Based on a review by the Committee on Foreign Investment in the United States (CFIUS), President Biden may soon issue a decision to block the purchase of a South Korean semiconductor company by a Chinese equity fund due to national security concerns, although the outcome is still uncertain at this point. The CFIUS review under the circumstances here indicates that the United States is further tightening China’s access to semiconductor technology, and to some extent may have internationalized the review process by working with allies on purchases of companies that mostly operate outside the United States. While the transaction at issue is a relatively small one, the CFIUS approach here suggests that both U.S. conflicts with China in the tech sector and China’s effort to be more self-reliant will continue.
The Korean semiconductor company and Chinese purchaser
In March of this year, the South Korean company Magnachip announced its sale for $1.4 billion to a Chinese company called Wise Road. Wise Road is a Chinese private equity fund, focusing on semiconductors and other high tech industries.
In the press release for this sale, Magnachip described itself as “a designer and manufacturer of analog and mixed-signal semiconductor platform solutions for communications, IoT, consumer, industrial and automotive applications” (an article in Foreign Policy by Tufts professor Chris Miller says that Magnachip “produces a type of semiconductor needed in the most advanced screens, such as those for the newest smartphones”).
One investment analyst described the company as being “headquartered in South Korea, incorporated in Delaware.” In 2020, “over half of its sales came from one customer, Samsung, and more than 60 percent of sales were derived from mainland China.” By contrast, “[r]oughly 1 percent, or $5 million, of [its] sales were from U.S. customers and the company has no other assets, operating activities, or employees located in the country”; and “other than this small amount of revenue, its domicile in Delaware, a few  board members residing in the U.S., and being listed on a U.S. exchange, [it] has no other ties to the country.” The press release states that after the sale “the Company will remain based in Cheongju, Seoul and Gumi, South Korea.”
The Korean and U.S. national security reviews
Magnachip did not notify the relevant government agencies in either Korea or the United States of a possible security issue due to a Chinese company taking control of its technology. In its initial SEC filing related to the purchase, it stated that “[o]ur Board considered that, although there is an antitrust filing that will be required to be made in the PRC, there are not likely to be significant antitrust or other regulatory impediments to closing, including none expected in the United States or in the Republic of Korea.” However, both governments subsequently notified the company that a review on security grounds/technology protection grounds would be taking place.
Starting with Korea, in a June 4 SEC filing, Magnachip said it did “not believe the Merger will require any approval in South Korea,” but noted that it would “cooperate with South Korean governmental authorities should they have any questions regarding the transaction.”
The relevant law in Korea is the Act on Prevention of Divulgence and Protection of Industrial Technology. The law was passed in 2017 and revised in 2019. The revised law came into force on February 21, 2020. The revision tightens the procedures for foreign mergers and acquisitions that involve a “national core technology,” requiring that any foreign transaction of this type must obtain prior approval from the government.
Under the law, the term "national core technology" means those technologies specifically designated by the government, based on the following criteria: “has high technological and economic values in the Korean and overseas markets or brings high growth potential to its related industries and is feared as a technology to exert a significantly adverse effect on the national security and the development of the national economy in the event that it is divulged abroad.”
The technology involved here is commonly referred to as OLED display driver IC, and is used for smartphone displays. In the June 4 SEC filing, Magnachip stated that “[e]ven if OLED DDIC is included as a National Core Technology under applicable regulations, the overseas sales of products made with such technology will generally not require any approval since the sale of products is not considered an export or a transfer of National Core Technology.”
Nonetheless, according to sources familiar with the transaction, on June 9 Korea's Ministry of Trade, Industry and Energy ("MOTIE") issued an administrative notice related to the possibility of designating OLED DDIC as a “national core technology.” Then on July 14, MOTIE designated OLED DDIC as a “national core technology.”
A June 16 SEC filing by Magnachip explains how the Korean government notified Magnachip about the review of the transaction: “On June 16, 2021, Magnachip Semiconductor, Ltd., the Korean operating subsidiary of the Company (“MSK”), received a letter from the Korean Ministry of Trade, Industry and Energy (“MOTIE”) requesting MSK to either apply for an approval or file a report, as may be applicable, under Article 11-2 of the Act on Prevention of Divulgence and Protection of Industrial Technology (the “ITA”) concerning the Merger.” Magnachip described the implications of this request from MOTIE as follows: “Under the terms of the Merger Agreement, MSK’s receipt of the request from MOTIE to apply for approval or file a report pursuant to the ITA concerning the Merger may be deemed to have resulted in the closing of the Merger now being conditioned on the receipt of MOTIE’s authorization without the imposition of a burdensome condition as defined in the Merger Agreement.”
