Josh Collins
11/21/2023
Taiwan Semiconductor Manufacturing Company
The Babson College Fund is initiating coverage on Taiwan Semiconductor Manufacturing Company
(NYSE: TSM) with a price target of $152 representing ~52% upside. TSMC is a Taiwanese
semiconductor manufacturer, and it is the largest manufacturer in the world. TSMC serves the
world’s largest technology companies, including Apple, NVDIA, Broadcom, Qualcomm, etc., and in
2022 it produced fully 30% of the non-memory chips in the world.
We believe that their immense economy of scale advantage, effective monopoly on high end chip
fabrication, the proliferation of chip production due to the GenAI revolution, and their capital
expenditure moat which will benefit from global industry subsidies, will justify the increased value of
TSMC. We believe the street underestimates these massive economies of scale and innovation moats
that make TSMC a unique, unmatched blue-chip player in the chip manufacturing space set to grow
at an unprecedented rate due to AI ballooning the need for the highest end chips.
Stock Selection Process
After discussion with the teams, the tech team indicated that they were considering pitching a silicon
company in order to gain exposure to that segment in their portfolio. Given the fairly extensive
research and modeling I had done over the summer in this industry, using my industry comparison
models I looked for a stock in the semiconductor space that wasn’t (as) overextended as the
NVIDIAs of the world.
This led to TSMC, as they produce the underlying components that underlie all of NVIDIA’s
success, and yet trade at a much lower multiple historically. As well, their strong financial position,
and pseudo monopoly status, and global secular tailwinds in the technology space confirmed my
model’s output.
Industry Overview
The semiconductor industry has evolved rapidly over the past few decades. Advances and
technological innovations have caused chips to quickly miniaturize, as manufacturers have created
better, more efficient ways of making chips. The above chart shows this trend.
Because manufacturing these incredibly intricate chips is difficult, the industry spends massive
amounts in capital expenditures in order to update current foundries and build new foundries to
expand production capacity and flexibility as the number of models of chips, and thus fabrication
capacity, grows. Said differently, the industry grapples with Moore’s law, as well as Moore’s second
law; they state that the number of transistors on a circuit double every ~2 years, and that the cost of
chip fabrication facilities doubles every 4 years, respectively
The industry is divided mostly into a few groups notably:
1. Fabless chip design companies (Apple, AMD, NVIDIA)
2. Chip fabricators (TSMC, Samsung, Intel)
3. Lithography/Tool providers (ASML, etc)
4. Design software providers (Cadence, Synopsis, etc.)
The design software and tool providers sell their IP to chip fabricators, with which they produce the
designs requested by the fabless chip design companies. An interesting result of this dynamic is that
the different partners work closely together, and spend billions in building out their mutual
manufacturing ecosystem. It is therefore very hard for new competitors to penetrate the existing
paradigm, as this oligopolistic industry is quite insular, and new players need to provide enough
volume/a reason to change the status quo, which is massively difficult in this industry.
As well, though Intel and Samsung compete as chip fabricators with TSMC, two of the largest
clients (Apple and NVIDIA) would never switch to a competitor because both Intel and Samsung
compete directly on chip design and smartphones respectively with NVIDIA and Apple, and
therefore NVIDIA and Apple are very interested in staying with the “neutral” manufacturing
partner in TSMC, who has no internal use for chip designs and thus has no incentive to steal IP.
As a result of the above, the industry is remarkably capital intensive, and therefore the leaders in the
space have a widening moat. Not only do their competitors have to catch up by building large
facilities to manufacture the previous generation chips which are still in demand, they have to plan
ahead in building facilities that take years to complete to produce cutting-edge chip models that only
a few companies have successfully produced. It is incredibly hard to innovate in the chip space, and
companies as large as Samsung have “given up” competing with TSMC given their superior
processes for some types of chips.
Company Overview
TSMC is a massive company, with a current market capitalization of ~$511bil. They had over $75bil
in revenue in 2022, ~90% of which came from silicon wafer (chip) fabrication, 55+% of which was
attributable to high performance/advanced technologies (7nm and smaller). In 2022, TSMC
produced more microchips than any other company on earth, which requires man large, expensive
fabrication facilities. While the majority of their facilities are located in Taiwan, they have geographic
diversity across the world with their 16+ fabs, and are further investing $40bil in a manufacturing
facility in Arizona and ~$4bil into a German facility due to US and European investment in the
space through the bi-partisan CHIPS and Science act and the European chips act, which are set to
act as a secular tailwind.
