The Capital Cycle Podcast - DeepSequel

Episode Date: June 30, 2026

How Chinese innovators and imitators are threatening Western businesses. Edward Chancellor talks to Laura Fyfe, an Emerging Markets Analyst.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello and welcome to another episode of the Capital Cycle Podcast. This is Edward Chancellor and I have with me again, Laura Fife, who's an emerging markets analyst with Marathon Asset Management. Welcome, Laura. Thank you. Now, Laura, perhaps the biggest economic story from China this decade has been the collapse of its epic real estate bubble. But there's another probably more important story that you'd outline in your latest contribution to the Global Investment Review. Namely, that's the extraordinary technological advances being achieved across many different sectors in China. And in some ways, this resembles Japan and Korea in the post-war period, but it's on potentially a far larger scale.

And you start your piece with an example of how China has jumped on the AI bandwagon. Yes. So China has actually demonstrated what I find to be quite striking efficiency with respect to certain links in the AI value chain recently. In January last year, we saw quite a vivid reminder of how even the most impenetrable seeming of moats can be breached quite suddenly. That was when DeepSeek released its R1LM. and Nvidia shed nearly 600 billion of market cap, which was at the time the single largest destruction of value ever stock in history. And you cite some token numbers for the Deep Seat model, which I don't quite understand.

Can you explain them? Yes, yes. So the R1 was priced at 55 cents per million input tokens and about $2.19 per million output tokens. And it cost reportedly about $6 million versus incumbents, billions. of dollars to train. And it was also released open source. So what was disruptive about this, I guess, is that capability that was assumed to require vast capital, talent that was really scarce, and the best chips was actually replicated at one-tenth of the cost and then given away. So what's interesting about that episode with the arrival of the deep seek model is that, as you

say, NVIDIA stock took a hit, but it's bounced back as you do. And the pre-market valuations of the US frontier models, Open AI and Anthropic have gone through the roof. I think Anthropic recently valued close to a trillion dollars. But interest in Chinese open source AI models is picking up again because they're said to deliver around 90% of the performance of the frontier models at about 10% or less of the cost. And we are coming to the end of something called token maxing in which employees were told to prove their AI skills by spending as much money on tokens as possible. Well, that era is over.

So these cheaper Chinese open source AI models are looking increasingly attractive. Anyhow, back to your piece, you're saying that advances are taking place in other areas, technological advances, say, for instance, in the auto. business. Yes. So we've seen some examples of Chinese competition surprising incumbents elsewhere, especially in autos, so good enough or actually increasingly superior physical products are increasingly becoming available at a fraction of the price and coming to the market more

quickly. In my essay, I use the example of a Chinese carmaker Cherry's J-Q7 model, which has been nicknamed the Chinese Range Rover. Yeah, which we see instantly on almost every road. You notice that driving along. The Jeku 7 became the UK's best-selling car in March and has a plug-in hybrid range, which is actually superior to the far more expensive range rover, Evox. So it's about a third cheaper than the Evoch.

And along with Cherry's other brand, Omoda, J-Q became the fastest emerging auto brand to hit a million units and did that in only three years. So both Deep Seek and Cherry have quite recently illustrated just how rapidly and significantly the cost curves can be lowered as Chinese competition adds capacity. And this is something we've seen across time and industries at Marathon, but what's perhaps interesting now is the speed that it seems to be taking on and the higher up levels of the value chain that it might be coming up against.

And you cite some other examples. Yes, I make the point that Chinese competition has done some damage, especially in commoditized industries. So those ones where incumbents' moats are mostly capital-based. So some consumer-facing examples of products that listeners might be familiar with as a result of this are anchor chargers, Zhaomi phones, DJI drones, anything pretty much from TEMU and clothes from Sheen. But on the more industrial side and in some newer applications, low-cost Chinese capacity

has also slashed pricing and shipping over the long. term, as well as solar and humanoid robots by up to about 90%, so comparable to those levels that Deep Seek disrupted incumbent models by, and with the disruption timeline, like I mentioned, seeming to shrink in each of those instances. And China's competitive dominance in the world of solar panels is well known, but still striking, and the robots have a similar type of efficiency gains. Yes, yes. So the 90% or so pricing disruption in solar,

took over a decade, but in humanoid robots, it took barely a year, actually, for Chinese humanoid robot manufacturer Unitri to come up with its G1 model selling at $16,000 versus rivals $150,000, for example. And you think there's more to come, namely that Chinese companies are set to pose competition in the worlds of memory chips, the hotter sector in the year, and to supply bottlenecks at a time of rampant demand? Potentially, yes. So at the moment, there's a memory oligopoly,

which includes Samsung, SK Hynix, and Micron, who control about 95% of global supply. And they're basking in an AI-driven scramble for what's called high-end, high-bandwidth memory, so HBM. And to make that, they're diverting capacity away from low-end commodity dynamic random access memory, which is DRAM,

thus causing a shortage. As anyone will know, these stocks now together, their aggregate valuation is $4 trillion of aggregate valuation and on $500 billion of profits. So these are businesses that own to the, as you say, to this oligopolistic structure are now super profitable, but you think that the Chinese competition will. start to upset that profitability. Potentially, yes, because what's important here is that DRAM supply, dynamic random access memory supply,

the commoditized part of the value chain, isn't a problem of especially scarce technological know-how, but rather of capital and time more so. So the product is fungible and its physics are well understood. So the oligophily incumbents, when they're earning operating margins above 60%, on an average basis offer somewhat of an invitation to Chinese competition. So China is coming to upset this oligopoly, you believe.

