Under the Spotlight Wall St: TSMC

Taiwan Semiconductor Manufacturing Company ($TSM) is arguably the world’s most important company right now. 

It’s a big claim. But TSMC is the reason why titans of technology like Nvidia ($NVDA), Apple ($AAPL) and Advanced Micro Devices ($AMD) can deliver the cutting edge tech driving the artificial intelligence (AI) revolution. 

TSMC is the world’s largest contract chip maker and, since its founding in 1987, has built a reputation for pushing the boundaries of science to increase the amount of information that can be processed on ever smaller chips.

The US$815b company was last placed Under the Spotlight in January 2022 – a time when pandemic-related supply constraints limited the flow of chips to car makers and smartphone producers like Apple. Since then, the dramatic emergence of AI as the next wave of innovation has fuelled a 47% rally in the share price to record highs. 

Blue chip

TSMC’s blue chip client list is a who’s who of the tech world. The reason these top companies rely on TSMC is because they’re fabless: they don’t have their own chip-making foundries, or fabs. They design a chip and then contract TSMC to produce it. 

On the other hand, advances TSMC makes in its chip size, processing power and energy savings drive the design process among clients. This two-way relationship was highlighted by TSMC fixing a flaw in Nvidia’s Blackwell AI chip, which will be sold to Apple, Microsoft ($MSFT) and Google ($GOOG) for high performance computing (HPC) tasks like generative AI.

TSMC Q3 revenue shows how well positioned it is to profit from the AI boom. Q3 revenue was US$23.5b, a year-on-year (YoY) increase of 36% and a 12.9% rise from the prior quarter. Around half of its revenue came from demand for chips used in HPC. About a third of revenue came from smartphones. 

Q4 revenue is forecast between US$26.1b and US$26.9b. Chips also have healthy margins: Q4 net margin is expected to increase to between 46.5% and 48.5% from 42.8% in Q3. Margins will be supported as some 5 nanometre (nm) capacity is converted to more profitable 3nm chips. 

A hot debate on Wall Street is about returns on AI investments and whether the surge in capital could lead to a bubble. CEO C.C. Wei told analysts on the Q3 earnings call that ‘the demand is real, and I believe it's just the beginning of this demand.’ He noted that TSMC had used AI in its own fabs and that a 1% productivity gain was worth about US$1b.  

Size matters

Leadership in the chip industry is all about the size of your chip and what you can do with it. TSMC stands tall in the measuring competition against rivals like Intel ($INTC) and Samsung: it’s got the smallest chip of them all. 

Around a third of its Q3 revenue came from sales of 5nm chips, while 20% came from the smaller 3nm chip. Apple included second-generation 3nm chips from TSMC in its AI-enabled iPhone 16 family unveiled in early September. 

But chip development moves fast: 3nm technology is so 2022. TSMC has developed a 2nm chip to meet client demands for faster processing speeds and energy savings. TSMC’s innovation track record reflects its heavy investment in its business. Capex is expected to be more than US$30b in 2024, with up to 80% allocated to advanced processing technologies.  

Trial production of 2nm chips started this year and will ramp up in 2025. Samsung will start 2nm production in 2025, while Intel abandoned its 2nm ambitions and has redirected funding and engineers to developing 1.8nm chips. Apple, which bought all of TSMC’s initial production of 3nm chips, is expected to be the first client to get 2nm chips for use in the iPhone 18 in 2026. 

Go west

Supply disruptions during the pandemic and rising geopolitical tensions have underscored the importance of chip supplies to the modern economy. A sharpened focus among western nations on self-sufficiency and economic security has opened the door for TSMC to expand its manufacturing beyond Taiwan, where it faces rising electricity costs.  

The company is building a multi-fab facility in Arizona after receiving US$6.6b in CHIPS funding from the U.S. government. Early results from the first 4nm fab have been positive: the number of usable chips is higher than similar facilities in Taiwan. First production will start next year and a second fab is under construction. A third is planned for a site that can host up to six fabs. These first three fabs will cost US$65b. TSMC is also building fabs in Japan and Europe. 

TSMC admits its overseas fabs have lower profitability than those in Taiwan because of their smaller scale. However, it expects profitability to improve as they ramp up, allowing it to invest in additional fabs and drive higher profits. 

Fantasy island

The last few years have proved that the chips made by Taiwan’s national champion are vital to the global economy.

Maintaining its technological lead over rivals comes with a hefty price tag. Investors want to see a return on its massive investments through strong and sustainable cash flows to fund next-gen tech – and dividends. 

Fortunately, TSMC’s big spend on R&D has made it the indispensable partner for the world’s tech giants looking to turn AI dreams into reality – and it is profiting handsomely.

This does not constitute financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.