This week we begin a two-part series exploring the recently passed CHIPS and Science Act and the Inflation Reduction Act (IRA). Two pieces of legislation, the passage of which will undoubtedly be the defining moments in the Biden presidency (and possibly make a big impact on your investment portfolio)... It may seem somewhat questionable that we would choose to combine these two pieces into one conversation given their disparate outcomes. But we contend that the passage of both acts represents a trend of particular importance to investors going forward. Simply put, it is the increasing intervention of policymakers into questions of capital allocation and picking the winners (and dare we say losers). Let's illustrate the last point with a story. The story begins with JEDI, an abbreviation for the Joint Enterprise Defense Infrastructure project. The story of JEDI started in 2019 when the Pentagon intended to consolidate its cloud infrastructure. Though awarded to Microsoft initially and estimated at a price tag of $10bn USD, the contract was eventually challenged by none other than Amazon (AWS). The entire project was rebranded as JWCC (Joint Warfighter Cloud Capability), with a multi-vendor approach and an unknown budget with the potential to run into the billions. Aside from making judgements on government inefficiencies, it certainly does show the potential for government and agencies to impact markets significantly. The days of software engineers threatening to resign, such as when Alphabet bid for Department of Defence (DoD) contracts, to Silicon Valley shying away from the Pentagon, are now officially at an end. The Russia-Ukraine war and increasing tensions with China have changed the nature of the game. As a result, Amazon and Microsoft now bid for DoD contracts. Venture capital (VC) funding for American aerospace and defence startups has also tripled from 2019 to $10bn USD p.a.. So how does this relate to the topic of the series, the IRA and the CHIPS and science act? We shall answer it simply below. What's in the CHIPS and Science Act?Let's begin with the CHIPS and Science Act, hereafter referred to as simply CHIPS. The law authorises the Department of Commerce (DoC), Department of Defense (DoD), and Department of State (DoS) to engage in activities to develop onshore domestic manufacturing of semiconductor chips critical to U.S. competitiveness and National Security. The house leadership specifically refer to the fact that only 12% of chips critical to U.S. competitiveness and national security in the U.S. are manufactured domestically. Furthermore, legislators take a mercantilist approach when referring to China and its continued investment in advanced capabilities. They state that regulators will have significant oversight in ensuring that “recipients of Federal funds” cannot build advanced production facilities that present a national security concern. Reading through the details of the actual legislation, specifically crucial for technology-minded investors, was the push toward shoring up the global telecommunications supply chain and intentionally targeting the scope of global involvement for companies with ties to China. Here, the elephant in the room is Huawei. What is also interesting on this front was a specific reference to funds being used to capitalise on U.S. software advantages and the development of an open-architecture (OpenRAN) model. We speak more in-depth about this in our 2019 article, “It's Huawei or the Highway: Empire Building Chinese Style.”. Beneficiaries here could include Huawei’s major competitors, potentially in for a 27 Billion USD windfall (for 5G rollout). These are global giants Samsung, Ericsson and Nokia, all of which reside in jurisdictions more palatable for legislators. Looking more domestically and using the broader categorisation of cloud and platform infrastructure, we can similarly see reasonable benefits flow through for Amazon (i.e. AWS), Oracle, Microsoft, Alphabet and VMware. Sticking on Microsoft, this changing landscape may bring back the company's interest in acquiring Nokia. Note on the above: For the more discerning; you may have noticed the similarities in companies discussed here regarding telecommunications to those likely to be beneficiaries of pentagon and DoD exposure. It may be that congress and the White House push valuations in the opposite direction as the Fed normalizes policy. This possibly also spells the death knell for confrontational regulators (the rhetoric was very much about competition and antitrust not too long ago). Looking into the NumbersSo now that we know broadly what CHIPS aims to do, let us get to the numbers. The total price tag for the program is $54.2bn USD. While this may seem a little less significant than the ambitions elucidated to date, the implied message is one of reshaping global telecommunications and semiconductor supply chains (effectively reversing years of capital and investment flows). We would suggest that this is only the beginning; more will come. Looking through the categories of how the money has been appropriated can shed significant insight into where the priorities lie (and where future flows are likely to go). We shall further combine this with the priorities of the IRA in our next piece to see a clearer picture, despite the bills seemingly addressing different issues. So let us break it down ($USD):
Now that we’ve understood what the headlines have made clear, we dive into something they did not. In classic form, the 1000 pages that make up the act calls for an additional $280bn in spending. Because of the nature of partisan politics, the bulk of the expenditure was authorised but not appropriated. What do the appendices imply? CHIPS also authorizes the largest investment in public R&D in history. This is an amount of over $169.9bn and an additional $82.5bn over baseline, with the largest allocations going to the National Science Foundation and Department of Energy. The Big PictureWithin this bigger context, the overlooked aspect of the legislation makes even greater sense. This detail pertains to the sweeping powers given to the Secretary of Commerce to consider updates, thresholds, prohibitions on manufacturing in countries, export controls and defining restricted process capability thresholds critical to national security. All of which will of course be done in consultation with the Secretary of Defense and Director of National Intelligence. Simply put, CHIPS will realign and take a more holistic view of existing supply chains and technologies subordinating commercial imperatives to the broader national security and geopolitical agenda. In other words give regulators the upper-hand. Next week we look at the IRA and how it relates to CHIPS and what it means for the investor broadly. In addition we also highlight some securities that will be beneficiaries going forward and the potential for increased M&A appetite in the sector (a rarity of late when it comes to the tech sector).
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