This article first appeared in Digital Edge, The Edge Malaysia Weekly on May 27, 2024 - June 2, 2024

At the recent soft launch of the KL20 Summit 2024, Minister of Economy Rafizi Ramli said chasing unicorns is a “policy of the past”. Indeed. In fact, Malaysia has long been a unicorn breeder — in the semiconductor space.

To illustrate, JP Morgan reports that the country hosts semiconductor companies valued at RM13 billion — dominating the market with about 72% of all ringgit-denominated listed unicorns in Asean — with a combined market capitalisation of RM56.5 billion. Start-ups in their own right at some point in their life cycles, these are fast-growing, profit-generating companies that are competing in an over US$500 billion (RM2.36 trillion) global industry. Not too shabby for the motherland.

As Minister of Investment, Trade and Industry Tengku Datuk Seri Zafrul Abdul Aziz mentioned, “Malaysia achieved a historic high in approved investments of RM329.5 billion in 2023, a 23% increase from the previous year, with foreign investments constituting 57.2% of the total.” The strategic “China Plus One” approach has attracted multinational corporations to Malaysia as an alternative production hub.

This is largely thanks to Malaysia’s five decades of “back-end” semiconductor manufacturing experience, giving the industry a well-established infrastructure to continue to proliferate, with most of the activities concentrated in Penang.

Today, Malaysia has a 13% share of the global market for chip packaging, assembly and testing services, according to the findings of the Malaysian Investment Development Authority. Amid global chip demand weakness, exports of semiconductor devices and integrated circuits (ICs) from Malaysia increased by 0.03% to RM387.45 billion in 2023.

From 2015 to 2022, Malaysia’s electrical and electronic (E&E) sector, which is largely dominated by the semiconductor space, contributed nearly RM458.3 billion to the country’s GDP and about 39% to the national export earnings. As a result, the country has grown into one of the world’s top five exporters of ICs and semiconductor devices.

More significantly, the export levels of E&E and ICs have grown at a compound annual growth rate (CAGR) of 9% and 16% respectively in the last five years — numbers not to be scoffed at — while boasting the highest rates in Southeast Asia.

With the ongoing geopolitical tensions between the US and China, Malaysia has begun to emerge on the radar screens of various stakeholders in the semiconductor industry. Well positioned as a neutral party in this chip war, the country appears to be an ideal alternative destination for foreign manufacturers to set up shop outside of “rival” states.

This tailwind could possibly propel Malaysia into one of the top destinations, not just for investors but also for people, as the industry would, no doubt, serve as a major catalyst for economic growth, skilled employment opportunities and more.

Such catalytic growth was evident in the 1970s, when American chip giant Intel (back then more similar to a start-up) chose to set up its assembly plant in Penang, which created thousands of job opportunities for the locals. The move was followed by other global players such as AMD, Hitachi and HP. These companies subsequently produced amazing local talents that went on to set up their own semiconductor businesses, such as the recently listed Oppstar Bhd.

The arrival of generative artificial intelligence applications, forecast to add up to US$4.4 trillion annually to the global economy, according to McKinsey, has only compounded the tailwind as the space requires almost an unlimited supply of computation power to keep up with the soaring demand, thus driving an unprecedented boom in the semiconductor industry.

Add to that the fast-growing electric vehicle (EV) market, which is expected to triple to US$1.6 billion by 2030, where the evolution from mechanical vehicles to EVs compounds the global need for ICs.

In theory, with most of the pieces in place, Malaysia should be well poised to capitalise on these tailwinds. But it is no longer the 1970s and the country is not the only attractive option for stakeholders in the space. In the words of Austrian philosopher Ludwig Wittgenstein, “Resting on your laurels is as dangerous as resting when you are walking in the snow. You doze off and die in your sleep.”

Malaysia is not the only one that seeks to propel itself as a global semiconductor hub.

Neighbouring Southeast Asian nations are wasting no time in courting global semiconductor players to set up operations on their home ground. Vietnam, for instance, has pledged tax incentives and other perks to help develop the sector. More importantly, it is the top target for US CHIPS Act subsidies, which could be viewed by companies as a stamp of approval provided by the US government.

Thailand too is vying for a piece of the semiconductor pie. Like Malaysia, its E&E industry is one of its main foreign investment magnets. The country’s Board of Investment has earmarked capital to be invested in an upstream semiconductor factory to produce wafers — a move to strengthen its front-end game.

Thailand is also creating a domestic sector that unites suppliers and production lines for EVs. A domestic EV industry would give the country an advantage in attracting foreign investment since these vehicles are anticipated to contain more semiconductor devices than petrol-powered ones.