Apple makes up ⅕ of TSM’s revenue mostly through their 5nm chip demand for iPhones, and
though they are Taiwan based, the US is their largest market (>65% of revenue). As well, TSMC
has an effective monopoly on the production of the highest end chips, being the only company
globally that can produce the silicon necessary for NVIDIA's cutting edge AI chips at scale due to
the complexity of the manufacturing process.
2022 showed TSMC's exceptional performance in a challenging global environment, emphasizing its
sustained revenue growth, profitability, and technological leadership. Despite global economic and
geopolitical challenges, TSMC achieved a 33.5% YoY increase in revenue and a nearly tripling of
earnings per share over three years. As well, TSMC has shown 13 years of record revenues, through
a challenging global environment that included COVID and supply chain disruption. In addition to
exemplary revenue growth, TSMC’s gross profit margin reached ~60%, reflecting the company's
efficiency and cost-effectiveness.
The company's commitment to technological innovation is evident in the successful development
and production of advanced nodes, with the 3-nanometer technology entering volume production in
2022. TSMC's strategic focus on R&D, including leading on the upcoming 2-nanometer technology,
positions it as a leader in the semiconductor industry.
TSMC is responding proactively to macroeconomic uncertainties by expanding its global
manufacturing footprint, with fabs in Taiwan, the U.S., Germany, and Japan. This strategic move
aligns with customers' preferences for geographic manufacturing flexibility and enhances the
company's growth prospects.
Overall, TSMC represents a compelling case for investment, showcasing its immense economies of
scale, resilience, innovation, and strategic positioning in the semiconductor industry.
Thesis 1 - TSMC operates with massive economies of scale in a hugely capital/R&D
intensive, oligopolistic industry, creating an ever-expanding moat that insulates their strong
revenue and margin growth from most competitive pressure
Typically, when an industry shows strong double digit growth along with high (>50%) margins,
there is significant competitive pressure. We have seen TSMC generate 13 years of record adjusted
revenue, showing incredibly strong top line growth with an average CAGR of ~12% over 23 years
and an ROIC north of 23% over the past decade, one of the best in the industry. TSMC’s margins
have also expanded during this same period, growing from 57% to 62% in the last 5 years.
The charts below show TSMC’s long term revenue, net income, and growth of cash balance. As we
can see, TSMC has an incredibly stable business, with increasing revenues, earnings, and free cash
flow.
In the
silicon
fabrication
space,
TSMC
competes
with only
Intel and
Samsung.
There have
been
attempts
by both
the
middle-
east and
China to
develop
their own fabs to enter the space, but they have been largely unsuccessful in replicating TSMC’s
incredibly high difficulty and quality manufacturing processes. Because the manufacturing processes,
especially of the high end chips, is so complex, TSMC has not only a moat in terms of the
(increasing) volume of CAPEX required to compete in the industry, but also because the
manufacturing process IP is remarkably hard to replicate with any amount of capital.
Further, TSMC’s management has stated that they plan to invest in CAPEX with an eye towards the
next 10+ years of capacity demand. Given that TSMC is one of the largest companies in the world
with a market capitalization above $500bil, they are one of only a few companies positioned to
spend this quantity of capital to satisfy exponential global demand for semiconductors. As a
reference, TSMC spent over $30bil on CAPEX in 2022 alone, and over $100bil in the last three
years, with little indication of slowing down much in the next ~5 years.
Thesis 2 - The global silicon demand pressure presented by GenAI will cause large industry
growth in cutting edge chips for which TSMC owns most manufacturing ability
Revenue contribution by segment over time
Historically, we’ve seen TSMC generate most revenue from three major segments, the Smartphone
High Performance Computing (HPC), and Other. These segments are representative of two of the
largest TSMC clients, NVIDIA (HPC) and Apple (Smartphones), as well as the breadth of their
other 500+ clients across the globe (Other). The other component is all the smaller segments/end
markets, such as cloud computing, automotive, normal compute, specialty custom chips, etc.
As we can see, the HPC segment has increased 59% between 2021 and 2022 (though has declined in
the beginning of 2023), and the Smartphone segment increased ~28% yoy (though again, 2023 was a
rougher year).
The actual and further expectation of growth in the HPC market can largely be attributed to high
end chips used in GenAI, which is dominated by NVIDIA. In June of 2023, NVIDIA's CEO stated
that TSMC is a “world class company with immense capacity and incredible agility”, while also
committing to source both the current and next generation from various TSMC foundries, including
the planned Arizona facility. He continued: “The process of diversifying in different geographies is
an excellent strategy by TSMC and so TSMC is now part of Nvidia's diversity and redundancy
strategy.” It is important to note that this year, Nvidia announced a revenue target more than 50%
above Wall Street estimates with plans to boost supply to meet surging demand for its AI chips.
