Identifier
Created
Classification
Origin
06SAOPAULO590
2006-05-30 12:05:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Consulate Sao Paulo
Cable title:  

SEMICONDUCTORS RETURN TO BRAZIL AFTER 15 YEARS

Tags:  ECPS EIND PGOV ETRD EINV BEXP BR 
pdf how-to read a cable
VZCZCXRO1419
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DE RUEHSO #0590/01 1501205
ZNR UUUUU ZZH
R 301205Z MAY 06
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 5149
INFO RUEHBR/AMEMBASSY BRASILIA 6275
RHEHNSC/NSC WASHDC
RUCPDOC/USDOC WASHDC 2444
RUEATRS/DEPT OF TREASURY WASHDC
RUEHMN/AMEMBASSY MONTEVIDEO 2004
RUEHKO/AMEMBASSY TOKYO 0393
RUEHBS/USEU BRUSSELS
RUEHBU/AMEMBASSY BUENOS AIRES 2267
RUEHAC/AMEMBASSY ASUNCION 2594
RUEHSG/AMEMBASSY SANTIAGO 1731
RUEHLP/AMEMBASSY LA PAZ 2822
RUEHNE/AMEMBASSY NEW DELHI 0059
RUEHBJ/AMEMBASSY BEIJING 0390
RUEHUL/AMEMBASSY SEOUL 0183
RUEHKL/AMEMBASSY KUALA LUMPUR 0296
RUEHDG/AMEMBASSY SANTO DOMINGO 0177
RUEHRG/AMCONSUL RECIFE 2953
RUEHRI/AMCONSUL RIO DE JANEIRO 7142
UNCLAS SECTION 01 OF 05 SAO PAULO 000590 

SIPDIS

DEPT FOR WHA/BSC, WHA/EPSC, AND EB/CIP
STATE PASS USTR FOR MSULLIVAN
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONESE, NRIVERA, CVERVENNE
NSC FOR SUE CRONIN
USDOC FOR 4332/ITA/MAC/OLAC/JANDERSEN/ADRISCOLL/MWARD
USDOC FOR 3134/USFCS/OIO/SHUPKA
TREASURY FOR OASIA, DAS LEE AND FPARODI

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECPS EIND PGOV ETRD EINV BEXP BR
SUBJECT: SEMICONDUCTORS RETURN TO BRAZIL AFTER 15 YEARS

REF: Brasilia 891

-------
SUMMARY
-------

UNCLAS SECTION 01 OF 05 SAO PAULO 000590

SIPDIS

DEPT FOR WHA/BSC, WHA/EPSC, AND EB/CIP
STATE PASS USTR FOR MSULLIVAN
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONESE, NRIVERA, CVERVENNE
NSC FOR SUE CRONIN
USDOC FOR 4332/ITA/MAC/OLAC/JANDERSEN/ADRISCOLL/MWARD
USDOC FOR 3134/USFCS/OIO/SHUPKA
TREASURY FOR OASIA, DAS LEE AND FPARODI

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECPS EIND PGOV ETRD EINV BEXP BR
SUBJECT: SEMICONDUCTORS RETURN TO BRAZIL AFTER 15 YEARS

REF: Brasilia 891

--------------
SUMMARY
--------------


1. (U) American company Smart Modular Technologies (Smart) recently
inaugurated its first semiconductor factory in Brazil. The Smart
plant, which encapsulates imported finished memory wafers, is the
first semiconductor facility in Brazil since the early 1990s when
all microchip companies closed operations and left the country. For
the last 15 years, Brazil has been importing microprocessor
components and assembling chips, but not producing semi-conductors
locally. Despite increasing operating costs due to the
strengthening Brazilian currency, Smart expects healthy profits
(owing to steep Brazilian import duties on semiconductors and a
protected market). GoB officials claim that the return of
semiconductors is the result of a successful GoB strategy (announced
in 2003) to attract technology companies to Brazil. However, this
GoB strategy played no part in Smart's decision to invest, and has
yet to achieve success in attracting other semiconductor investment.
Brazil ostensibly wants to attract foreign investment in the
technology field, but does not appear ready yet to open its market.
In our view, a good first step would be for the GoB to adhere to the
1997 WTO Information Technology Agreement, which zeros out tariffs
on a wide range of high-tech goods, including semiconductors.
However, the GOB appears as yet unready to take such a step. END
SUMMARY.