Yes, exactly. So the invitation, so to speak, does seem to have been accepted in Hefe where a state-subsidized company called Chongshin Memory Technologies, which is abbreviated CXMT, is scaling capacity from about 100,000 towards 300,000 wafers per month with its revenue up already over 700% and it's expected to garner about 15% of global DRAM within the year. So as we've seen elsewhere in those other examples,

it can flood the commodity tier, push down pricing, and erase billions of market value. And many global customers are actually already adopting Chinese DRAM. So it's interesting, Laura, because if you remember in the capital returns book, which I edited, we had a global investment review, I think from 2013, that pointed out the problems of the digital semiconductor cycle,

namely that when returns were high or abnormally high, capital was sucked in. And that capital cycle in semiconductors or memory, let's say, seems to have been perhaps interrupted somewhat in the first years of the current century when competition eroded in Japan, which is why those memory makers have been a nice position recently, but here the capital cycle is reestablishing itself. And pretty fast, and you have to bear in mind also that those memory makers are themselves. The leading companies are also expanding capacity. So there are some areas, some real pinch points in the world of semiconductors,

but that strongest competitive moat actually appears to belong to. to ASML, which provides the technology that's vital for producing, as far as I understand, most technologically advanced chips. Can you explain that position? Yes, the pinch point to use your word between commodity and premium memory is a technology as advanced as its name suggests, actually, called Extreme Ultraviolet Lithography, abbreviated EUV. And the Dutch company, ASML, which is a marathon holding, as you point out, monopolizes the business of producing the ultra-high-tech tools and equipment which make UV possible.

Why is this technology so vital? It's vital because it's the only practical way to draw the tiniest features on today's fastest chips, and it's hard to copy because doing it requires a highly complex machine where every part, and there are many parts to it, much beyond my understanding, are at or beyond current engineering limits. So ASML's EUV capabilities have taken decades of physics and supplier learning and service knowledge and customer integration and feedback to build, which is extremely difficult. And I would say it's fair to say that ASML as it stands wields true technical scarcity. But you think even here China with its abundance of capital and patience and rapid technological advance,

could make inroads? Yes, and this is actually the crux of my essay because price erosion of commodity moats is one thing, but the more unexpected challenging of more sophisticated moats, rather or not the challengers themselves are economic, is another thing. And I found China's EUV ambitions quite striking. Recent estimates place China's EUV handicap at as few as five years,

so less than half what was previously assumed under even the most optimistic of assumptions. And from this sort of starting point, its progress might even quicken because China is allocating $300 billion U.S. dollars to an AI buildout plan, and it will give a piece of that to EUV. At the moment, China only has a prototype, but it doesn't even need to close the gap with ASML entirely to do real harm, and it may, in fact, narrow it faster than expected.

And you say that CXMT is going down a different route to produce a more sophisticated chips? Mm-hmm. So CXMT actually expects to begin mass production of HBM, so the higher-end chips by the end of this year. And it's hoping to do that by substituting less sophisticated deep ultraviolet lithography or DUV for EUV, which is a costly workaround, which has attracted some skepticism from industry experts. Laura, beyond the realm of semiconductors, you point to Chinese entrance, having graduated from imitators to global standard setters. I mean, you don't mention actually in your piece, Who Our Way, but that almost is a poster child for that. But you talk about some other examples.

That's right, yes. I would say imitators are increasingly innovators in pharma, for example, and one quarter of the world's newly licensed assets now originate from China. which is quite impressive given it used to be just a low-cost manufacturing hub. AstraZeneca, for example, agreed to license almost $19 billion from China's CSPC in January. Elsewhere in electric vehicles, B-Y-D, outsells to Tesla, which again you might see on the streets around you and our listeners might see on the streets around them, it pretty much dominates the low end of the cost curve for EVs. And in batteries, a company called CATL supplies 40% of the world market. being based in China and dictates the storage economics as well,

which is an emerging technology to watch. And then beyond that, DJI and Unitary, the robotics company I mentioned earlier, lead on drones and humanoid robots by volume. And this is happening at a time when American tech companies are themselves extremely highly valued, especially compared to the Chinese equivalents. SpaceX, after its recent IPO, being used.

case and point, but you don't think this evaluation discrepancy will last forever. Yes, and it's quite a valuation discrepancy. So SpaceX listed at 100 times loss-making sales, surpassing Sun microsystems and Nvidia's 10 times and over 26 times peak ratios in 2000 and 2005. So on this basis, SpaceX looks pretty much priced to have an impenetrable mode, despite Capital Cycles theory telling us that where there's a larger potential, profit pool. Competition generally seems to be lining up to take a piece of it. So I suppose time will tell whether AI and the conquest of space are immune to this phenomenon. So Laura, how does this thinking on Chinese technological advances competitiveness influence Marathon's

portfolios? Well, on one hand, we own a couple of globally competitive Chinese challengers, which have proven that they can disrupt global profit pools. And on the other, we seek to avoid the companies that are vulnerable themselves to low-cost capacity. So can you, give me an example of the former. Mm-hmm, mm-hmm. A company called Sani Heavy Industry, and it has been the world's leading manufacturer of excavators and concrete machinery by volume since 2020. It competes with Caterpillar and Kumatsu, which listeners might know of.

