May 7, 2021
[4 min Read]
TSMC is the most advanced semiconductor foundry in the world, and produces chips for all kinds of products. Due to the high-tech nature of semiconductor manufacturing, it is not enough for a company to be successful with capital alone; Rather TSMC has found a lot of its success due to the long-term relationships it has cultivated with its customers (i.e. Apple).
We expect demand for semiconductors to grow in tandem with increasing demand for artificial intelligence solutions accentuated through IoT, high-powered computing (HPC), developments in 5G wireless communications, and the growth of Industry 4.0 and data centers. The one constant required for these digital transformations to occur is semiconductors.
Through the COVID-19 pandemic, TSMC was unscathed as demand for cloud computing and consumer electronics surged due to work-from-home mandates across the globe. Post-pandemic, we expect demand for semiconductors to continue growing over the long-term. Although TSMC has competitors, it is far more technologically advanced, and competition decreases as the semiconductors become smaller. TSMC's superior lithography capabilities allows it to produce smaller wafers with greater processor efficiency.
TSMC's knowledge and physical capital built over the years has given them a significant competitive advantage over potential competitors and contributes to the high barriers to entry for potential new entrants. In fact, would-be competitors such as AMD and Intel are outsourcing the fabrication of their 7nm gaming chips, and Core i3 computer processing chips, respectively to TSMC (James, 2021). A segment of TSMC customers are the fabless chip designer companies. Fabless semiconductor companies focus on the design of the semiconductor chips before outsourcing the actual fabrication of those chips to TSMC. Fabless and fab-light chip makers (design and produce hybrid) include Nvidia, AMD, Qualcomm and Broadcom.
With their technology leadership TSMC is well-positioned to capture the growth of 5G networks driven by AI and cloud-computing with expectations of long-term revenue growth between 10% to 15% CAGR through to 2025 in U.S dollar terms (Jeff Su, 2021).
Catalysts for TSMC in the near-term include the production of the new N3 chip, which is a 3 nm chip. In fact, demand from customers seems to be relatively high when compared to past chips; “We are seeing a much higher level of customer engagement for both HPC and smartphone application at N3 as compared with N5 and N7 at a similar stage” (Lee, 2020).
The number of connected IoT devices is expected to surge to over 40 billion over the next few years (Schneider Electric, 2020). Self-driving cars are expected to have at least $550 more semiconductors under their hood than today's vehicles (Schneider Electric, 2020). Demand for powerful server systems used in cloud computing is high, and expected to grow (Schneider Electric, 2020).
Recent trends indicate that Big Tech firms such as Amazon, Apple, Microsoft, and Google are increasingly investing towards in-house designed chips (E.g. Apple M1 produced by TSMC have replaced Intel chips for their MacBook). This is a threat to fabless design firms such as Qualcomm and Broadcomm but is good news for TSMC, as this trend could serve to disintermediate the distance between the pure-play foundry and firms producing consumer technology. “TSMC is the archetype of a company that exploits Moore's Law” (McFarlane, 2020).
Risks, Opportunities and Threats
Risks associated with TSMC include foreign exchange, political and competitive risk from China. It is also worth noting that TSMC is reliant on Apple for more than one-fifth of its revenues so maintaining a good relationship with them is critical.
Foreign exchange risk between the New Taiwan Dollar (NT-USD) can be hedged. Political risk exists due to Taiwan's relationship with China which, could threaten the company's stability. In addition, China is investing heavily into its own Semiconductor Manufacturing International Corporation (SMIC) to become less reliant on Taiwan and the US for their semiconductors. However, SMIC is a laggard when it comes to technological advancements with their smallest chips produced being relatively larger and less efficient, in the 16nm/14nm range as compared to 5 nm chips on the market. This lag was further exacerbated by the US-China trade war as US companies supply the machinery and equipment required to manufacture more advanced semiconductors. Nevertheless, SMIC could be a threat in the long-run (5-10 years) as they have invested, along with Shenzhen's government $2.35 Billion to build a new semiconductor factory in order to becoming more self-sufficient and less reliant on foreign technology (Kharpal, 2021).
On the other hand, TSMC is currently in the process of building a $3.5 billion factory to produce 12 nm chips in Phoenix, Arizona (Reuters Staff, 2020). Thus, an established base in North America will allow for TSMC's management to better manage currency risks, and is also a natural hedge through geographic diversification away from Asia. This will also bring TSMC closer to most of its customers, which will surely be beneficial in the short and the long-run. Apple which, accounts for over 20% of TSMC's revenues is another contributing factor as to why TSMC is a Buy. A reason why TSMC has been so successful is the close relationship and coordination it maintains with Apple. Every innovation Apple develops is an opportunity for TSMC to capitalize on by providing the hardware required for those products to be brought to market.