Investment Banking & Asset Management – FINC356

Technology | Semiconductors

Benjamin Wang

Investment
Recommendation
Benjamin Wang | 0
Investment Banking & Asset Management – FINC356
Technology | Semiconductors

Contents
Investment Recommendation .............................................................................. 2
Company Overview ............................................................................................... 3
Business Description ............................................................................................. 4
Management & Governance ................................................................................. 6
Analysis of Semiconductor Industry ................................................................... 7
Financial Analysis ................................................................................................ 10
Valuation .............................................................................................................. 11
Investment Considerations ................................................................................ 13

Benjamin Wang | 1
Investment Banking & Asset Management – FINC356
Technology | Semiconductors

December 7, 2021
Investment Recommendation
Benjamin Wang
Taiwan Semiconductor Price Target: $128.5
Manufacturing Company, Stock Rating: Outperform
Ltd. (TSMC) Symbol: TSM (NYSE)
Price: $122.32
I believe TSMC stands to prosper from both the Market Cap: $566.8B
technology and investment communities’ Dividend/Yield: 1.30%
interests in manufacturing microchips to quench Fiscal Year End: December
a never-ending thirst for more processing power. Valuation 2018A 2019A 2020A
On a macro perspective, following the COVID-19 Revenue $33.6B $35.7B $54.3B
pandemic, demand for semiconductors has eclipsed P/E 16.6x 26.1x 28.0x
pre-pandemic levels. The Company continues to
P/B 3.7x 5.4x 7.7x
reinvest profits directly into producing its next line of
EPS (dil.) $0.44 $0.44 $0.71
products. In the near term, TSMC’s capital
expenditure towards developing the 3nm fabrication Debt $5.9B $6.4B $13.1B
facilities is estimated to cost upwards of $20B. Staying Trading Data
with industry trends, TSMC will likely be one of the Shares Outstanding (mil.) 519.0
first and only manufacturers to provide the 3nm Float (mil.) 486.0
technology, invoking high confidence for growth in Average Daily Volume (mil.) 5.45
revenue and market share. Beta (5Y) 1.00

In my view, TSMC’s 5nm and 7nm process are a

good distance away from being fully utilized in consumer technologies. Recently,
NVIDIA (Nasdaq:NVDA) has announced that they will be using TSMC’s 5nm process for their
consumer Graphics Processing Unit (GPU) moving forward, away from their current supplier
Samsung. This shift away from a diversified supply chain is incremental to understanding
management decisions and partnerships for the semiconductor industry, as consolidation
trends upwards, so will TSMC’s share of the foundry market.
An overlooked catalyst for TSMC’s growth prospects is the demand from less advanced
mature technologies industries. As supply-chain delays rattle the global economy, demand
for less advanced technologies continue to grow at a rapid pace, including power management
ICs, fingerprint identification chips, and complementary metal-oxide-semiconductor (CMOS)
image sensors. TSMC has an edge on its foundry competitors with the largest manufacturing
network in the industry, allowing for the Company to meet demand for technologies that do
not make the headlines, but supply significant diversification in revenue segments.

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Company Overview
Taiwan Semiconductor Manufacturing Company known as TSMC (NYSE:TSM),
is the world’s first and largest silicon foundry, headquartered in HsinChu,
Taiwan. TSMC was founded in 1987 by Morris Chang, a Taiwanese-American
businessman. Founded on the principle of being a pure integrated circuit (IC)
foundry, the Company ensures that it never competes with its customers. Thus,
the key to TSMC’s success has always been to focus on its customers’ success.
TSMC’s foundry business model has enabled the rise of the global fabless
industry, and since its inception TSMC has been the world’s leading
semiconductor foundry. The Company manufactured 11,617 different products
using 281 distinct technologies for 510 different customers in 2020.
TSMC-made semiconductors serve a global customer base that includes a wide
range of applications. These products are used in a variety of end markets
including mobile devices, high performance computing, automotive
electronics, and the Internet of Things (IoT). Diversification helps to smooth
fluctuations in demand, which in turn allows TSMC to maintain higher levels of
capacity utilization and profitability and generate healthy returns for future
investment.
The annual capacity of the manufacturing facilities managed by TSMC and its
subsidiaries exceeded 12 million 12-inch equivalent wafers in 2020. These
facilities include four 12-inch wafer GIGAFAB® fabs, four 8-inch wafer fabs, and
one 6-inch wafer fab – all in Taiwan – as well as one 12-inch wafer fab at a
wholly owned subsidiary, TSMC Nanjing Company Limited, and two 8-inch
wafer fabs at wholly owned subsidiaries, WaferTech in the United States and
TSMC China Company Limited.
In May 2020, TSMC announced its intention to build and operate an advanced
semiconductor fab in the United States, in order to better support customers
and partners there as well as to attract global talents. This facility, to be built in
Arizona, will utilize TSMC’s 5-nanometer technology for semiconductor wafer
fabrication and will have a capacity of 20,000 semiconductor wafers per month.
Construction is planned to start in 2021 with production targeted for 2024.

