The Semiconductor Leader
As electronics and microchips made their way into virtually every product, from washing machines to cameras and phones, their manufacturers became increasingly large and important companies.
The first dominant actors of the nascent tech industry were established in the USA, with companies like Intel (INTC -1.43%) and IBM (IBM -0.89%). Quickly after, the industry shifted toward Asia, with Japan and then Taiwan benefiting from the combination of high-quality labor and lower costs.
This shift over costs turned into a long-term advantage. Experience and accumulated R&D effort transformed the Asian chip foundries into giants, which today produce most of the global chip supply.
Besides almost the entire industry, one company dominates the most advanced chip production process: the Taiwan Semiconductor Manufacturing Company, or TSMC.
Taiwan Semiconductor Manufacturing Company Limited (TSM +0.07%)
A State-Led Initiative
TSMC was founded in 1987, at the initiative of the Taiwanese government to build the country’s chip industry from scratch. It was a spin-off from the government research institute ITRI (Industrial Technology Research Institute).
This was after industry leaders like Texas Instruments and Intel declined the opportunity, with only Philips willing to sign a joint venture and invest $58M & IPs in exchange for 27.5% in TSMC.
Today, the Taiwanese government still owns 6% of TSMC, and Philips would sell all its TSMC shares in 2008.
Dr. Morris Chang was instrumental in founding the company. Born in China, and with 25 years of experience working at Texas Instruments, he would be remembered as known as the “father of semiconductors”.
Source: The Curiosity Chronicle
Cutting Into Intel’s Business Model
At the time, there were plenty of “fabless” chip producers, companies designing the chips, but having no manufacturing facilities, having this job done instead by the likes of Intel (a fab, or foundry, is the industry term for a chip factory).
This was in large part because the manufacturing needed equipment worth $50M to $100M to engrave silicon wafers and turn them into computer chips.
Source: eTeknix
The chip manufacturing process is a very complex one, relying on an ultra-specialized supply chain, where the foundry (fab) is in charge of assembling together as efficiently as possible the diverse manufacturing equipment (wafers, lithography, heating, doping, packaging, assembling, etc.).
Source: EITC
As a result, Intel could not only ask for high prices but even force fabless producers to have the right to design. Intel could later on bring its own competing design that is produced in-house.
TSMC would make its way into the industry by being the first pure “foundry”, offering manufacturing services without competing with its fabless clients.
At the time, TSMC was lagging behind in technology, but this offer proved highly successful. Early customers included companies like Broadcom (AVGO -1.33%), and later on, Apple (AAPL -0.88%), Nvidia (NVDA +2.08%), AMD (AMD -1.29%), etc.
TSMC would IPO in Taiwan in 1994, and be listed on the NYSE in 1997, the same year it reached a 1 million silicon wafer capacity.
Rise Of A Tech Giant
The Elephant In The Room
Another factor in TSMC’s success was its dedication to R&D. Determined to quickly fill the technological gap with industry leaders, the company invested a massive amount of money in new machinery and research.
The large ownership by the Taiwanese government was also important in the early days. The government was satisfied with the company’s progress in the industry and high-value jobs and did not care much about a quick return on its money.
Over time, TSMC became the semiconductor foundry, with no less than 59.5% of the industry’s revenues, far ahead of its largest competitor, Samsung (16.1%).
Source: Eric Flaningam
This lead is getting stronger over time, with TSMC having captured a very large part of the industry growth from 2019 and the Q2 2024 revenue share reaching 62%.
Source: SemiWiki
Leading In Advanced Nodes
From its beginning as a more fair production partner, TSMC has progressively become the technology leader of the industry, especially in the “leading edge” chips.
Chips are generally classified by the size of their processor.
In general, all nodes above 16-28 nanometers (nm) are considered legacy semiconductors. They are still very important for the global economy, as they are the bulk of the world’s semiconductor consumption for appliances, cars, infrastructures, defense equipment, etc. These chips are, however, mostly a commodity with very low margins for the producers.
Source: Techovedas
In contrast, the most recent nodes are where most of the profit of the industry is made, with often more demand than the foundries can provide, and that holds especially true for TSMC.
Today, the company is leading in the most advanced node, 3nm, and the upcoming 2nm is even more in demand, expected to be larger than 5nm and 3nm combined.
Mass production of TSMC’s 2nm node is expected to start in 2025. It will likely be a tight competition with Samsung, which has also started preparing 2nm and 1.4nm production lines.
Source: TSMC
A turning point for TSMC was in 2010, when Apple chose it as the supplier for the chips of its iPhones, whose sales were exploding. For the past two decades, smartphones and advanced computers and data centers (or HPC—High-Performance Computing) have been the core applications for the most advanced chips, advancing the industry and paying for the associated massive R&D costs.
Source: TSMC
To this day, Apple is still TSMC’s largest consumer, followed by Nvidia.
Source: Moomoo
EUV
What makes the smallest and most advanced nodes unique is that they use a new technology called EUV (Extreme UltraViolet lithography), an upgrade from the previous DUV (Deep UltraViolet).