--------------
SMART SETS UP SHOP
--------------


2. (U) American company Smart Modular Technologies, headquartered in
Fremont, California, recently inaugurated its first semiconductor
factory in Brazil, in Atibaia, Sao Paulo state. At the ceremonial

opening, Smart President Iain MacKenzie and Smart Brazil General
Manager Noboru Takahashi hosted GoB officials from the Ministry of
Development, Industry and International Trade (MDIC); the Sao Paulo
state Secretariat of Science, Technology and Economic Development;
the Sao Paulo Governor's Chief of Staff; representatives from
Samsung, one of Smart's tier-one wafer supply partners; and
EconOffs. This is the first semiconductor plant to operate in
Brazil since the early 1990s when Intel, Sun, and every other chip
processor left. Since then, Brazil has been importing
microprocessor components and assembling chips, but not producing
semi-conductors.


3. (U) COMPANY PROFILE: Smart (NASDAQ: SMOD) is a leading
independent designer, manufacturer and supplier of electronic
subsystems to original equipment manufacturers (OEMs). In addition
to its recently inaugurated factory in Sao Paulo, Smart has
international operations in Santo Domingo, Dominican Republic;
Bangalore, India; Penang, Malaysia; Dong Guan, China; and Gunpo,
Korea. Domestically, Smart operates in Tewksbury, MA; Irvine, CA;
Fremont, CA; and Aguada, Puerto Rico. Smart offers more than 500
standard and custom products to OEMs engaged in the computer,
industrial, networking, gaming, and telecommunications markets.
Smart's comprehensive memory product line includes DRAM, SRAM, and
Flash memory. Smart's Display Products Group designs, manufactures,
and sells liquid crystal display (LCD) solutions to customers
developing casino gaming systems as well as embedded applications
such as kiosk, ATM, point-of-service, and industrial control
systems.

SAO PAULO 00000590 002 OF 005




4. (U) SMART'S ATIBAIA OPERATION: Located 47 miles from the city of
Sao Paulo, the Atibaia site is currently producing two million
semiconductors per month. The plant only conducts the final stage
of the semiconductor process, called encapsulation, in which silicon
laminates (memory wafers) are cut, encapsulated in microchips, and
then incorporated into semiconductor boards. Smart imports finished
memory wafers from Korean electronics giant Samsung. Smart
executives estimate that producing the wafers in Brazil would
require an investment of USD 1 billion.


5. (U) PROFITING FROM PROTECTION: Under the Brazilian tariff
regime, imported semiconductors face an 18 percent duty, while
imported semiconductor components that will be assembled in Brazil
face an 8 percent duty. Imported memory discs such as those
supplied by Samsung to Smart face no duty. In 2005, 5.6 million
personal computers (PCs) were sold in Brazil. Smart estimates that
only forty percent of the memory cards in these PCs were of legal
origin. Smart assembled about half of these legal cards using
imported components. Now Smart will actually manufacture the cards
here and take advantage of having avoided tariffs in the hopes of
increasing its market share against illegal memory cards. Smart
executives say that demand from local PC manufacturers is already
overwhelming. To meet demand, Smart employs 100 workers working
around the clock in 3 shifts. Nevertheless, Smart already has a
backlog of orders from Dell, Hewlett Packard, IBM, Toshiba, and
every other major computer maker in Brazil. Prior to commencing its
Atibaia operation, Smart operated from Guarulhos, Greater Sao Paulo,
assembling (though not producing) memory cards. The opening of the
Atibaia facility is part of Smart's global strategy to vertically
integrate production. With the opening of the Atibaia plant, the
Guarulhos plant will close down.


6. (U) IPR PROTECTION: When asked about Brazil's poor reputation
for intellectual property rights (IPR) protection, President
MacKenzie told EconOffs, "We don't even bother with applying for
patents in Brazil. In the time it takes for someone to clone our
product, we've already moved on to the next generation of
technology. We're ahead of the curve. If someone wants to copy our
technology, then they will always be behind us." But MacKenzie was
quick to point out that access to proprietary information will be
very tight in Atibaia. Smart is in the process of installing SAP
software to be able to integrate the Brazilian branch with its
global operations, but confirms that it will not engage in research
and development in Brazil, nor will any proprietary information
reside on Smart's Brazilian network servers. MacKenzie went so far
as to say, "Smart Brazil employees won't even have access to our
proprietary technology."