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Business Description
TSMC is structured as a pure-play foundry. This means that the Company’s
only objective is to manufacture semiconductors designed by their customers.
The foundry business model prevents TSMC from ever competing in the same
product markets as its customers, as well as leaving the financial burden of
research & design up to chip design companies. This is not to say TSMC along
with the foundry industry do not incur high research and development costs.
The onus is on the manufacturer to be able to supply these high-tech chips
efficiently which is why fabrication facilities are constantly being built.
TSMC supplies four main product end markets, including mobile devices, high-
performance computing, automotive electronics as well as the internet-of-
things (IoT).
0.15/0.18um,
0.25um and 7%
Revenue by Technology
above, 1%
0.11/13um, 3%
90nm, 2%
65nm, 5%
5nm, 20%
40/45nm, 8%

28nm, 11%
7nm, 29%

16nm, 13%
20nm, 1%

10nm, 0%

Regarding TSMC’s revenue streams, the Company generates nearly half of its
revenue in the 5nm to 7nm semiconductor technology in the last fiscal year.
5nm stands for “5 nanometer”, and 7nm stands for “7 nanometer”, which has no
relation to any physical feature of the semiconductor chip, it is a commercial
term to refer to a new and improved generation of silicon semiconductor chips
in terms of increased transistor density. The 7nm chip began production in 2016
and the 5nm process entered production in 2020. The new generation of 5nm
chips claims to have a 15% speed improvement or 30% lower power
consumption than the 7nm chips. This 5nm product services TSMC’s high
performance computing and smartphone customers such as Apple, Qualcomm,
Huawei, Marvell and Nvidia.

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TSMC has sixteen wafer manufacturing fabrication plants in the company. At

the top, 12-inch GIGAFABs make up TSMC’s largest and most efficient plant in
terms of manufacturing capability as well as product quality. These GIGAFABs
currently have the highest capacity of all fabrication facilities in TSMC’s
network, with the ability to produce >100,000 300mm wafers monthly. As
semiconductors nodes get smaller, the demand for more advanced technology
needed to fabricate these nodes is needed, resulting in exponential growth of
capital expenditure on fabrication plants, with a single 12-inch GIGAFAB
totaling $5.4 billion. These GIGAFABs are primarily located in Taiwan (4), with
one additional GIGAFAB located in China (1).

TSMC’s 8-inch Fabs are the next line up fabrication facilities under TSMC’s
manufacturing network, primarily focused on less advanced mature
technologies such as power management ICs, fingerprint identification chips,
complementary metal-oxide-semiconductor (CMOS) image sensors etc.
Demand for the newest and highest processing power chips is evident, with
most of the industry focused on meeting demand where processing power is
most needed, but as the world moves towards implementing smart systems in
all aspects of life, so will demand rise for less advanced technologies. TSMC has
noticed this demand early on and is investing in 8-inch fabrication facilities to
meet this overlooked demand. TSMC’s network of 8-inch fabrication facilities
spans between Taiwan (4), and two wholly owned subsidiaries in China (1) and
the United States (1).
Finally, backend fabs help integrate individual devices on to the wafer of the IC,
with all backend fabs located in Taiwan (4).

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Management & Governance

Dr. Mark Liu is Chairman of Taiwan
Semiconductor Manufacturing Co. Ltd.
(TSMC). Prior to assuming this post, he was
President and Co-CEO of TSMC from 2013 to
2018, where he oversaw TSMC's leading-edge
technology development, and was Co-Chief
Operating Officer from 2012 to 2013. Before
that, he served in a number of executive
positions at TSMC, including Senior Vice
President of the Advanced Technology
Business and Senior Vice President of
Operations. Dr. Liu established TSMC's first 12-inch fab, and later TSMC's
GIGAFAB® operations. He also served as President of Worldwide
Semiconductor Manufacturing Corp prior to its merger with TSMC. Dr. Liu
joined TSMC in 1993 as an engineering deputy director and established TSMC's
first 8-inch fab.
Dr. C. C. Wei is Chief Executive Officer of
Taiwan Semiconductor Manufacturing Co.
Ltd. (TSMC). Prior to this appointment, Dr.
Wei was TSMC's President and Co-CEO from
November 2013 to June 2018 and Co-Chief
Operating Officer from March 2012 to
November 2013. From 2009 to 2012, he was
TSMC's Senior Vice President of Business
Development. Before that, Dr. Wei was Senior
Vice President of Mainstream Technology
Business.
Since its establishment, TSMC has not only strived for the highest
achievements in its core business of dedicated IC foundry services but has also
actively developed positive relationships with all stakeholders including
employees, shareholders / investors, customers, suppliers / contractors, and
society to fulfill its responsibility as a corporate citizen and pursue a sustainable
future.