Currently, EUV is the monopoly of the Dutch company ASML (ASML -1.82%), the sole manufacturer of EUV lithography machines.
Back in 2019, TSMC’s 7nm node chips were made with the first EUV process, delivering high volume customer products to the market.
The next step, a lithography machine called High NA (Numerical Aperture) EUV, is now being shipped to semiconductor foundries, to Intel in December 2023, and to TSMC a year later, and Samsung is expected to get it by 2025.
It should be noted that beyond production itself, the design costs for chips using increasingly smaller processors is growing almost exponentially, indicating that maybe at some point in the future, the race to smaller processors will bring diminishing returns.
Source: Quatr
China, US Factories & Trade Wars
Taiwan’s Awkward Diplomatic Status
Due to the importance of advanced chip manufacturing for AI, defense, and the tech industry in general, this is a very strategically important industry.
At the same time, the Chinese government officially considers Taiwan as a “rebellious province of China”, and not an independent country. A situation that is currently the official position of most countries, including the US (“One China policy”), with, for example, a declaration by Joe Biden in 2024 that the “U.S. does not support Taiwan independence”.
At the same time, the US is arming Taiwan to defend against a potential Chinese invasion and has repeatedly implied it would go to war with China over an attack on the island.
TSMC As A Target?
This puts TSMC, as the producer of the most important industry of the island, in a tough geopolitical spot.
On one hand, it is a technological leader in a de-facto (but not de jure) independent country under the protection umbrella of the USA.
On the other hand, it could become the prime target in any military action, with US lawmakers even suggesting the US itself should be ready to bomb TSMC’s factories to prevent China from acquiring them in case of an invasion.
This idea was strongly supported by Elbridge Colby, now Trump’s nominee for Under Secretary of Defense for Policy.
Source: Elbridge Colby
TSMC American Factories
Under the geopolitical risk of an interruption of Taiwan’s supply, the US has been pressuring TSMC to open more factories in mainland America.
This led to plans since 2020 to open a large foundry in Arizona, to which another fab was added in 2022, bringing the total investment to $40B.
Source: TSMC
The move has not been without issues, as TSMC is struggling to find adequately trained local workers and reports of conflicts arising from differences in work culture between Taiwanese and American employees.
Nevertheless, the first production should start in 2025 for the first fab, and production yield (the efficiency of properly engraved chips, a key industry metric) is now higher in Phoenix than in Taiwan.
The second fab will start production in 2028 for 3nm and 2nm process. A third fab was even announced that will focus on the 2nm process and beyond, to start production by the end of the decade.
Trade War Collateral Damages
As the US tries to limit access to advanced technologies in China, especially for computing and AI, the country’s semiconductor industry has been subject to restrictions and sanctions.
This started with banning the export of EUV machines to China, to an ever-expanding list of banned products, including all advanced chips.
If this had succeeded, it would have been great news for non-Chinese chip manufacturers.
However, this has led China to develop it domestic foundry capacity as aggressively as possible. At the heart of this effort are state-owned SMIC and Huawei.
SMIC claims to have developed a 5nm process without EUV. China is also looking at developing its own EUV lithography, as well as replacing the entirety of the international semiconductor supply chain with domestic manufacturers.
Among the possible alternatives to EUV, and even more High-NA EUV, the following solutions have been proposed:
In the long run, this could prove the largest threat to TSMC, more than its traditional rivals. This is because China is already consuming more than 50% of the global chip supply.
So, it could provide companies like SMIC the domestic demand to scale up to the size where it could rival TSMC while also benefiting from tax advantages, access to capital, and other advantages provided by the Chinese government to a strategic sector.
TSMC Financials
For an industrial company, TSMC had a remarkably high gross margin of 57.8% in Q3 2024, up 3% from the previous year. This converts into an equally impressive 42.8% net profit margin. The company has very little debt, with total liabilities equal to the cash on hand.
The stock price has grown threefold since its low point at the end of the pandemic and tenfold in the past ten years.
Taiwan Semiconductor Manufacturing Company Limited (TSM +0.07%)
The company also started to pay dividends in 2004 and has never reduced dividends per share since.
Conclusion
TSMC is maybe the most important chip & semiconductor manufacturer in the world. The company has a long history of building a solid competitive advantage, first with fairer deals, and then with a persistent lead in quality, technology, and yields, allowing it to generate consistently impressive margins, especially for a manufacturing business.
As a result, although it is not without competition, with Samsung and Intel serious contenders, it is far behind in market share of the uncontested leader. It will likely take years at best for Chinese foundries to catch up as well.
An investment in TSMC is not without risks; however, the largest is almost completely out of control of the company’s management. Would a Chinese invasion of Taiwan occur, it would certainly devastate the company’s ability to produce chips and even maybe destroy its factories or see them seized by what would then be a hostile foreign nation.
So, investors in the company will need to monitor not only whether TSMC’s advantages in technology and manufacturing excellence persist, including against SMIC and other Chinese firms, but also the global geopolitical situation.
