Trump and TSMC (ii)

Over the weekend The Economist published an article about the administration’s attack on Huawei, denying Taiwan Semiconductor Manufacturing Company (TSMC) the use of US intellectual property in making chips for the Chinese telecom firm. The article basically paralleled my post from the 18th.  And it concluded that the ban could easily end up hurting the US far more than China.  In other words, it’s vintage Trump.

Although I didn’t mention it a week ago, I think it’s interesting to observe the behavior of the US companies affected by the initial order, which prevented them from supplying US-made chips to Huawei.

A basic fact about chip manufacturing is that although the output comes from gigantic, multi-billion dollar factories, the chips themselves are tiny and weigh next to nothing.  Output can easily and cheaply be shipped anywhere.  So plants don’t need to be located near customers.  They are highly automated, so no need for a large nearby workforce, either.  The key variables in locating a fab: areas where there are no earthquakes and where government tax breaks and subsidies are the highest.

Anyway, US firms continued to supply Huawei as usual after the initial directive, just from non-US facilities.

 

My point isn’t about administration ineptitude in taking months to realize this elementary workaround.  It’s that the chipmakers acted as businessmen.  They did what they thought was best for the long-term survival and prosperity of their firms.  Logically, it’s what they should have done as stewards of other peoples money.  More important, it’s what they did do.  That is, we have a reason to think that they will continue in this manner–to at least plan to put their operations out of the reach of Washington.  In addition, they will presumably pressure their suppliers of capital equipment–the semiconductor production equipment makers, some of which are heavily concentrated in the US–to do likewise.

 

 

 

 

 

 

 

Trump and Taiwan Semiconductor Manufacturing (TSMC)

Note:  the post just before this has a brief description of TSMC.

new restrictions on TSMC

Last week the Trump administration announced that foreign users of American-made semiconductor design software or production equipment will need permission from Washington to use these to fashion chips for Chinese telecom company Huawei, the world leader in 5-G wireless technology.

At the same time, TSMC announced that it will be opening a new $12 billion fab in Arizona in 2024, its second in the US.  No details yet on why, although presumably Washington is footing the bill.

my thoughts

Huawei is TSMC’s second-largest customer, after Apple.  60% of TSMC’s output goes to the US, 20% to China.

I’m a fan of TSMC as a company but not of TSM as a stock.  This is because I don’t have any edge in evaluating TSM.  I find Taiwanese accounting opaque and I believe a ton of local knowledge is needed to be successful in sizing up that market.  While the latter is true just about everywhere, Taiwan is, for me, an extreme case.

I wonder how this new Trump rule can/will be enforced.

What would I do if I were TSMC?  I’d see if I could rearrange assembly lines to avoid making Huawei chips using US-sourced machines.  My ultimate goal, however, would have to be to minimize the threat to my business by transitioning away from US equipment suppliers.  This might mean giving extra assistance to Japanese or EU companies, or encouraging technology transfer to develop Chinese alternatives.  It could mean moving advanced production equipment to foundries on the mainland to supply Huawei from there–making clear this output is not coming from Taiwan.  I’d probably be figuring I’d shed current generation US-made equipment I already own by moving it to the new US foundry.

If I were a current US supplier to TSMC?  If I wanted to keep TSMC business, I’d be starting to figure how to shift at the very least that part of my operations out of the US.  The same if I were a US-based maker of semiconductor design tools.

 

I think this will end up being another aspect of the “chaotic disaster” that is the Trump economic policy.  In this case, though, the purpose of the move appears solely to be to deflect attention from Trump’s worst-in-the-world response to COVID-19, in support of his lie that somehow not his bungling but Beijing and/or the Obama administration are responsible for the unnecessary deaths of tens of thousands of Americans.

I continue to think that Trump and his enablers in government and the media are doing enormous damage to the long-term economic prospects of the US.  What strikes me most about the developing TSMC situation, however, doesn’t have much directly to do with the stock market.  It’s that Trump et al are concerned only about covering up what they’ve done; their cynical strategy is to lie and to distract by doing more harm elsewhere.  There isn’t the slightest hint of remorse for what they’ve done nor sympathy for the relatives of the death.

 

 

 

 

 

 

 

 

Taiwan Semiconductor Manufacturing (TSMC): background

what TSMC is

In the early days of semiconductors, chip-making firms tended to be vertically integrated, meaning the companies that designed semiconductors also manufactured them in their own plants.

That changed as the semiconductor industry began to expand rapidly in the early 1990s, for several related reasons:

–chip designs became progressively more specialized and complex, putting increased focus on the design process

–the cost of building chip fabrication plants to manufacture newer, higher-specification, designs rose exponentially, putting them out of reach for all but the biggest firms, and

–TSMC opened in 1987 as a third-party manufacturer, allowing dedicated design shops to set up on their own and still be able to have their designs fabricated.  The design business, something at which Americans have excelled, has flowered since.

Today, TSMC is the most advanced chip manufacturer in the world, and by far the best third-party fabricator, matched only by Samsung, an integrated firm, and maybe Intel.

