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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 
 
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SUMMARY 
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¶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