7. (U) EXPORT OUTLOOK: Later in the year, Smart will start to
export memory cards from Brazil, though only to its own
international Smart affiliates, such as production sites in the
Dominican Republic and Malaysia. Smart is working to implement
"Recof," a special customs rate created by Brazil Customs that
facilitates the importation and exportation of goods into and out of
Brazil. Recof requires a minimum of USD 5 million in exports during
the first year and USD 10 million in the second. Smart's Takahashi
predicts, "We'll meet this requirement easily." When asked about
expansion of exports to other markets, Smart President MacKenzie
confirmed that he has little hope of exporting beyond shipments to
their own affiliates, "We just can't compete with giants like
Samsung in open markets." Although Smart may try to export within
Mercosul, MacKenzie claimed, "For now, we are going to have our
hands full supplying Brazil. But we have room for expansion.

SAO PAULO 00000590 003 OF 005


Since Brazil is one of the world's fastest growing emerging markets,
our enhanced capabilities locally will provide us with a competitive
advantage as business opportunities in this region continue to
grow."

--------------
ATTRACTING SEMICONDUCTORS TO BRAZIL
--------------


8. (U) GoB officials heralded Smart's Atibaia operation as the first
success in a national strategy to attract technology investment. In
November 2003, President Lula approved a proposal for industrial
policy guidelines that would, among other things, provide for
investment in technology and tax exemptions for capital goods.
Launched in March 2004, the Industrial, Technological and Foreign
Trade Policy (PITCE) seeks to "attract technology in key sectors."
The PITCE elected four sectors as strategic priorities:
pharmaceuticals, capital goods, software, and semiconductors. To
attract investment in these sectors, the GoB offers a bundle of
tariff and export incentives. Moreover, at the PITCE inauguration,
MDIC Minister Furlan announced that, in 2004 alone, the new strategy
would count on over USD 200 million of GoB support and USD 6 Billion
in financing incentives from the Bank of Brazil (BB) and the
National Economic and Social Development Bank (BNDES). Furlan also
announced that the Recof customs regime would play an important role
in attracting investors.

--------------
COMMENT: OUTLOOK CLOUDY FOR FUTURE INVESTMENT
--------------


9. (SBU) PITCE NOT A FACTOR: The PITCE was announced in 2003 and
inaugurated in 2004. However, the results of this USD 200 million
program are less than impressive. Smart's self-financed Atibaia
operation represents a relatively modest USD 15 million investment
and did not rely on PITCE incentives from BB or BNDES. In fact,
when EconOffs asked about the reasons for Smart's decision to start
production of semiconductors in Brazil, Smart executives didn't even
appear aware of PITCE. Instead, they focused on the opportunities
created by small-scale producers within closed economies like
Brazil. The recent and expected growth in Brazil's consumer
electronics and PC markets was cited as the sole reason for deciding
to start producing. Industry estimates placed ten percent of the
2005 world consumption of electronics products in South America,
with the Brazilian Association of Electrical and Electronic
Industries (ABNEE) claiming that Brazil accounts for 68 percent of
that demand. ABNEE forecasts a USD 125 billion Brazilian
electronics market by 2010. Operating in Brazil since 2002, Smart
saw that it could either continue to import and assemble at an eight
percent duty, or manufacture with no duty on component parts.
According to Smart Brazil's General Manager Takahashi, "The choice
was simple." According to Smart President MacKenzie, "Samsung is
too large-scale to set up operations in a closed market like Brazil.
But Smart has the mid-sized flexibility to set up a small operation
in Brazil and sell domestically." Smart executives further noted
that the decision to manufacture was part of an effort to vertically
integrate Smart's global operations and was more a result of
internal corporate strategy than GoB development strategy. Smart's
Treasurer commented to EconOffs, "It's not even that large of an
expansion, since at the same time we're opening here we're shutting
down our Guarulhos plant."


10. (U) OTHER SEMICONDUCTOR PLANS: As part of the digital
television standard negotiations (reftel),Japanese and European

SAO PAULO 00000590 004 OF 005


firms have stated they will consider establishing semiconductor
manufacturing plants in Brazil, contingent upon the GoB's choosing
their respective standards. These discussions are independent from
PITCE strategies, although other plans for semiconductors that would
make use of PITCE incentives are also in the works. In September
2005, the GoB announced plans to establish a semiconductor industry
in the state of Minas Gerais, where approximately 990 acres are
being dedicated to semiconductor and semiconductor-related
manufacturing and design. The Minas Gerais Technological Park will
be anchored by Companhia Brasileira de Semicondutores (CBS). The
target completion date is early 2007. The Minas Gerais
Technological Park is Brazil's flagship semiconductor manufacturing
venture. CBS is backed by various Brazilian development banks and
private investors worldwide. The company is focusing on analog and
mixed-signal products for consumer, automotive, and industrial
applications.