 

semiconductor equipment makers

Today’s semiconductor fabs are extremely expensive.  TSMC has just agreed to build a new fab in Arizona, for example.  The cost:  $12 billion.  (More on this in the accompanying post)  The equipment inside, the most advanced pieces of which can cost hundreds of millions of dollars, comes from a small number of specialized machinery firms, which are located mostly in the US, Japan or the EU.  Because of the complexity of semiconductor manufacturing and the expense and long lead times involved in developing and testing new equipment, there tend to be very close cooperative research and development relationships between the fabs and their equipment manufacturers.

 

foundries are the future…

…absent some revolutionary change in computer technology.  A decade ago, when I was more up-to-date on semiconductors, a state-of-the-art fab cost about $4 billion.  Operated efficiently, it would churn out, say, $7 billion worth of output.  Both figures are out of reach for most firms.  Hiring a trusted third party to manufacture your designs is the easiest way to go.  Although the ratio of sales to assets has shrunk since I was better informed, the absolute numbers have risen a lot.

 

 

 

 

 

Broadcom (AVGO) and Qualcomm (QCOM)

(Note:  the company formerly known as Avago agreed to buy Broadcom for $37 billion in mid-2015.  Avago retained its ticker symbol:  AVGO, but took on the Broadcom name.  Hence, the mismatch between name and ticker.  That deal is on the verge of closing now. Presumably AVGO’s recent decision to move its corporate headquarters from Singapore to the US is a condition for approval by Washington.)

AVGO and QCOM

AVGO is a company that has very successfully grown by acquisition (my family and I have owned shares for some time).  Its specialty, as I see it, is to find firms with excellent technology that are somehow unable to make money from either their intellectual property or their processing knowhow.  AVGO straightens them out.

QCOM, a firm I’ve known since the mid-1990s, seems to fit the bill.  The company makes mobile processors for cellphones.  It also collects license fees for allowing others to use its fundamental and important cellphone intellectual property.  QCOM has been in public disputes over the past couple of years with the Chinese government, which has forced lower royalty payments, and with key customer Apple, which is threatening to design out QCOM chips from its future phones.  As I see it, these disputes are the reason the QCOM stock price has stagnated over the recent past.

the offer

AVGO is offering $70 a share in cash and stock for QCOM, a substantial premium to where QCOM shares were trading before rumors of the offer began to circulate.  The current price for QCOM (I’m writing this at around 10:30) of $63.90 suggests that the market has doubts about the chances for AVGO’s success.

Standard tactics would be for QCOM to seek another buyer, one that would keep current management in place.  Since an overly pugnacious management has arguably been QCOM’s main problem, my guess is that a second bidder is unlikely to emerge.

If I were to try to participate in this contest (I don’t think I will), it would be to buy more AVGO.  I believe AVGO’s assertion that the acquisition would be accretive in year one.  So it’s likely to go up if the bid is successful.  If not, downward pressure from arbitrageurs would abate.  On the other hand, I don’t see 10% upside as enough to take the risk QCOM will find a way to derail the bid.  After all, it has already found a way to anger Beijing and 1 Infinite Loop.

Silicon Valley backlash?

I think we may be at a watershed moment in terms of the acceptability of the corporate behavior of tech/internet-related companies.

Up until now, it has been enough for investors that Silicon Valley produce increasing profits.  Institutionalized poor behavior on the part of the firms’ managements–whether that be violation of some employees’ civil rights or less-than-ethical treatment of customers or shareholders–has made little difference to their stocks’ performance.

Uber is perhaps the poster child for this phenomenon, which has also been, aptly, I think, characterized as “fratboy” behavior.  But now Uber appears to be losing its license to operate in London, which holds 5% of the worldwide active users of the taxi service, because of its not being a “fit and proper” operator.

The case of Facebook (FB) is just as interesting.  Founder Mark Zuckerberg announced plans last year to give a large amount of his stock in FB to a charitable trust that he and his wife would run.  In order to preserve his majority control of FB despite divesting a large chunk of his shares, he proposed that each A share, the ones with super voting power that insiders like him hold, be “split” into one A + two C shares, the ones with no voting rights.  Zuckerberg could then give away the C shares, representing about 2/3 of his wealth, without any decrease in his 53% voting control of FB.

The board of FB appointed one of its members, Marc Andreessen, a developer of the Mosaic and Netscape browsers, to represent third-party shareholders in this matter–to ensure that this restructuring would be fair to them.

Institutional investors sued.  During discovery, they found among other things, emails between Andreessen and Zuckerberg in which, far from defending third-party holders,  Andreessen appears to be coaching Zuckerberg on how to present his proposal to the board in the most favorable light for him.

Today, FB announced it’s dropping the restructuring plan.

 

If I’m correct about a fundamental change in investor sentiment, what does this mean for us as investors?

At the very least, I think it means that the business-is-what-you-can-get-away-with attitude (borrowing from Andy Warhol) of many tech companies will be penalized with a discount valuation.  It may also prevent some early stage firms from being able to list–preventing employees from cashing in on what they’ve built.  On tech/internet’s notorious anti-woman bias, I’m not sure.  After all, the investment business isn’t that far ahead of tech in eliminating this form of prejudice.