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Analysis of Semiconductor Industry

TSMC holds over 55% of market share in the foundry market currently,
benefitting from being the first-mover in the market three decades ago. TSMC
has been able to maintain this share of the market as it continually reinvests
profits back into the operations of the company.
The pandemic has revealed that large companies with extended supply chains
are more vulnerable to disruption in the past. As lockdown restrictions slowed
economic activity, automakers idled factories amid waning demand. US orders
for durable goods declined by an astounding 18.2% last April alone. As the US
slid into recession, automakers’ just-in-time cost-cutting inventory-
management strategy, which helps control variable costs, seemed like a good
idea given the sharp decline in demand. However, in the months that followed,
demand for semiconductors reached a fever pitch alongside robust consumer
tech spending on PCs, cell phones and other entertainment devices.
The ongoing microchip shortage emphasizes the vulnerability of the industry’s
supply chain, dominated by a few giant players like Taiwan Semiconductor
Manufacturing Company (TSMC). Due to economies of scale, high barriers to
entry and the global scope needed to compete effectively, a natural oligopoly
has emerged.
Foundries are increasingly focusing on adopting automation, Machine
Learning, and analytics. The benefits offered by these technologies, such as
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optimizing the production process and increasing the yield without

compromising the quality, are driving their demand. With the high production
capacities and reducing costs, vendors are expected to take up higher
production contracts, resulting in significantly higher supplies.

2020F Pure-Play Foundry Sales by Region

Japan
Europe 5%
6%

Asia-Pacific
15%
Americas
52%
China
22%

By geography, the Americas are the primary end market for more than half of
foundry sales in 2020. The trade tensions between China and the United States
during the Trump administration are expected to continue under the Biden
administration. Notably, China has grown from 8% of foundry sales in 2010 to
22% of sales in 2020, a 14% change in demand over the course of ten years. This
represents the largest shift in demand of all end markets and is expected to
grow considerably through this decade.

Semiconductor Foundry Industry Forecast

($ in billions)
$127
$119
$110
$103
$96
$89
$83

2020A 2021F 2022F 2023F 2024F 2025F 2026F

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The semiconductor foundry market is valued at $83.32 billion in 2020, and it is

expected to reach $126.91 billion by 2026, registering a CAGR of 7.3%, during
the period of 2021-2026. The semiconductor foundry sector witnessed strong
revenue growth during the year 2020. Despite the effects of the COVID-19
pandemic, major vendors operating in this space observed significant revenue
growth during the year, which is expected to further increase in 2021, owing to
the growing demand for 5G smartphones and high-performance computing
(HPC) products such as PCs, tablets, game consoles, servers, and 5G base
station.
One of the more cyclical sectors in the market, the semiconductor industry
enjoys increased spending on the corporate and consumer sides during times of
economic prosperity. Increased sales are important to the industry because
higher sales allow for improved fixed cost absorption. The foundry industry
serves one of the most unique group of customers in the world, one which buys

Fab Module Construction Cost

($ in billions)
5.4

2.9

1.7
1.1 1.3
0.7 0.9
0.4

65nm 40nm 28nm 22nm 16nm 10nm 7nm 5nm

Chip size, nanometers

advanced new products long before the previous product has become
dysfunctional.
The foundry industry has a low threat of disruption due to the highly capital-
intensive operations that come with fabrication. Fabrication plants cost over
$400 million to construct, with TSMC’s GIGAFAB requiring over $9 billion in
construction expenses. Construction also takes upwards of two years to build a
fab, with a 3-month production time for any given integrated chip.

6-inch Fabs

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Financial Analysis
Historically, TSMC has experienced appreciation in the value of their stock
directly associated with the announcement or anticipation of new technological
processes. Most recently, the 5nm process began manufacturing in 2020, with
implications of its technological advantages to previous generations seen in
Apple’s A14 Bionic chip (iPhone 12, iPad Air).