11. (SBU) WHY SEMICONDUCTORS FLED: Smart is not the first company
to produce semiconductors in Brazil, but it is the first company in
the past 15 years to produce here. Industry insiders regularly
refer to the "tech flight" of the early 1990s, when every single
producer of semiconductors closed shop and left Brazil. when
protectionist policies begun during the time of the military
dictatorship were ended. In 1984, Brazil codified these policies to
promote a local computer industry by restricting imports and
promoting local manufacture and foreign investment through a
comprehensive and highly restrictive "informatics law." As a
result, tech industry companies flowed into Brazil to take advantage
of the sheltered market. (The 1984 informatics law and its
implementation were the subject of a U.S.-initiated Section 301
investigation between 1985 and 1989.) At the end of the 1980s, the
Brazilian electronics component industry could count more than
twenty domestic semiconductors companies. In 1991, Brazil revised
its informatics legislation to phase out some of the import and
investment restrictions, resulting in the final removal of
quantitative import restrictions. By October 1992, import
restrictions that had been in place since the mid-1970s for
computers and related (informatics) products were removed. However,
the government's lifting of restrictions on the importation of
electronic components led to widespread failures among the country's
domestic semiconductor companies. Foreign companies -- Intel, Sun
Microsystems, and every other semiconductor company -- shut down
operations. As a result, the Brazilian domestic electronics
components industry has become heavily reliant on imports in the
last decade. The few remaining component manufacturers produce
components with limited technological content, and spply only 20
percent of the internal demand. The remaining 80 percent
represented a 2003 trade deicit of USD 3 billion, with USD 1.7
billion due o semiconductors.


12. (SBU) BRAZIL'S SEMICONDUCOR OUTLOOK: Looking around the world,
developin countries with low or no duties on electronics components
and systems over the past two decades (Hog Kong, Taiwan, Singapore)
have been successful n developing strong, vibrant economies with
dynaic high-tech industries. Meanwhile, developing contries with
high duties (Latin America, India) have not been successful. A
special case was Korea which built a narrow semiconductor industry
in pite of its 8 percent duty. With the PITCE, it apears that
Brazil hopes to replicate Korea's expeience. However, Korea's
growth was largely based on exports of semiconductors, not on
supplying smiconductors to its domestic electronic producers.
There are no indications that Brazil will stop potecting its IT
sector or adhere to the WTO Infomation Technology Agreement (which
zeros out tariffs on semiconductors and other high-tech goods).

SAO PAULO 00000590 005 OF 005


Indeed, this stance has left Brazil uncompetitive in world IT
markets. The negative effects of the Brazilian model have long been
recognized even by some of its own industry executives, as evidenced
by a 1991 quote from the Wall Street Journal from Touma Elias,
President of Sao Paulo PC company Microtec: "We made PCs before the
Taiwanese and the Koreans, but instead of being a USD 1 billion
company, like (Taiwan's) Acer or (American) AST or Dell, we're a USD
35 million one hoping to be a USD 100 million one. Why? Because
our market wasn't open, which made components more expensive." Very
little has changed in the last 15 years. Brazil's market is still
closed and its efforts to promote semiconductor investment are more
likely to draw participants like Smart who will take advantage of
Brazil's market protection than to attract the research and
development (RND)-driven investment that the GoB desires. To date,
Brazil's efforts to establish a global electronics presence have
been mixed. Companies such as Motorola have announced RND
initiatives in the telecommunications sector. However, efforts to
bolster the country's presence in sectors such as semiconductors
have not been as warmly received. In 2003, Intel CEO Craig Barrett
reportedly ruled out setting up a chip plant in Brazil because of
high labor costs. With the Brazilian Real having strengthened more
than 35 percent since then, Brazil is becoming even less of an ideal
export platform. In the future, it is more likely that Brazil will
see foreign investment come from small- to medium-sized tech
companies (like Smart)interested in selling to the local market,
rather than from large companies (like Intel) focused on exports and
RND. END COMMENT.


13. (U) This cable was coordinated with AmEmbassy Brasilia.

WOLFE