Magnachip applied for approval on July 20, and MOTIE is still in the technical review process.
Turning to the situation in the United States, Magnachip may have believed that its connection to the U.S. market was too limited to require a notification. A WSJ report noted that “Magnachip officials said the deal doesn’t deserve U.S. scrutiny because its operations are in South Korea and almost all of its sales and employees are in Asia and Germany.” As the company itself explained in an SEC filing, its U.S. entity is “a holding company” with minimal connection to the U.S. market:
All manufacturing and research and development activities take place in South Korea, and substantially all sales activities take place in South Korea, with the remainder of sales operations located in China, Hong Kong, Taiwan, Japan and Germany. Substantially all of the employees are based in South Korea and employed by Magnachip Semiconductor, Ltd., the Korean operating company (“MSK”); and the remainder of the employees are located outside the United States. There are no tangible assets or IT systems located in the United States, and all intellectual property is owned by MSK or, to a very limited degree, other non-U.S. subsidiaries of the Company.
However, the U.S. government apparently disagreed. As explained in Magnachip’s August 27 SEC filing, the company was contacted by the U.S. government about the purchase:
As previously disclosed, on May 26, 2021, outside legal counsel of each of the Company and Parent received an e-mail from the U.S. Department of Treasury on behalf of the Staff Chairperson of the Committee on Foreign Investment in the United States (“CFIUS”). In the e-mail, the CFIUS Staff Chairperson, acting on the recommendation of CFIUS, requested that the parties file a notice concerning the Merger and thereby undergo formal CFIUS review of the Merger. The Company and Parent filed such notice with CFIUS on June 11, 2021.
Then on June 15, the U.S. Treasury Department, acting on behalf of CFIUS, sent a letter with an “Order Establishing Interim Mitigation Measures.” This Order imposed the following interim measures, effective as of June 15:
(i) neither of the Company or Parent shall take any action, directly or indirectly, to close, consummate, complete, or effectuate the purpose of the Merger, including: (a) the transfer, lease, license, or sale of any asset or subsidiary of the Company to Parent or any affiliate thereof, (b) the merger of Parent or any affiliate thereof with or into the Company or any affiliate thereof, or (c) the acquisition of any equity or other ownership interest in the Company or any affiliate thereof by Parent or any subsidiary thereof; (ii) Parent shall not take, and shall ensure that none of its subsidiaries take, any security interest in the Company or any affiliate thereof; and (iii) the Company shall not take any action to: (a) change its state of incorporation from Delaware to any other jurisdiction or (b) delist from, or modify the existing listing of the Company on, the New York Stock Exchange.
Finally, on August 27, Treasury sent a letter indicating that:
(i) CFIUS has identified risks to the national security of the United States arising as a result of the Merger, (ii) CFIUS has not identified any mitigation measures, including those proposed jointly by the Company and Parent, that CFIUS believes would adequately mitigate the identified risks, (iii) absent new information arising during the investigation period that alters CFIUS’s assessment of the national security risks or the feasibility of mitigation measures to resolve those risks, CFIUS anticipates that it will refer the matter to the President for decision, and (iv) the Company and Parent could provide additional information to CFIUS for consideration, including proposals to permanently mitigate the identified national security risks.
Based on this explanation, it appears that CFIUS notified Magnachip of its decision to block the transaction. That places the final decision with President Biden, who will act after receiving a recommendation from CFIUS.
In a September 13 SEC filing, however, it seems that Magnachip is making one last effort to explore options for mitigation measures that might allow the transaction to go through, and that CFIUS has granted extra time for this:
By letter dated September 10, 2021, the Company and Parent, through outside legal counsel, asked CFIUS to permit them to withdraw and re-file their June 11, 2021 notice concerning the Merger, in order to permit further discussion with CFIUS concerning potential options for permanently mitigating risks to the national security that have been identified by CFIUS. By letter dated September 13, 2021, the Acting CFIUS Staff Chairperson notified the parties that CFIUS had granted this request and that a new CFIUS review period for the Merger would commence on September 14, 2021 and conclude no later than October 28, 2021. On October 28, 2021, CFIUS may extend its review process by undertaking a 45-day investigation. There can be no assurance that the Company and Parent will develop or agree to any proposals that would result in CFIUS clearance.