The effects of the pandemic have not slowed down TSMC’s top line growth as
revenues outpaced 5-year growth for a 33% YoY growth from FY2019. On a 5-
year basis, compounded annual growth rate stands at 12.6%, aided by the
Company’s strong performance in 2020.
EBITDA margin for the Company remains around the mid-sixties, twenty
percentage points above the industry average of 45.6%. TSMC is able to
generate a substantial bump above peers in EBITDA margin due to its sustained
position in the market given strong demand from significant global
investments across 5G networks, high performance computing and electrical
vehicles.
As of December 9th, 2021
Name Ticker Stock Price Market Cap ($B) EV ($B) P/B P/E Dividend /share Dividend Yield
Applied Materials, Inc. AMAT 155.11 142.0 137.6 11.4x 23.7x $ 0.96 0.6%
Intel Corporation INTC 50.77 210.5 203.1 2.3x 9.8x $ 1.39 2.7%
NVIDIA Corporation NVDA 312.93 795.6 772.5 32.8x 95.0x $ 0.16 0.1%
Tower Semiconductor Ltd. TSEM 37.63 4.2 3.6 2.6x 31.5x - 0.0%
Taiwan Semiconductor Manufacturing Company Ltd. TSM 120.66 568.6 547.4 7.5x 27.3x $ 1.55 1.3%
Texas Instruments Incorporated TXN 195.38 181.4 178.1 14.8x 24.7x $ 4.60 2.3%
Compared to industry peers, TSMC has the second largest market capitalization
(568.6B), with a price-to-book multiple of 7.5x and a price-to-earnings ratio of
27.3x, fourth and third in class, respectively. TSMC also gives a healthy dividend
at $1.55 a share, at a 1.3% yield.

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Valuation as of October 4, 2021

Valuation

Four methods of valuation were considered for TSMC, including two

comparable companies’ analysis, price-to-earnings and enterprise value to
EBITDA, respectively, as well as a dividend-discount model and discounted
cash-flow model. A consensus value of TSMC is $128.5, providing an upside
target of 18%.
With the comparable companies’ analysis for price to earnings ratios in Figure 1,
TSMC was benchmarked against Intel, STMicroelectronics, NVIDIA, Tower
Semi and Texas Instruments.
Figure 1

Three scenarios were used in this assumption, with low, mid and high
projections of implied value. The average P/E multiple was taken from the field

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of comparable companies, multiplied by LTM Net Income to find the equity

value. Finally, the equity value is divided by shares outstanding, giving implied
value in Taiwan dollars. Accounting for FX rates, TSMC is valued at $128.2 a
share at time of valuation.
A comparable companies’ analysis for EV/EBITDA was also done, with the same
approach as the previous model. Taking the EV/LTM EBITDA average of all
benchmarked companies, an intrinsic value range was derived at $148.74.
Figure 2

A discounted cash-flow model was also used, projecting the 5-year EBITDA exit
for the Company, shown above in Figure 2, concluding an implied fair value of
$139.83.
Figure 3

Finally, a dividend-discount model assuming stable growth was used to project

an implied fair value of $158.61 by taking the present value of discrete dividends
and adding it to the present value of terminal value to derive total equity value,
adjusted for the FX rate to arrive at total equity value in USD. Total equity
value divided by shares outstanding results in the final implied stock value.

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Investment Considerations
Risk: Geopolitical Tension
The first and most impactful risk to TSMC’s operation and supply chain is
political tension between Taiwan and China. Taiwan is where the majority of
TSMC’s operation is located and China’s recent posturing to unify all of China,
including Hong Kong and Taiwan is highly concerning for TSMC. Politically,
China wants to assume Hong Kong and Taiwan to bolster the Chinese economy
as well as push foreign powers out of areas of Chinese interest. Taiwan along
with Japan, South Korea and the Philippines act as a proxy to the United States
as a strategic ally over shared interests of political freedom.
Mitigants: TSMC has actively sought solutions to this geopolitical tension,
which is ultimately out of their control, but has announced plans to the spend
$100 billion in investment over to next three years to expand its fabrication
network, including a GIGAFAB in Arizona, diversifying its core supply-chain by
adding a flagship fabrication facility outside of Taiwan, as well as another wafer
research lab in Japan.
Risk: COVID-19 and Pandemic Related Disruption
Further disruption due to the pandemic and physical operation closures pose a
risk to the global supply-chain as TSMC produces products for end markets
oceans away from Taiwan. As seen during 2020, TSMC had no major impact on
their ability to function operationally because production has been automated
pre-pandemic.
Mitigants: TSMC can create more automated fabrication facilities so that
physical employees have less contact points in production. As mentioned
previously, in an effort to diversify the Company’s supply chain network,
building fabrication facilities outside of Taiwan is crucial to mitigate supply-
chain disruptions, and having a fab in the country that is the majority of
TSMC’s end market will solve a lot of demand related issues.
Risk: Loss in Innovation
Inability to lead the 3nm market and subsequently new technology markets will
lead to loss of market share for the Company.
Mitigants: Increased capital expenditure to create facilities to facilitate
fabrication of these new technologies will keep TSMC in its current position of
market dominance.

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