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.

 

 

 

 

 

Intel (INTC) and ARM Holdings (ARMH)

At its Developer Forum yesterday, INTC announced that it is opening its cutting-edge fabs to manufacture chips that employ ARMH designs created by third parties.  So, as at least part of its business, INTC intends to become a foundry like TSMC.

(An aside: despite its glitzy style, it’s much harder to find information about the move on INTC’s website than on ARMH’s.  I don’t know whether this has any significance, but it’s the sort of odd fact that rattles around in a security analyst’s head until an answer can be found.  Is it me?  Is INTC more interested in sizzle than steak?  Is INTC’s IR effort still mired in the mindset of the former regime?…)

I’m not sure what the total significance of this move is, but at the very least:

–TSMC, the premier foundry, a Taiwanese company, trades at about a 17x price earnings multiple.  INTC now trades at about the same PE, although it has typically traded at a lower rating than TSMC in the past.  In contrast, ARMH trades at about 70x, a PE that I think must be unsustainably high, even though ARMH has managed to do so for years.

For my money, INTC’s fabs are better than TSMC’s.  Making loads of ARM chips for others will likely not lower INTC’s pe ratio.  Arguably, as the foundry business expands, INTC’s pe will rise.

–in every generation, the size of chips shrinks while the cost of a next generation fab rises. As a result, the amount of output that a fab must have to be able to operate profitably increases, while the penalty for having too little output goes up as well.

The ARMH partnership signals, I think, that INTC believes that to maintain its manufacturing edge, it must accept manufacturing orders from outside parties.

 

More tomorrow.

 

 

 

 

Softbank and Arm Holdings (ARM)

My thoughts:

–the price Softbank is offering for ARM seems very high to me.  That’s partly intentional on Softbank’s part, not wanting to get into a bidding war.  It’s also based on Softbank’s non-consensus belief that the development of the Internet of Things will be a much bigger plus for ARM than the consensus understands.

–I’m rereading the resignation of Nikesh Arora as a sign of his disapproval of the acquisition, not of Masayoshi Son’s remaining at the helm of Softbank

–ARM seems to be content to be bought.  And why not?  Holders of ARM stock and options will get a big payday.  Softbank has no semiconductor design expertise, so ARM will likely run autonomously under the Son roof.  Softbank is also apparently promising to keep the company headquarters in the UK as well as to substantially increase the research staff.

–A competing bid is unlikely.  That’s mostly because of the price.  But ARM management knows it would never have the operating freedom as a subsidiary of Intel or Samsung (the most logical other suitors) that it would as part of Softbank.  When the company’s assets leave in the elevator every night, any unfriendly bid is inherently risky.  Doubly so when it threatens a really sweet deal.  No, I don’t think antitrust issues would be a deterrent to a bid.

–Will the UK allow the deal?  The Financial Times, which should be in a position to know, suggests that the UK might not.

How so?

ARM is basically the country’s only major technology company, so domestic ownership may be an issue of national prestige and pride.  There’s certain to be some opposition, I think.  And crazier things have happened.  For example, France disallowed Pepsi’s bid for Danone on the argument that the latter’s yogurt is a national treasure.  In the late 1970s, the US barred Fujitsu from buying Fairchild Semiconductor on grounds that foreign ownership presented national security risks   …and then allowed it to be sold to French oilfield services firm Schlumberger.  More recently, the US scuttled the sale of a ports management business that runs Newark and other US ports to the government of Dubai, an ally, on security grounds.  The would-be seller was also foreign, P&O of the UK.

This is the major risk I see.

merger mania in the computer chip business: why?

This year has been market by a spate (like that word?) of mergers/acquisitions in the computer chip industry, the latest being the potential combination of stodgy Analog Devices with Maxim Integrated Products.   Why is this happening now?

Three reasons:

–cheap financing, even though not necessary in all cases, is still plentiful.  This may not continue to be the case as interest rates in the US rise

–the cost of creating and fabricating new generations of products is becoming very expensive, to the point that some firms can no longer afford to stay independent and remain in the game

most important, though, is the emergence of mega-customers like Apple and Samsung, or Acer and maybe even Asus, which has changed the competitive structure of the industry.  The situation now is that these few large buyers of components can play one supplier off against another to get better prices.  The only way suppliers can get any market clout is to combine.

 

One might think that this is evidence of the overall tech industry maturing, meaning that we’re entering a period of slower industry growth.  While that may be true, maturity isn’t the sole, or even the main, reason for consolidation.  When the EU was created, for example, cross-border mergers became feasible for the first time.  Small national supermarket chains combined to become EU-wide powerhouses.  For a while, food suppliers remained as small as before.  But the mammoth size of EU-wide purchase orders from the big supermarket chains became so enticing that food suppliers offered unusually high discounts to get the business.  These firms soon realized that they needed scale, both just to get the big supermarket orders and fulfill them and to streamline operations and lessen profit-destroying discounting.  The large scale of the customers forced the suppliers to scale up as well.

