies more than others.  We think the odds are higher for smaller conflicts in Korea as we think both sides want to avoid all out war but a lot of "tit for tat "  could get nasty with things flying both ways across the DMZ and South Korea is clearly in the collateral damage zone.

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