We look at the semiconductor industry with a brief overview on Taiwan Semiconductor Manufacturing Co (TSM), the world’s largest semiconductor foundry. Investing in semiconductors requires first to understand the backdrop and current trends of the industry.
In particular, we look at TSMC’s products, competitors, customers, its market share, how TSMC makes money and many more. Critically, we discuss the recent Intel setback on its 7nm process and how it impact the wider sector.
The goal of this article to build an understanding in the global semiconductor space via the lens of TSMC. More importantly, an appreciation of the current trends and themes can help generate investment ideas in this sector. We conclude by summarizing why TSMC is your gateway to investing in semiconductors and why TSMC is a buy today.
Introduction to TSMC
Founded in 1987 and headquartered in Hsinchu Science Park in Taiwan, TSMC pioneered the pure-play foundry business model with a focus on manufacturing customers’ product. Simply put, TSMC is in the business of fabricating design of other companies for its customers, namely microchips with process nodes from 2 micron to 7 nanometers (see below). These products are widely used in smartphones, CPUs, industrial computers etc.
To avoid conflict of interest, TSMC abstained from design, manufacture or market any semiconductor products under its name. This is what led to its success over the years and is now the world’s largest semiconductor foundry, manufacturing >10,000 products using >250 unique technologies, serving close to ~500 customers.
How TSMC makes money
TSMC manufactures products on behalf of its clients. Of its revenue, ~85% comes from wafer, with the remaining coming from other products.
TSMC annual revenue growth and profit margin
TSMC grew its revenue at a CAGR of ~11% from 2010-2019. Additionally, gross profit margin over the time period was stable, with an average of 48.4%.
TSMC revenue by country / region
US remain the single largest revenue driver for TSMC, despite the gradual decrease since 2014, partially driven by increasing revenue from Asia. In absolute terms, US revenue grew by 20%, while Asia grew by 160% from 2014-2019. Other regions remain flattish.
Understanding semiconductor manufacturing process
The key types of semiconductor are microprocessors (CPUs), discrete graphic processing units (GPUs), field programmable gate arrays (FPGAs), memory (DRAM, NAND etc), application specific logic chips (ASICs & ASSPs) and microcontrollers (MCUs).
For example, CPUs are constructed with millions (if not billions) small transistors that perform the calculations needed. These need power. Consequently, the smaller the transistor the less power is needed. For this reason, the industry adopt “the smaller the better” mantra. 7 nanometer process discussed earlier (better known as 7 nm process) is simply the measurement of the size of these transistors.
Interestingly, Moore’s law observes that the number of transistors in a chip doubles about every two years. The process of course gets increasingly expensive the smaller it becomes.
TSMC market share and competitors
TSMC is the world’s largest semiconductor foundry, with >50% market share. TSMC’s main competitors consist of both listed companies and unlisted companies. The global foundries market is fairly concentrated with the top 3 players commanding ~80% of market share.
The semiconductor foundry ranking of 2019 is depicted in the chart below.
TSMC works with ~500 customers including AMD, Apple, Braodcom, Marvell, MediaTek, Nvidia, Qualcomm, Applied Micro and many more.
While TSMC does not disclose its revenue split by customers, it publishes its major customers representing at least 10% of its net revenue anonymously. Currently, there are two customers that belongs to this category. Although not officially confirmed, Apple is presumed to be its largest customer, contributing ~22% of its 2019 net revenue. In our view, Huawei is likely to the second largest revenue contributor of ~14% in 2019.
Global semiconductor trend 2020 and beyond
While growth have experienced a slight decline since 2018, it remains one of the larger subsector in the industry. The decline can be explained by the already high penetration in many developed countries. We view the imminent migration to 5G will act as a catalyst for further demand growth in the medium term.
High performance computing
High performance computing platform includes PC, tablets, game consoles etc. Interestingly, desktop usage has reduced significantly since 2009 and now command just >50% of total usage worldwide.
While PC/desktops are just one part of the segment, we expect a muted growth for this segment, if any. Having said that, we do not believe that this segment is facing an existential crisis, as there continues to be key irreplaceable platforms such as data center AI server demand, next generation gaming console and higher powered and more efficient CPUs etc.
Internet of Things (IoT)
Internet of Things (IoT) includes various platforms of connected devices, such as wearables, speakers, drones etc. With more functionality being built in to connected devices, combined with the effect of COVID-19, we expect the segment to grow mid-teens. Albeit in its infancy, this is a segment to watch in the coming years and likely to be a significant revenue driver for the industry.
The sector correlates with the number of car sales globally. Clearly, COVID-19 has dented the segment in the near term. In the long term, with electric vehicles (EV) now taking center stage, we expect increased sophistication and semiconductor content requirement, which will ultimately drive demand.
How Intel's setback affected its competitors
Late July 2020, Intel, also a formidable chip manufacturer, added that it’s delaying its new 7 nm processors by approximately 6 months because internal testing has revealed the below expectation yield, a measure of manufacturing quality.
Additionally, the US chipmaker parted ways with its Chief Engineer and is considering outsourcing more of its manufacturing to make up for the delays. According to reports, this is to ensure that its products remain competitive from 2023. Since then, Intel’s stock price fell by ~20%, while competitors AMD and TSMC rallied.
With Intel facing difficulties in its manufacturing, its closest competitor, AMD benefits from reduced competition through its reliable foundry partner, TSMC. In particular, AMD should be able to gain a notable market share for years to come in the computing segment.
Consequently, TSMC will also stand to benefit from greater demand for its manufacturing capacity. Given capacity constraint and a healthy surge in demand for its products, TSMC benefits from a higher pricing power, potentially leading to further margin expansion.
Political sensitivity in the semiconductor space
Data privacy, technology and intellectual property have frequently been in the crosshair of regulators and governments. Often, this is in part driven by national security concerns. Huawei is a great example of how a leading 5G provider is facing enormous pressure by its unstable relationship with the US and its allies.
Consequently, TSMC confirms in July that it plans to halt chip supplies to Huawei beginning in September. Our estimate suggest that TSMC could see a decline in its revenue, given that Huawei is a significant customer. Despite this, the Group gave optimistic revenue target of more than 20% growth in 2020, thanks to strong demand for 5G smartphones, infrastructure and its high performance computing segment.
TSMC is in a unique position for a few reasons. It hails from Taiwan and not China, so that significantly reduces the possibility of any Chinese targeted restrictions by other countries. Secondly, its pure-play foundry business model allows TSMC to act as a middleman, which will be affected more by industry trends than political ramifications. Finally, there’s a mountain to climb for firms looking to dethrone TSMC’s position. TSMC has the leadership, tech and cost advantage over its competitors that is hard to replicate in the near term.
Semiconductor stocks investable universe
The investable universe of global semiconductor space are
(this is not an exhaustive list)
Investing in semiconductors
In our view, investing in semiconductor stocks puts more emphasis in understanding the trajectory of structural trends in the medium term. We are particularly bullish on the future development of smartphones and increasing AI-fueled and computing sophistication in the automotive sector.
TSMC is the largest semiconductor foundry manufacturer with >50% market share. The recent Intel manufacturing debacle can act as a catalyst for chip designers and chip manufacturers to consider outsourcing much more. Even without this, we are projecting that the demand alone will lead to higher compound growth for TSMC.
As long term investors, while we missed the earlier part of the rally, our thesis for the stock is that it remains a multi-year growth story. With this article, we include the stock in our portfolio.