Description
· World’s largest independent semiconductor chip manufacturer with 55% of revenue tied to mobile (manufacturing chips for smartphones and tablets)
· Short synopsis of the business model: Chip designers without manufacturing capacity contract out to TSM to manufacture their chips. TSM builds new manufacturing capacity for the newest generation of chips every 1-1.5 years. Smartphone and tablet customers who require the best chips will buy the newest generation from TSM. TSM will charge a higher price for the newest chips vs. older chips (their previous new generation). When a new manufacturing process is established, pricing on the previously new process steps down as competitors catch up. Inelastic customers always buy the newest chips so TSM’s revenue growth is predicated on continuing to be able to sell the newest chip in as large of a quantity as possible and at as high of a price as possible.
· Base: 100 TWD/$16 USD, 13x earnings multiple assuming Intel or Samsung/QCOM
· Bear 67 TWD/$11 USD, 13x multiple assuming Intel+QCOM+Samsung
· Risk 172 TWD/$28 USD, 15x assuming no market share loss
· Three major points to the short thesis
o (1) Increased competition from Intel in mobile
§ Intel has the best manufacturing process in the industry but they have historically focused on PCs and servers, not mobile (smartphones and tablets)
§ Under a new CEO they are making significant progress in mobile
· They have captured 25% of share of the tablet market (20% of overall mobile) within 2 quarters (Q2 and Q3 2014)
· They expect to capture share in smartphones in late 2016 after they develop a smartphone chip in-house (currently in the works)
§ They have announced partnerships with Chinese smartphone/tablet chip makers and the Chinese government
· This is very strategically important given how much growth will come from China
o (2) Increased competition from Samsung/Global Foundries at the newest manufacturing process
§ Increased competition from Samsung
· Samsung will have a 1 quarter lead over TSM at the newest manufacturing process
§ Qualcomm shifts from TSM to Samsung
· Samsung is ramping development of their own Exynos, internally designed chips
· Samsung has been using Qualcomm for the chip for their Galaxy line of phones
· Qualcomm is afraid of losing Samsung phones to Samsung’s internal chip
· As such, Qualcomm is shifting production from TSM to Samsung in order to keep Samsung from using internally developed chips
§ Apple shifts from TSM to Samsung
· Apple has asked Samsung to license their technology to Global Foundries since Apple is interested in doing the majority of their production in the US
· Our checks have shown they told Samsung this is the condition to switch their newer generation chip orders from TSM to Samsung
· We don’t know when Glofo will ramp production yet but could be for the next iPhone or the subsequent one
o (3) Hitting a technology wall – capex is increasing at the newest manufacturing process, resulting in higher costs and fewer customers willing to move
§ The cost to develop the newest generation of chips is increasing and the performance is not improving as much
§ TSM is stuck between a rock and a hard place – either accept lower gross margins or lower revenue growth
§ As such, customers buying chips for lower end mobile devices (phones/tablets in China/India) will opt to stick with the older manufacturing process
§ Competition is catching up in the older process, lowering ASPs from UMC/SMIC/Global Foundries
Risks
· Intel mis-executes and takes no mobile share
a. At 13x consensus earnings and 8% normalized earnings growth in semiconductors, assuming the revenue hits quantified below happen, excluding Intel, TSM’s revenues simply grow at a slower pace in 2016 but the multiple is not egregious, so earnings growth offsets the revenue miss, the multiple slightly expands and the stock simply does not move for 1.5 years
· Samsung cannot get yields on their new manufacturing process higher
a. If Samsung/Glofo cannot get yields up in their new process, the return is not justified. This means TSM maintains its monopoly position and pricing power.
b. In this scenario, with 8% revenue/earnings growth and a 13x multiple, the business continues to generate value with likely stock downside of 15-20%
· TSM is an ADR
a. Significant national pride in Taiwan for TSM and due to large size, comprises 23% of the EWT (Taiwan Index); high correlation to moves in EWT could mean irrational multiple even as fundamental thesis plays out
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Share loss to Intel/Samsung+Glofo