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A Long-Term Case For TSMC

Summary

TSMC’s competitive advantage and scale allow it to maintain pricing power over competitors for years to come.

The trend of increased usage of “fabless” companies for semiconductor companies directly benefits TSMC.

Customer reliance on TSMC’s production gives TSMC a meaningful connection to important customers such as Apple.

Taiwan Semiconductor Manufacturing Company, better known as TSMC, is a strong growth play over the next few years, and will benefit from both industry trends and company specific strategic advantages, offering investors a sound investment. Given TSMC’s 56% hold on the foundry market, it maintains competitive advantages of both pricing and scale, which allows it to hold a position of power both with customers and against its competitors. Over the next few years, TSMC should provide investors a safe return given its increasingly important role in everyday technologies.

TSMC’s dominance in the 7nm chip space underscores its relative strength and safety going forward. It indicated 50 7nm tape-outs by 2018, and is expected to dominate the industry within this chip category in 2018 and 2019. On this front, TSMC possesses two key competitive advantages: technology and production cost. TSMC is consistently setting the industry standard for chip technology, and operates at 20% lower costs than competitors Intel or Samsung. Because of this, TSMC 7nm chips end up being cheaper for customers than a competitor’s 10nm chip.

Over the next few years, the semiconductor industry will transition from a smartphone focus into high-performance chips (HPCs) for use in artificial intelligence and Internet of Things capabilities. TSMC currently holds a 30% market share of an 11.7Bn market share opportunity of silicon manufacturing, which positions it well to capitalize on this industry growth going forward. From 2016 to 2021, TSMC predicts a ~20% CAGR for IoT-related revenue, which should drive the stock price beginning in 2019.

A fundamental analysis of TSMC yields reasonable upside for a robust growth investment. Using a 9% cost of capital and 9.5% revenue CAGR with a 9x terminal multiple over the next five years yields about a 16% potential upside in addition to its 2.73% dividend yield. This model assumes slight gross margin expansion in 2021 to 74.5% while keeping other factors relatively constant. In summary, TSMC is a good long term bet that has significant potential to capitalize on secular industry trends given its strong competitive positioning.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.