Because TSMC remains by far their largest manufacturing partner, they will benefit as NVIDIA
grows without the downside exposure from NVIDIA’s high volatility. This market is expected to
grow at a 30% CAGR through 2030, per the chart below, and barring significant, rapid advancement
by competitors, TSMC remains the only company capable of manufacturing such chips:
AI Chip Revenue Growth Projections (Statista)
While less explosive, we also expect growth in the smartphone and “other” segments as well. In the
smartphone segment, experts predict anywhere from a 2% to 8% market CAGR through 2029,
largely driven by non-US markets, as the US smartphone market is fairly saturated and growth
appears to be slowing down. As smartphones advance, we expect them to transition from 3nm chips
to the future 2nm chips, and TSMC is the market leader and holds an effective monopoly on this
new innovative design, and we expect them to continue as the market leader as designs continue to
further miniaturize every ~2 years of so. Therefore, our model reflects increasing market share in
this segment as part of the revenue projections.
Thesis 3 - TSMC has an immensely strong financial position and track record. These give it
a unique position to gain free CAPEX leverage from global silicon manufacturing subsidies,
including the CHIPS and Science act in the US, and maintain their world leading position
Despite the capital intensive nature of their industry and challenging global conditions over the past
3 years, TSMC has a strong cash position, had recorded 13 straight years of revenue growth, and has
tripled EPS in the last 3 years. The above graphic from their 2022 annual report shows more
accomplishments of the company in recent years. TSMC also has relatively little debt relative to size,
with only ~$30bil in debt. It maintains a cash reserve of over $49bil, and therefore TSMC operates
with negative net debt, despite the incredible capital requirements in the industry. They are able to do
this because of their immense financial growth and free cash flow, both with regard to top line and
earnings, over the past decade.
Partially due to the CHIPS and Science act, TSMC is investing ~$40bil into a new US fabrication
facility in Arizona, and ~$4bil towards a joint facility in Germany, and expects to receive a combined
~$20bil in government subsidies from both the US and Europe. This is indicative of the desire for
large world players to increase their silicon production ability. Because TSMC has such massive cash
reserves (~$45bil) and therefore can expand CAPEX to take advantage of global subsidies, TSMC
will benefit from programs all over the world aimed at this goal, thus reducing their costs and
accelerating the payback period for massive expenditures. This also further increases their
competitive moat, as subsidy distribution is inherently a zero sum proposition. Since TSMC stands
to receive a large share of the subsidies to build their own fabs, their competitors will receive less as
a result. TSMC expects to receive about $15bil in combined tax credits and subsidies from the
CHIPS act, and $5bil from the European chips act. As well, these subsidies reduce the overall cost
of these large fasciitis, and contributes to ensuring that chips produced in global fabs can remain
cost competitive with those produced in Taiwan.
The reason that this CAPEX is important is the competitiveness of the industry. The below graphic
from a leading silicon research firm projects the innovation trend in the industry over the next
decade:
In order to stay on the cutting edge, we can see that major new manufacturing innovations occur
roughly every 2 years. It requires a large amount of both forward planning and capital expenditures
to upgrade or build new manufacturing facilities in order to produce the new technologies.
Currently, TSMC and Samsung lead on the production of the cutting edge 3nm chips, but TSMC is
well ahead in terms of their production ability for the next generation 2nm chips, set to premier in
2024.
Manufacturing capacity is especially important, because even the older technologies remain in use
for a long time. There are still 280nm chips in demand, an architecture developed in 1997, and 16nm
(available since ~2015) or larger chips still account for >45% of revenue presently. This trend shows
that it is important to maintain adequate manufacturing capacity for many different chip
architectures, and therefore more manufacturing capacity is needed to keep up with innovative new
architectures. TSMC clearly understands this, and plans to invest tens of billions of dollars into new
fabs across the world.
Catalysts and Risks
Catalysts
Faster than expected development of higher end technologies
It is hard to fully quantify the ultimate growth potential of the next generation end markets such as
GenAI, 5g, cloud computing, IoT, EVs etc. however, what we do know is that Moore’s law
continues to (mostly) persist, and as these markets grow, TSMC will be a direct beneficiary as they
are the only firm capable of producing the next generation chips in a sustainable and profitable
manner. If, as has been the case many times in the past, new technologies advance more quickly
than predicted in the next few years, the estimates in the model will prove to be low.