And having survived China's brutal post-property construction equipment glut, which aligns well with your opening point on the property boom and bust in China, it now earns more than 60% of its sales abroad, and it actually does so at higher returns on a value. invested capital. So something impressive it's done is turn the battle scars of what was a vicious home market capital cycle into a durable, global cost advantage. And most recently, it showed 28% gross profit margins. So it doesn't offer much rent for a new entrance to come and compete away from it, or to use the example that we touched on earlier, it's quite an unappealing invitation. But you think the scope for Sani to continue to what you call move up the value chain,

Yes, there is actually scope for Sannie to continue to move up the value chains as it gains share abroad. So it's very profitable service business is only 10% of its sales versus its competitors having more than 30. And there's also scope for it to consolidate the market. It continues to lead at home, given it has a superior receivable position. And then you point to electrification being another area of potential interest? Yes, I actually think that's potentially the most intriguing. But so, Sannie's the first mover in electric construction equipment with a leading market share in electric mixers, electric dump trucks, electric excavators, cranes, and earning a greater share of its sales from these products than either of its main peers as well. Further validating this, in addition to being cheap, it's proven it's trusted because it got a major agreement for 100 electric excavators from a marquee global customer, which many listeners may know, called Holsom.

which is what a cement company. Yes. It's also partnered with the battery behemoth CATL, which we mentioned. So it has especially efficient battery systems that are globally competitive. And at the moment, when we last spoke to management, they view the current installed capacity is able to support twice their current sales base. And Sannie, in contrast to SpaceX trades at less than two-time sales. You believe that many moats priced as unassailable,

they are merely yet to be assailed by. Chinese capital at scale. That's right. So true inimitability, so to speak, is rare and it rarely endures. Deep Seek, as the example we started out with, dramatized our long-held belief that supernormal returns tend to invite competition and the other examples also support that. What about the moats you think can endure? Well, that's what we spend a lot of our time trying to discern. But perhaps one of the best ways to be immune to deep pocketed competition would, of course, be to do something that capital can't replicate.

A couple of examples of this might be scale-based networks or beneficiaries of overall capacity growth, so metaphorical toll roads, or companies with moats predicated on geographically unique, physically constrained capacity. So those companies operating in the physical and material world. And your thing here of, say, for instance, like the copper, mining where there's a shortage of copper ore and mines to extract it. Yes. Also, those companies that have networks which are hard to replicate, those type of businesses can hopefully injure against imitation risk by AI or China or both.

And you cite two examples of Chinese holdings to benefit from network effects, Shenzhou International and Tencent, which is owned via the South African company, NASPAs. Start with Shenzho. Tell us what you think there. So Shendro operate what I described as a toll road like business model, which enables them to harvest the fruits of disruption without actually needing to win said disruption. As the vertically integrated knitwear manufacturer

for leading sportswear brands like Nike and Adidas, it enjoys a scale advantage, and it actually earns about mid-20s gross margins, and it does so regardless of fashion fluctuations. But what's interesting about these mid-20s levels is that they don't attract competition, and that's quite the opposite of what we're seeing with memory at the moment. It's likewise immune to supply additions further downstream. So if ANTA, which is a Chinese sportswear brand, were to usurp, for example, Nike,

Shenzhou is pretty much indifferent. And Tencent? Tencent's Wii chat ecosystem is similarly to Shenjo brand and sector agnostic, and it acts as somewhat of a distribution layer that gets to tax whoever wins across gaming, payments, advertising, AI, what have you. And on top of this, it has stakes in the broader Chinese tech complex, which gives it optionality on companies like Deep Seek that are disrupting other incumbents and even within China. In this way, Tencent is able to be asset light as an incumbent and not need to outspend any rivals. And Laura, give me some examples of the second type of company you alluded to geographically unique businesses.

An example in the emerging markets portfolio might be Copa Airlines, which is a Panamanian airline uniquely positioned on the Isthmus of Panama, which is something that just cannot be replicated with capital. As well, you've spoken with Alex on previous podcasts about our holdings in copper and platinum group metals. The final takeaway, how to think about the. competitive moats and Chinese competition? I think the discipline is to distinguish the more underwhelming barriers of capital and time, which Chinese companies have preyed on from the genuinely scarce ones.

We try our best to select the likely survivors, especially those that have already endured cycles over incumbents whose premiums rest on the sometimes optimistic assumption that no one will build next door. Great. Thank you very much, Laura. Thank you. Thank you for your time today. I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.