Though the investment community is infatuated with the daily swings in Apple's (AAPL) share price, the major opportunities have been in the shares of firms within the tech-giant's supply chain.
Investors in Cirrus Logic (CRUS) who entered positions in early 2012 are sitting on a 200% return (with a 52-week high that allows for 300% gains) as a result of the massive revenues generated from three Cirrus audio chips in the iPad mini and iPhone 5.
Arm Holdings (ARMH) has also had an excellent 2012, now trading near its 52-week high thanks to its integration into Apple's mobile products.
Perhaps the least discussed Apple derivative play is Taiwan Semiconductor (TSM). Shares are up nearly 31% on the year, largely in part to realized revenue gains from its part in Apple's supply chain, and speculation centered around major potential future deals.
Taiwan Semiconductor is the biggest pure-play semiconductor foundry in the world. TSM produces the semiconductor concepts for large tech firms such as Qualcomm (QCOM), Advanced Micro Devices (AMD), Altera (ALTR), Broadcom (BCOM), and Nvidia (NVDA).
Revenue growth exploded in Q3, up 33% year over year; returns on equity were exceptional, above 30%. TSM is planning on CAPEX of nearly $9 billion, up significantly from 2011 in response to flourishing wafer demand.
Currently Apple sources its A5, A6, and A6X processers from Samsung (SSNLF.PK), which is a relationship that Apple is obviously trying to break due to patent fights and general product competition between the two. A year ago, such a move was potentially illegal. The early designs had input from Samsung, and thus some intellectual property that Apple didn't own. Asking TSM to produce the processors would have led to major lawsuits against Apple.
However, Apple is the sole designer of the new A6 and A6X processors used in iPads and the iPhone 5. Samsung currently produces the A6 using a lower power 32-nm technology, but rumor has it Apple is experimenting with production utilizing TSM's even higher quality 28-nm tech.
This rumor doesn't appear to be simple speculation. Apple and Qualcomm already unsuccessfully attempted to gain sole access to TSM's fab capacity, and TSM's gargantuan capital expenditure plans implies that the company is preparing for demand that would have a transformative impact on the firm's bottom line.
In regards to TSM's 20nm process, J.T HSU, an analyst from Citigroup Global Markets, was quoted as saying,
Volume production is expected to start in the fourth quarter of 2013, raising the possibility that TSMC will hike capital expenditure to US$11-12 billion in 2013 and 2014.
There is a major shakeup underway in the Apple supply chain, and it looks like TSM is going to be the major beneficiary. The ultimate effect on the bottom line is difficult to project, but if the management of TSM sees the need to for almost $9 bb in CAPEX this year, with projections of another $2-3 bb over the next two, the potential is quite exciting.
With next generation iPads, iPhones, and an Apple TV in the works, TSM has earnings growth potential that its current valuation (16.5, in-line with the broader market multiple) simply doesn't reflect. The company has a net-cash position of $1.5 billion, little debt, and pays a solid dividend of 2.3%.
While TSM's main upside is dependent on its relationship with Apple, the company is well diversified and management is (so far at least) unwilling to allocate too large a portion of its capacity to just one customer. TSM's overall competitive position, competent management, strong balance sheet, and growth prospects offer an apparent asymmetric risk-reward return profile; I recommend purchasing shares of TSM at current prices and on any pullbacks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.