China chips: Bomb, or just a lot of firecrackers?

To be sure, nobody is writing China off.

Even though China's economy is slowing down compared with its blistering 11 percent to 12 percent growth in recent years, China's GDP is still growing at a rate of 8 percent to 9 percent. In contrast, the U.S. GDP is fast approaching zero growth by year's end.

This slippage of semiconductors from a double-digit growth industry prompts larger questions: Will China find a way to build its own semiconductor industry--ever? If so, who will become China's Intel?

Some investors and electronics companies remain hopeful of finding gems among the more than 500 chip companies reportedly existing in China. U.S. semiconductor vendors routinely fish for potential acquisition targets among them, hoping to claim a foothold in the Chinese market.

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But Walden's Tan is broadly skeptical. "The number of Chinese chip companies is more like 300 now, instead of 500," he said. "They are very tiny design houses, whose sales are $1 million to $10 million." Further, "Most of them develop 'me-too' products--and they are just hanging in, often subsidized by the government."

Actions, Spreadtrum and Vimicro are known in the industry as "first-wave" Chinese semiconductor companies, founded and run by Chinese returnees.

This poses the argument that a "grown-up" Chinese electronics industry will not form until pure-bred local companies start to emerge and take on competitors outside China. Alex Hui, president and CEO at Pericom Semiconductor (San Jose), said he sees a few signs of this among China's big telecom operators and equipment companies--such as China Mobile and Huawei Technologies--which are beginning to carry their weight in the global market. But, he added, "We're still in a very early phase."

Meanwhile, filling the gap between now and the future of Chinese electronics are the "second-wave" Chinese chip companies: Pericom Semiconductor, Telegent Systems, Monolithic Power Systems, Legend Silicon and others. Significantly, these semiconductor companies are based not in China, but in Silicon Valley.

Among other common threads, most are run by elite Chinese CEOs (born and educated in China, with U.S.-earned Ph.Ds and substantial work experience in U.S. companies), they keep a laser-sharp focus on the Chinese market, and they've leveraged their Chinese identity to raise capital.

But most significant is the strategic decision to maintain dual storefronts--in Silicon Valley and China.

Unlike the first-wave companies, whose CEOs went straight back to China, second-wave chip companies are keeping their U.S. headquarters, Walden's Tan explained. Meanwhile, they are running huge R&D and sales operations in China.