The outcome of this extension is uncertain. It could lead to mitigation measures that mean the transaction goes through; the transaction could still be blocked; or Magnachip might move on from Wise Road and find another purchaser.
The Chinese government is probably not happy about the U.S. blocking the deal. A recent Global Times opinion piece argued that “[i]f the US succeeds in blocking the deal this time, it could set a very bad precedent for global high-tech mergers and acquisitions, further consolidating the industrial concentration in the US.” Another Global Times opinion piece (link in Chinese) from June 24 used stronger words, stating that “the United States has intervened in many cases of overseas mergers and acquisitions by Chinese companies, which has resulted in these investment plans falling through. In the acquisition of Korean companies this time, the United States simply intervened. It has clear goals: not only to block China in the areas of chip strategy, technological exchanges and the construction of the industrial chain, but also to gradually control the Korean chip industry and influence its core groups to sever the American’s manipulation of the international industry, and to further disrupt the China-South Korea relations, high-quality cooperation and huge potential in this field. This is Washington's plan of ‘multiple birds with one stone.’”
China’s antitrust review
A much less controversial step in the process was the antitrust review carried out by the Chinese authorities. According to Magnachip in an SEC filing, the initial filing with Chinese antitrust authorities for clearance under China’s Anti-monopoly law “was jointly made by the Company and Parent on May 7, 2021.” Not surprisingly, the merger approval went smoothly.
On July 16, China’s State Administration for Market Regulation (SAMR) published (link in Chinese) its decision to categorize this transaction as a simple market concentration case, explaining that the businesses involved are not in the same relevant market and do not have an upstream and downstream relationship. In addition, they both have a share of less than 25% in each market related to the transaction. On June 21, SAMR unconditionally approved the transaction and published (link in Chinese) the decision on its website.
Magnachip reported the Chinese regulator’s approval in an SEC filing as follows:
On June 30, 2021, based on an application filed by the Company and Parent on May 7, 2021, the State Administration for Market Regulation (“SAMR”) announced that the Merger was cleared pursuant to the Anti-monopoly Law (China) on June 21, 2021. Under the terms of the Merger Agreement, the parties’ receipt of the clearance from SAMR satisfies one of the conditions to the closing of the Merger.
Lessons for future cases: A tougher and more international approach to security reviews of tech mergers and acquisitions with little connection to the U.S.
It is difficult to determine the extent to which the Korean and U.S. governments were cooperating on these issues, but that possibility cannot be excluded. The pre-2018 version of the U.S. foreign investment review mechanism did not explicitly provide for coordination with other governments, but under Section 1713 of the Foreign Investment Risk Review Modernization Act of 2018, cooperation with “governments of countries that are allies or partners” is permitted “in the discretion of the chairperson” of CFIUS.
The WSJ piece quoted a former U.S. government official saying, “[n]ot only will [Biden] likely be more aggressive, but as the Magnachip matter shows, he is multilateralizing Cfius among U.S. allies.” And Chris Miller of Tufts noted that, “[t]his apparent tag-teaming by U.S. and South Korean regulators seems strange, especially because, despite the CFIUS order, hardly anyone in Washington is aware that the U.S. government is blocking a transaction between a Chinese and a South Korean firm.” He also said that “[i]t isn’t clear whether the initial impulse to block the deal came from Washington or Seoul.” He concludes: “apparently in conjunction with the South Korean government, the Biden administration has de facto decided that all chip firms—even if small, seemingly innocuous, and barely linked to the United States—are off limits to Chinese buyers.”
The specific terms of the relevant U.S. and Korean legislation are not the same, but the fundamental goal is similar: To prevent important technology from getting into the hands of a geopolitical rival. Both laws give the responsible government agencies a great deal of discretion in assessing the risks and reaching a conclusion.
The initial CFIUS decision on the Magnachip transaction reflects an assertive and aggressive approach by the Biden administration to national security reviews for Chinese purchases of foreign technology companies. It shows how broadly the administration envisions its jurisdictional authority, as it has treated a purchase of a foreign company with only limited connections to the United States as a covered transaction. And it makes clear how important semiconductors are, as even a company with products that may have minimal security implications was deemed important enough to raise concerns. All of that suggests a tough approach to security reviews of tech mergers and acquisitions, even if they have little connection to the United States, going forward.