China's biggest chipmaker, Semiconductor Manufacturing International Corp, is in advanced talks to acquire Japanese tech giant NEC's China venture to boost scale in the country's competitive chip market, two sources familiar with the situation said on Monday.

SMIC's Hong Kong-listed shares rose 4.4 percent on Monday in an overall weaker market after the news, erasing a 1.1 percent dip earlier in the day.

The deal would create a stronger chip industry leader as it may eventually boost SMIC's monthly production capacity by 40 percent -- as long as costs are kept down, analysts said.

I can see the benefits of such a merger, said Warren Lau, analyst at Macquarie Research.

Foreign chipmakers, including Taiwan's Semiconductor Manufacturing Co (TSMC), and mainland Chinese firms such as HeJian Technology are racing to beef up their production in China, the world's fastest growing major economy.

China accounts for over one-fifth of global demand for microchips, as the country is now a major consumer of chips used in everything from cellphones to home appliances.

Beijing is also keen to nurture firms to become national champions in its technology sector, analysts said.

Senior executives at SMIC, which has posted losses for most of the past two years, have been in talks with top officials of Hua Hong NEC for a possible merger for months, the sources, who asked not to be identified, told Reuters.

Some board members of Hua Hong NEC also prefer merging with SMIC rather than an originally planned Hong Kong listing, citing a complicated IPO process and Hong Kong's tough accounting standards, one of the sources said.

The sources said SMIC, which is also listed in New York, was seeking to acquire Hua Hong NEC as its attempt to bring in private equity investors stalled over SMIC board members' differing opinions earlier this year.

SMIC was unable to get a private equity buyer in the end, so teaming up with Hua Hong NEC is seen as another option, one of the sources said.

Details on the structure of the proposed merger have not yet been hammered out, they added.

A SMIC spokeswoman could not be reached for comment. A Hua Hong NEC spokeswoman had no comment. NEC Corp, which holds a near-20 percent stake in Hua Hong NEC, had no immediate comment.


Analysts said the potential acquisition may boost SMIC's monthly production capacity by around 40 percent. SMIC aims to raise monthly production capacity to over 193,000 eight-inch wafers by the end of 2007, it said in its annual report.

SMIC, valued at US$2.25 billion, is expected to have total production capacity of 538,000 eight-inch wafers in the whole fourth quarter of 2007, according to Nomura International.

Hua Hong NEC has said it hopes to ramp up its monthly capacity to 80,000 eight-inch wafers by the end of this year.

Domestic market demand for chip products is expected to rise rapidly over the next few years, partly because sales of audiovisual and home appliances are likely to increase in China, where annual economic growth has been running at around 10 percent in recent years, analysts say.

The global market for custom-built microchips is dominated by TSMC and United Microelectronics Corp.

HeJian Technology Co, another major Chinese chipmaker, told Reuters last year it expected its production capacity to more than double to 100,000 wafers per month in five years.

Once source said Singapore-based Chartered Semiconductor Manufacturing's Chief Technology Officer Simon Yang, a Shanghai native, was tipped to become the merged entity's new head, replacing SMIC's current Taiwanese CEO Richard Chang.

SMIC went public in Hong Kong and New York in a March 2004 initial public offering that raised US$1.8 billion, but the performance of its shares, like many other chipmakers, has disappointed investors.