Semiconductor market bottom
Misunderstanding of how crucial the company is in the global supply chain for chips has caused the
company to decline from ATH of ~$145 since early 2022. Since the semiconductor industry is
historically cyclical, the street is over-punishing the stock. We believe that thought the industry has
become less traditionally cyclical, the COVID supply chain disruption and overstocking as a result
has caused ripples that look like a cycle of the past. Since this bottom action often precedes a large
run up, if it continues we see it as a boon for TSMC
Cooling in geopolitical tensions/China Derisking
China met with the US last week, and we once again see military to military communication, which
can remove the “accident risk” that we believe has been unduly punishing TSMC’s stock.
Geopolitical risk is real (see more in risks below) but we believe that due to how integral TSMC is to
global technology, both the US and global technology firms that rely on TSMC would be very loath
to allow China to get anywhere close to nationalizing TSMC. Further, as tensions between the US
and China cool, this risk eases.
Risks
China invading Taiwan
This is clearly one of the larger risks of investing in TSMC. China has been engaged in saber rattling
about invading Taiwan. However, we view this risk as less severe than most, and we believe the
street may be overestimating this risk Since they are such a global leader in the semiconductor space,
and because they have some monopolistic/oligopolistic control over some of the most advanced
semiconductor production, TSMC being taken over/nationalized in any sort of China Taiwan
invasion would set the rest of the world back decades in terms of silicon manufacturing capabilities.
The US Government has repeatedly indicated that they would not allow this to happen, for obvious
national security technological readiness reasons. As well, US China tensions, after a period of
choppiness, are moving back in the right direction with Xi’s visit to San Francisco and meeting with
Biden. Even if tensions revert and deteriorate, any sort of Taiwan invasion will likely result in
WWIII, in which case we will have larger problems to worry about than a TSMC investment.
TSMC has also hinted in the past that they have strong countermeasures in place should China
invade, and therefore China knows that invading might cause TSMC to simply leave with their
people and destroy their fabs, in which case China would not accomplish their goal.
As well, because many massive technology companies (Apple, NVIDIA, etc) rely heavily on TSMC
for their chip manufacturing, the systemic risk of losing TSMC to the global technology supply chain
would be catastrophic, and therefore any and all companies in this supply chain would also suffer
greatly in the event of TSMC going away. Therefore, we believe that though China invasion risk is
real, both the likelihood and drastic consequences should one occur mean that it should not prevent
us from investing in such a blue-chip, financially strong company with a great history, strong
financials, and an ever expanding technological and CAPEX moat.
The AI chip trend fizzles out/doesn’t live up to expectations
The AI market is still quite new, and so it is hard to predict how demand will evolve, and if the
technology will take hold across industries in the time period that stocks are pricing in. Because the
exponential growth of AI is priced into many stocks (though TSMC less than companies like
NVIDIA), there is risk to the investment if this market is overestimated by the street.
We believe that this is unlikely however, since we’re already seeing increased demand, and all of the
hyperscaler companies (Microsoft, Meta, Amazon, NVIDIA, etc) are investing hugely into the space.
The GenAI models only get harder and harder to train as time goes on, and the current cutting edge
is estimated to require over $300mil in hardware. Thus we see this risk as small.
Competitors outstrip TSMC in terms of R&D
This risk would be that Samsung or Intel (or another Chinese fab) can replicate the manufacturing
process of TSMC and take market share, especially in cutting edge chips where TSMC currently
dominates. However, for the reasons laid out in the report above, while this is technically possible, it
is highly unlikely in our view, as the industry continues to follow Moore’s law, and TSMC’s moat
grows ever larger both in terms of manufacturing process knowledge and CAPEX leads.
Comps
Intel, Samsung
See model for details/larger view
DCF
See Excel model for details
Appendix
FAQ/IR Responses (Answers Paraphrased)
Question: Will TSMC be able to achieve the projected margin expansion given the higher
production costs of producing chips outside of Taiwan at the global fabs?
IR Answer: The reason for geographical expansion is customer demand for such, and therefore the
entire market understands that premium pricing will be charged on these chips and is ready to accept
this in exchange for decreased geopolitical risk and proximity. The US government has said they will
help TSMC defray these increased costs through subsidies, and this is what spurred the Arizona Fab,
which is complete pending tools and engineers. All this said, expect 3-5 years before fab efficiency
equals that of Taiwan.
Question: How will TSMC decide on pricing, both in Taiwan and abroad?
IR Answer: TSMC sits down with big partners each year to discuss their needs for the coming year,
and then it is able to decide on pricing based on this. Because the large partnerships are so sticky
given TSMC’s basic monopoly, pricing power is high here.
Question: Will the global silicon subsidies be a problem for/create competition with TSMC?