Over the years, our next-door neighbour Singapore has built up capabilities in the front end, particularly wafer fabrication. Today, the island state is responsible for about 5% of the world’s wafer capacity.

While Malaysia has one of the most comprehensive and fastest-growing semiconductor ecosystems in the region, it has remained mostly a key player in assembly, testing and packaging activities, generally known as the back-end part of the entire supply chain.

There is nothing wrong with back-end manufacturing, of course. But it contributes only 10% to the value of a finished semiconductor chip. With all the ongoing competition across the region, Malaysia risks losing its lead and importance in the semiconductor industry if it does not move up the supply chain.

But similar to raising a child, it requires a village — or in this case, every stakeholder — to do so.

In the past, Malaysia took steps to move up the semiconductor supply chain through the establishment of SilTerra in 1995, a company that focuses on IC fabrication. But the project, which cost the country a whopping RM5.5 billion, still failed to make a mark in the front-end industry due to insufficient volume production, which led to an inability to recover the high operating costs of the overall business.

SilTerra’s arduous journey highlighted that various stakeholders, not just the government, need to be involved in developing the front-end sector. Establishing a fabrication facility is only a small part of the equation in propelling the sector forward. Other areas, such as the early stages of innovation, prototype creation and testing and developing concepts, are equally important in the grand scheme of things.

But the pursuit is and will be a costly one.

Recent research by RHB Investment Bank noted that the path towards developing high-value segments in the coming decade would suggest Malaysia needs to increase its foreign direct investment (FDI) inflows to levels seen in East Asia development markets of around 15% to 20% of GDP, against the country’s 4.2% of GDP as at 2022 (that’s about RM64 billion for anyone not doing the maths).

A huge undertaking but definitely not impossible.

The Malaysian government is ramping up its engine through the establishment of a National Semiconductor Strategic Task Force to look at incentives, talent and ecosystems that could drive the industry forward. On capital involvement, government-linked funds such as Permodalan Nasional Bhd, the Employees Provident Fund and Kumpulan Wang Persaraan (Diperbadankan) recently made a RM2 billion investment in ams Osram AG’s Malaysian operations.

It is common for the public sector to play a catalytic role in spurring involvement from the private sector. But it is extremely crucial that Malaysia gets its narrative right this time.

The country needs to play on its strengths, that not only does it have a solid back-end ecosystem that can support front-end activities but it is also a viable destination for investors — foreign and domestic — to place their bets here with a clear set of exit options.

SilTerra struggled because Khazanah Nasional Bhd was the only core pillar funding it and there were only so many losses and risks that the sovereign wealth fund could stomach. Arguably, as any sovereign wealth fund should be a staunch protector and harvester of any national proceeds, Malaysia needs to diversify its risk with foreign investors. Tax incentives and subsidies are some of the ways to lure in foreign capital — one of the many first steps of the movement — although there is a natural floor to any natural tax policies globally (that is 100%). Viable exit options matter more in the long run as investors need to generate returns.

Based on this context, venture capitalists are well positioned to capitalise on this development due to their relatively higher risk appetite.

While the semiconductor space is deemed less “in” than pure tech companies, it potentially does boast “tech-like” gross margins. Malaysian semiconductor companies such as Unisem (M) Bhd and KESM Industries Bhd are generating margins of 63% and 83% respectively and on top of that, they remain consistently profitable. These companies may no longer be deemed start-ups but they have been through the journey of one: starting up, scaling growth, eventually achieving profitability and listing their operations on Bursa Malaysia.

One of those that have captured such nuance is the recently announced US$200 million BlueChip VC Sdn Bhd co-founded by Datuk Lai Pin Yong, a former engineer for Intel’s Penang facility back in the 1970s who then went on to build a successful career in the semiconductor industry. The fund is targeting upstream activities, specifically IC design, advanced packaging and niche equipment.

Efforts are being made, but do they suffice? For a once-in-a-lifetime global opportunity, probably not.

Malaysia has one of the strongest, if not the strongest, leads in the semiconductor manufacturing sector in the world. It is now time to capitalise on the solid foundation that we have built over the last 50 years to thrust the nation forward or risk being left behind in an increasingly competitive world. In the immortal words of George R R Martin (specifically for the character Cersei Lannister), “When you play the game of thrones, you win or you die. There is no middle ground.”

It is now or never.

Raja Hamzah is a director of Talentcorp, and an avid investor and advisor in the technology space

Y C Ng is a partner at Jakarta-headquartered AC Ventures, which invests in early-stage technology companies, and oversees the firm’s mobility fund (Southeast Asia Frontier Fund LP)

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