China's ASML Retrofitting and the Resilience of Its Semiconductor Ecosystem

The global semiconductor industry is at a crossroads, with China's aggressive push for technological sovereignty reshaping the competitive landscape. Amid U.S.-led export controls and geopolitical tensions, China has embarked on a dual-track strategy: retrofitting older ASML equipment to sustain near-term production and investing heavily in domestic EUV lithography development for long-term autonomy. For investors, this dynamic presents both opportunities and risks, as China's semiconductor ecosystem navigates technical hurdles, geopolitical constraints, and the promise of self-sufficiency.

Retrofitting ASML Equipment: A Stopgap for AI Ambitions

China's immediate focus on upgrading deep ultraviolet (DUV) lithography machines from ASML underscores its urgency to maintain AI chip production. By retrofitting older DUV systems, Chinese manufacturers aim to produce 7nm chips-a critical threshold for advanced AI applications-despite lacking access to cutting-edge EUV tools China has boosted AI chip output by upgrading older ASML machines. This strategy leverages existing ASML equipment, often sourced from secondary markets, and integrates incremental improvements to extend their utility. For instance, companies like SMIC have reportedly adopted self-aligned quadruple patterning (SAQP) techniques with DUV to achieve near-5nm performance, albeit at higher costs and lower yields compared to TSMC's EUV-based processes.

While these retrofitted systems provide a temporary lifeline, they are inherently limited. DUV-based 7nm and 5nm nodes require complex, multi-step patterning, leading to higher defect rates and production costs. SMIC's 5nm wafers are estimated to cost 50% more than TSMC's, with yields as low as 33%. This economic inefficiency highlights the fragility of China's short-term approach, which relies on patching together older technology rather than mastering advanced manufacturing.

The EUV Prototype: A Long-Term Gamble

China's more ambitious bet lies in its EUV lithography prototype, developed in a high-security Shenzhen laboratory by former ASML engineers. This project, often dubbed the "Manhattan Project" of Chinese semiconductors, represents a strategic pivot toward self-sufficiency. While the prototype can generate EUV light, it has yet to produce functional chips, with government targets set for 2028 and more realistic expectations pointing to 2030.

The technical challenges are formidable. EUV machines require ultra-pure materials, advanced metrology tools, and precision optical systems-components still subject to U.S. and Western export controls as China builds its EUV prototype. Moreover, replicating ASML's proprietary technologies, such as its high-numerical aperture (High-NA) EUV systems, remains a distant goal. However, the mere completion of a working EUV prototype signals China's determination to break the monopoly of Western suppliers and reduce reliance on ASML, which currently controls over 90% of the global EUV market.

Financial and Strategic Implications for Investors

The financial stakes for Chinese semiconductor firms are immense. State-backed entities like Shanghai Micro Electronics Equipment (SMEE) and SiCarrier are at the forefront of this effort. SMEE, a key player in lithography development, has benefited from the third instalment of China's National Integrated Circuit Industry Investment Fund, which allocated $48 billion to bolster domestic capabilities. Similarly, SiCarrier's recent patent for SAQP-based DUV patterning demonstrates incremental progress, though it remains constrained by the limitations of DUV technology.

For investors, the key question is whether these firms can scale their innovations into commercially viable solutions. While China's government-driven model provides a steady flow of capital, it also creates dependency on state subsidies. The financial performance of ASML itself offers a cautionary tale: despite strong Q2 2025 sales of €7.7 billion, the company anticipates a decline in China sales by 2026 as domestic alternatives emerge. This shift could disrupt ASML's revenue streams but also signals growing confidence in China's ability to develop its own tools.

Geopolitical Constraints and Market Resilience

China's semiconductor ambitions cannot be separated from the geopolitical context. U.S. export controls have restricted access to advanced equipment and materials, forcing China to rely on reverse-engineering and secondary markets. However, the country's ability to leverage former ASML engineers and repurpose older ASML parts demonstrates a form of "innovation through adaptation." This resilience is further bolstered by China's emphasis on integrating into the global innovation network, even as it pursues self-reliance as highlighted in People's Daily.

For investors, the long-term potential lies in China's capacity to overcome these constraints. If the EUV prototype achieves commercial viability by 2030, it could disrupt the global supply chain and reduce China's reliance on Western technology. However, technical hurdles and geopolitical risks-such as further export restrictions or supply chain disruptions-remain significant.

Strategic Recommendations for Investors

1. Semiconductor Manufacturing: Prioritize firms with strong government backing and access to state funds, such as SMEE and SiCarrier. These entities are central to China's long-term strategy but face high costs and technical risks.
2. Equipment Suppliers: Monitor ASML's market position as China's EUV development progresses. While ASML dominates today, its dominance could erode if China's prototype scales.
3. AI-Driven Tech Firms: Invest in Chinese AI companies that benefit from domestic chip production, such as Huawei and Baidu. Their success hinges on the availability of advanced semiconductors, making them both high-reward and high-risk.

Conclusion

China's semiconductor ecosystem is a study in resilience and strategic ambition. While retrofitting ASML equipment provides a temporary bridge, the true test lies in its ability to develop EUV lithography independently. For investors, the path forward is fraught with uncertainty but also rich with potential. The coming years will determine whether China can transform its "Manhattan Project" into a reality-or remain a shadow of its Western counterparts.