IR Answer: The raw capital expenditure of TSMC stands up to the entire size of the subsidies, and
further TSMC will reap a good portion of those subsidies. Therefore, the subsidies and global
tailwinds will not hinder TSMC through competition, and indeed competing with TSMC in terms of
CAPEX remains impossible even with these subsidies.
Question: Share based comp/comp structure?
IR Answer: The vast majority of comp is cash bonuses. Based on shareholder return/dividends for
executives, and revenue growth, gross margins, and ROE for other bonus eligible employees. Many
executives are 20+ year tenure, some don’t work for money because they’re already wealthy.
Question: CAPEX Looking Forward?
IR Answer: Two most important business decisions are CAPEX and R&D spend. TSMC focuses
on a much larger time horizon (the next ~10 years) when planning CAPEX such that they can at
least partially anticipate the growth in demand.
Question: Discuss TSMC’s moat
IR Answer: TSMC has a ~30% market share in the early 2000s, now it is so large they don’t often
report it in fear of anti-trust issues. They believe they have such a large gap over competitors in the
space, and they have become so large, that more and more partners will choose TSMC and therefore
they will only snowball in the future.
Management and Management Compensation
Misc Charts
Sources
Chips and Science Act Info
https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/09/fact-sheet-chips-
and-science-act-will-lower-costs-create-jobs-strengthen-supply-chains-and-counter-china/
TSMC Article
https://www.nextplatform.com/2022/10/13/tsmc-the-leading-indicator-for-an-entire-industry/
Taiwan Article
https://www.usnews.com/news/technology/articles/2023-06-01/nvidia-ceo-feels-safe-relying-
heavily-on-taiwan-manufacturing
Semiconductor Measuring Article
https://spectrum.ieee.org/a-better-way-to-measure-progress-in-semiconductors
Semiconductor Market Share
https://www.visualcapitalist.com/top-10-semiconductor-companies-by-market-share/
Financial Details
https://stockanalysis.com/stocks/tsm/revenue/
Semiconductor Size History
https://en.wikipedia.org/wiki/List_of_semiconductor_scale_examples
Smartphone Growth Article
https://www.fortunebusinessinsights.com/industry-reports/smartphone-market-100308
https://wccftech.com/tsmc-ships-15-million-wafers-in-2022-marking-7-7-annual-growth/
2nm Chip Article
https://asia.nikkei.com/Business/Tech/Semiconductors/TSMC-to-make-cutting-edge-2-nm-chips-
at-new-plant-in-southern-Taiwan
Chip Revenue By Segment
https://www.anandtech.com/show/21102/tsmc-q3-earnings-3nm-production-node-accounts-for-
6-of-revenue
Damodaron ERP Data
https://pages.stern.nyu.edu/~adamodar/
Intel Tax Info
https://csimarket.com/stocks/singleProfitabilityRatiosy.php?code=INTC&itx
Samsung Tax Info/Burden
https://www.koreatimes.co.kr/www/tech/2023/11/129_339886.html
TSMC 20-F
https://investor.tsmc.com/sites/ir/sec-filings/2022%2020-F.pdf
TSMC Customer List
https://exploresemis.substack.com/p/tsmcs-top-10203040-customers-
who#:~:text=The%20company's%20top%2D10%20customers,automotive%20and%20IoT%20seg
ment%20exposure.
Accenture Semis Report
https://www.accenture.com/content/dam/accenture/final/accenture-com/document/Accenture-
Pulse-Semi-Research-Survey-2023.pdf#zoom=50
TSMC Growth Article
https://www.the-waves.org/2023/01/21/rise-of-tsmc-why-and-how-to-replicate/
Semi Industry Image
https://www.semi.org/en/semiconductor-industry-2015-2025
AI Trend Article
https://medium.com/technology-media-telecom/global-genai-spending-to-reach-143-billion-in-
2027-
a6821d4d8110#:~:text=GenAI%20Business%20Applications%20Growth%20Forecast,with%20an
%2082.7%20percent%20CAGR.
Global Fab Market Share
https://www.idc.com/getdoc.jsp?containerId=prAP50994023#:~:text=Among%20the%20top%20
10%20semiconductor,2021%20to%2055.5%25%20in%202022.
Semi CAPEX
https://semiwiki.com/uncategorized/331322-semiconductor-capex-down-in-2023/
TSMC CAPEX
https://www.brownstoneresearch.com/bleeding-edge/tsmcs-capex-is-hitting-record-levels/
TSMC vs NVIDIA
https://finance.yahoo.com/news/tsmc-tempers-capex-outlook-32-053256564.html
Buffet Sale Article
https://www.cnn.com/2023/05/16/investing/berkshire-hathaway-taiwan-tsmc-stock-exit-hnk-
intl/index.html
