Taiwan Semiconductor Manufacturing, or TSMC, is the world’s largest dedicated contract chip manufacturer, or foundry. It makes integrated circuits, or ICs, for customers based on their proprietary IC designs. The firm has long benefited from semiconductor firms around the globe transitioning from integrated device manufacturers to fabless designers. TSMC, like all foundries, assumes the costs and capital expenditures of running factories amid a highly cyclical market for its customers. Such cyclicality stems from the fact that foundries tend to add excessive capacity during times of burgeoning demand that can result in underutilization during downturns that hampers profitability.
The rise of fabless semiconductor firms has been maintaining the growth of foundries, which has in turn encouraged increased competition. However, most of these newer competitors are confined to low-end manufacturing due to prohibitive costs and engineering know-how associated with the leading-edge technology. To prolong the excess returns enabled by leading-edge process technology, or nodes, TSMC initially focuses on logic products, mostly used on central processing units, or CPUs, and mobile chips, then focuses on more cost-conscious applications. The firm’s strategy is successful, illustrated by the fact it’s one of the two foundries still possessing leading-edge nodes when dozens of peers lagged.
The company has two long-term growth factors. First, the recent consolidation of semiconductor firms is expected to create demand for integrated systems made with the most advanced nodes. For example, major customer Nvidia is acquiring Arm to consolidate intellectual property and bolster high-end offerings in data centers, artificial intelligence, or AI, and the “Internet of Things.” Second, organic growth of AI, Internet of Things, and high-performance computing, or HPC, applications may last for decades. AI and HPC play a central role in quickly processing human and machine inputs to solve complex problems like autonomous driving and language processing. The trend of going from CPU to GPU is fully going forward and unfolding rapdiely. Cheaper semiconductors have made integrating sensors, controllers, and motors to improve home, office, and factory efficiency possible, but not always with the expected outcome.
Opportunities:
- TSMC should consistently earn higher gross margins than competitors thanks to its economies of scale and premium pricing justified by cutting-edge process technologies.
- TSMC wins when customers compete to offer the most advanced processing systems using the latest process technologies.
- TSMC will benefit from more semiconductor firms embracing the fabless business model and Internet giants designing their own datacenter chips.