Summary of Key Points
Indium phosphide is the fundamental material (substrate) for laser chips in optical modules used in AI data centers. With the surge in demand for high-speed data transmission driven by large AI models, the supply-demand gap for indium phosphide is even greater than that for memory, with orders backlogged until 2028. Although China controls 70% of the world's indium resources (the core ingredient for indium phosphide), it only accounts for 10% of the global production of finished substrate products, which are dominated by Japanese and American companies. Domestic firms like Yunnan Germanium Industry are making rapid progress with the support of Huawei, but there is still a gap in terms of yield and high-end product capabilities. The sharp rise in A-share stocks related to indium phosphide carries the risk of a bubble.
Why Has Indium Phosphide Become如此 Valuable in the AI Era?
Simply put, AI requires fast data transmission—fiber optics are used to transfer data between servers, and optical modules act as converters that convert electrical signals into light signals. The laser chip is the heart of the optical module, with indium phosphide serving as its foundational substrate.
Why is indium phosphide the ideal choice? Its physical properties enable it to emit light at wavelengths of 1310/1550 nanometers, which experience minimal loss in fiber optics and meet the requirements for high-frequency, efficient light emission. Currently, there is no alternative material.
How significant is the demand from AI? Lumentum, a leading supplier of optical chips for NVIDIA, reports that customer orders have increased from a few hundred units to hundreds of millions, with backlogs extending until 2028. An 800G optical module requires 4-8 indium phosphide chips, while a 1.6T optical module needs nearly three times that amount. Moreover, the higher the data transmission speed, the faster the demand for indium phosphide grows. In 2026, optical modules above 800G accounted for 60% of the global market, leading to a dramatic increase in indium phosphide demand.
China's Dilemma: Possessing Indium but Struggling with Substrate Production
China has a significant advantage in indium resources, producing 70% of the world's refined indium. By 2025, it plans to include indium phosphide in its export controls to restrict foreign access to this material. However, China can only produce raw indium and cannot manufacture high-end substrate products. Three Japanese and American companies (Sumitomo Metal Industries, AXT Corporation, and JX Metals) control 90% of the global substrate market, while all domestic manufacturers combined account for only 10%.
The reason for this is that indium is a by-product of lead-zinc mining and cannot be produced independently in large quantities. Additionally, high-purity indium (7N grade, with 99.99999% purity) is difficult to refine, and only a few domestic companies are capable of doing so. Substrate production is even more complex, involving crystal growth at temperatures above 1000°C and pressures of 27 atmospheres, resulting in high losses during the process. Customer certification also takes 1-2 years, which are major challenges for domestic firms.
How Large Is the Supply-Demand Gap?
Yole Research estimates that the global demand for indium phosphide substrates will be between 2.6 and 3 million pieces (2-inch size) in 2026, but effective production capacity is only 750,000 pieces, indicating a gap of over 70%. This gap would increase to nearly 2 million pieces for 4-inch substrates and potentially 5 million pieces by 2028.
Why is expansion so difficult? The challenges are multifaceted:
- Technical difficulties: The growth of indium phosphide crystals requires high temperatures and pressures, and manual operations affect yield. Equipment must be custom-designed.
- Long certification process: Substrates must be tested by downstream laser manufacturers, with a certification period of 1-2 years.
- Resource constraints: The supply of indium is fixed, and price increases do not lead to increased production.
Japanese and American companies are also expanding their capacity: JX Metals is investing 5.8 billion yuan to increase production by 7-10 times, while AXT Corporation is raising $600 million for expansion, but the gap will not be fully addressed until at least 2027.
Domestic Manufacturers Are Catching Up, but There Is Still a Gap
The leading domestic company is Yunnan Germanium Industry (its subsidiary, Xinyao Semiconductor):
- Progress: Huawei's investment has provided orders and technical support, with plans to ship 100,000 indium phosphide substrates in 2025. This year, the company secured large contracts worth 570-855 million yuan (50%-80% of its annual revenue).
- Gaps: The yield is low, at only 7-8% compared to 25% for American companies like TMIC. The company mainly produces 3-4-inch substrates and is still testing 6-inch versions, which could reduce chip costs but pose higher technical challenges.
- Other Companies: XianDao Technology focuses on producing 2-6-inch substrates, while MingGa Semiconductor specializes in crystal synthesis, both still in the early stages of development.
Opportunities and Challenges
The introduction of export controls may lead to a shift in production capacity from abroad to China, opening up market opportunities for domestic optical chip manufacturers (such as Dongshan Precision and YuanJie Technology). However, domestic substrates must meet customer certification standards to be successful.
The Boom in Concept Stocks: Beware of a Bubble
This year, stocks related to indium phosphide have soared, with Yunnan Germanium Industry's stock price doubling and its market value exceeding 60 billion yuan, resulting in a dynamic P/E ratio of 1700 (the industry average is 26). However, there are concerns:
- Limited business impact: Indium phosphide accounts for only 12.93% of Yunnan Germanium Industry's total revenue in 2025.
- Cross-industry investment: Companies outside the electronics sector, such as XingYe Technology (which manufactures leather products), have acquired indium phosphide businesses with little past profitability and minimal orders, yet their stock prices have risen significantly.
- Bubble risk: Although indium prices have increased by 80%, AI's actual demand for indium phosphide is only 5%. LightCounting predicts that the global market for indium phosphide-based optical chips will reach $6.9 billion by 2031, which is not a large market.
In summary, indium phosphide is a critical material for AI applications. China has a resource advantage but needs to overcome technical challenges. The short-term supply-demand gap is unlikely to be resolved quickly. Investors should focus on companies with genuine technological capabilities rather than those merely riding the wave of popularity.