The economics works in the other direction, too.  Large scale on the suppliers’ part forces customers to scale up.

In the case of chip companies, I don’t see an easy way to make money right away from ongoing consolidation.  Many of the actors remain unattractive on a stand-alone basis, in my view.  Also, the general rule is that half of the combinations won’t work out, either because the principals can’t get along post-merger or an acquirer pays too much for a target.  Better to let the dust clear and try to assess the combined firms, say, next Spring.  Having said that, I do own Intel and Avago, two consolidators.

2Q15 earnings for Intel (INTC): back to waiting mode

the results

After the close last night, INTC reported 2Q15 results.  Revenue came in at $13.2 billion, down 5% year-on-year.  Operating profits were down by 25%.  Net was $2.7 billion, however–off by only 3%.  EPS came in at $.55, flat yoy (due to continuing share repurchases shrinking the total shares outstanding).  That figure beat the analyst consensus of $.51.

The main points, as I see them:

–cloud business was stronger than expected

–PC business was weaker, due presumably to overall GDP softness in emerging markets, especially China, and in the EU

–the overall business is shifting to higher-end, more cutting-edge products.  This is resulting in lower than expected volumes.  Higher prices and margins are offsetting this

–even though INTC is expecting a bounceback during the back half of the year from an unusually weak first six months, it is edging down its full-year forecasts slightly to account for continuing weakness is the PC market

–the 2Q tx rate was a miniscule 9.3%, compared with 28.8% in 1Q.  That’s because INTC has decided that some cash balances earned abroad and held overseas are permanently invested there and is asking the IRS for a refund of taxes previously paid on this money.  Eps would have been around $.47 at the 1Q15 tax rate.

waiting for…

–the Altera (ALTR) acquisition to close and new field programmable gate array-based microprocessor products to emerge

–world GDP to accelerate

–the product balance to shift to non-PC products (the cloud, the internet of things…) to a degree that they, not PCs, define the company

–tablets to become profitable

in the meantime

I’ve been surprised by the weakness in INTC shares over the past six weeks or so, as the extent of softness in the 2Q15 PC market has become apparent.

My picture has been that the stock goes sideways, supported by a discount PE multiple and a 3%+ dividend yield, while the company (successfully) transitions into a post-PC world.  I continue to think that this is not so bad for shareholders during a time like the present when the market in general is likely to go sideways.

The key question, for which I have no strong answer (because I’ve been thinking I still have time to formulate one), is what to do as/when economic activity begins to accelerate.  Clearly, in my mind at least, if overall corporate profits begin to rise quickly, being paid 3% to wait for future developments won’t appear to be such a good deal.  I don’t think the current weakness in INTC shares is the first inkling of this sort of shift.  But it’s something I have to consider.

 

Avago (AVGO) and Broadcom (BRCM) …and Intel/Altera

Two days ago the rumor hit Wall Street that chipmaker and serial acquirer AVGO had found its newest target, BRCM.  Yesterday the offer was announced:  cash and AVGO stock, in approximately 45/55 proportions, totaling $37 billion.

my thoughts

When customers in a given industry group become bigger and more powerful, the natural response among suppliers is to do the same.  This is part of what is going on here.  More than that, AVGO appears to seek out companies whose technological virtuosity far outstrips their management skills.  So it gains not only the marketing benefit of size but also the rewards of improving the profitability of firms whose main virtue has been their intellectual property.

What’s striking about this deal is that in revenue terms AVGO is more than doubling its size.  Although I have no intention of selling the AVGO shares I own, experience says that acquirers often bite off more than they can chew when they make the jump from small acquisitions to super-size ones like this.

One of AVGO’s rumored other targets had been Xilinx (XLNX), the junior partner with Altera (ALTR) in the field programmable gate array duopoly.  I had thought that ALTR would feel more favorably disposed to overtures being made by Intel (INTC), given the possibility that AVGO would buy XLNX and turn the firm into a much more aggressive competitor.  That threat is now gone.  INTC must now rely on pressure on ALTR management from its major shareholders (shareholders are, after all, legally the owners of ALTR and the employers of management) to return to the negotiating table.

As a practical matter, managements have a lot of autonomy, despite the fact that we the shareholders are, technically speaking, the bosses.  Wall Street seems to believe that ALTR is holding out for a higher price from INTC.  While that may be the rhetoric being used, I think the real issue is more basic.  Who would want to go from being the master of all he surveys as the top dog (and treated as a demigod) at a major publicly traded company to being a near-invisible division head in a conglomerate?