The most important company you may have never heard of
If you look around, chances are there would be multiple TSMC products sitting within hand-reach. However, most people don’t even know what TSMC is and what it produces.
That’s because TSMC’s products are embedded inside many of the electronic devices we use day-to-day. It is the world’s undisputed leading manufacturer of semiconductor chips or ‘microchips’ as they are also known. This includes chips sitting in your iPhone, laptop, TV screens and even within your car.
TSMC, a US-listed stock, has a market capitalisation of US$1.7trn, which makes it one of the largest companies globally. It is a great corporate success story in Taiwan, where it is headquartered and operates the majority of its manufacturing facilities.
One of the most important companies in the world
TSMC is often referred to as one of the most important companies in the world, because it has a market share of above 80% in ‘leading-edge chips’. This refers to the most advanced chips that use the latest technology, such as those in iPhones, Nvidia’s leading AI computers, and leading defence technologies. If TSMC was to stop producing these chips, it would potentially take more than a decade to rebuild the manufacturing capability it has. This would set world technological progress back years.
It is important to differentiate TSMC from a chip designer like Nvidia. Nvidia designs chips – kind of like the architect of a house. Nvidia then sends the plans for these chips to TSMC which manufactures them – sort of like the builder of the house.
TSMC has manufacturing facilities called ‘fabs’ located around the world. Manufacturing tiny microchips in unit volumes counting in the millions, for thousands of companies, is an incredibly difficult task. For a start, a single leading-edge fab these days costs upwards of US$20bn to build. The fabs must operate in a near-vacuum to avoid contamination from dust and other particles. Specialist equipment is required that can cost near NZ$1bn for a single machine. Producing a single chip can take up to nine months, with hundreds of steps required. A single mistake can destroy the chip and force the process to restart. Additionally, thousands of highly skilled engineers are required, who are reliable, hard-working and do not make mistakes. Very few companies in the world now attempt to do this, and even fewer are able to excel at it.
Over the past 40+ years, TSMC has been perfecting its technological know-how and manufacturing processes to a level that means there are only two competitors remaining in leading-edge chip manufacturing – Samsung and Intel. However, both these rivals have steadily been losing market share to TSMC, particularly over the past decade, as they have been unable to match the technological advancements and reliability TSMC achieves. In other words, TSMC’s competitive lead continues to widen.
Integral to the AI infrastructure build-out
TSMC manufactures all the most advanced chips used to power artificial intelligence data-centres. This includes the leading chips from the likes of Nvidia, Google and AMD. For this reason, TSMC represents a key bottleneck in the race for AI leadership that many of the world’s largest technology companies have embarked on. Nvidia can only sell more chips if TSMC is able to produce more for them. This makes TSMC the most important company in Nvidia’s supply chain.
The TSMC management team has a reputation for being rational and conservative. Yet at its recent results announcement in January, it guided to AI-related revenues growing at 50% per annum until 2029. This implies revenue from AI chips alone will exceed US$100bn per year by the end of the decade. Supporting this outlook is a large ramp-up in chip demand from the likes of Google, Microsoft and Open AI. Also contributing to the growth is the strong pricing power TSMC enjoys, as it is the leading company with capability to produce these chips consistently and reliably. This has led to price rises for its chip wafers of about 20% per annum in recent years.
We like investing in TSMC as a way to capture potential AI infrastructure gains, because we don’t have to worry about which chip designer is winning (e.g. Nvidia vs Broadcom). TSMC produces all the chips for the designers, so as long as demand for AI chips is strong, then TSMC should do well.
Attractive valuation and investment proposition
TSMC ticks most of the boxes we look for in an investment that can provide strong returns over many years. This includes having a strong competitive advantage driving market share gains, exposure to an attractive industry with long-term growth drivers, high returns on invested capital, a strong balance sheet, and a high-quality management team which will invest and return capital sensibly.
We see TSMC as having the potential to grow its earnings at around 30% per year over the next five years, which is a faster growth rate than most of the large American-based technology companies. Yet we can buy TSMC at a cheaper valuation than most of these companies.
No investment is without risk
There are a couple of risks to TSMC worth highlighting. First, like all companies exposed to the AI investment boom, at some stage AI spending will slow and the drop-off could be very sharp. TSMC earnings – and likely its share price – will suffer when this happens and take some time to recover. We actively manage our position size based on our outlook for AI-related demand growth.
Secondly, TSMC has the largest concentration of its manufacturing facilities in Taiwan, which poses a risk given current geopolitical tensions between China and Taiwan. This is part of the reason why TSMC is currently expanding furiously in Arizona to diversify its production globally. The other driver is because President Trump wants to de-risk the American supply chain of leading-edge chips by having more fabs located in US soil, so he is pressuring chip companies to build on US soil.
