TSMC recently released their Q4 2020 quarterly financial report. The results were quite good.
TSMC has become one of the world's most profitable companies. In 2020, the company generated net
income of something in the neighborhood of $17.5 billion (depending on the USD-TWD exchange rate).
TSMC generated more 2020 profit than Wal-mart or Tencent and roughly as much as Facebook. Its
products make 53% gross margin, which matches Intel's reported 53% gross margin in Q3 2020.
Though Intel has a lot of moving parts and that probably brings things down a bit.
But the big surprise was not the profit but TSMC's company guidance for Q1 2021 capital expenditure.
Capital expenditure represents expenses spent on expanding overall capacity
and upgrading manufacturing technologies. This number is a
long term leading indicator of where TSMC believes the market is to be.
In 2020, TSMC spent $17.2 billion in capital expenditures.
This is a billion over the $15-16 billion range that they had projected back in 2019.
They had raised it midway through the year. The $17 billion was a record for the company.
Analysts had expected the company to announce $20 billion of capital expenditure for 2021.
It would roll over the $17 billion from 2020 and add the capital for the Arizona plant.
TSMC had earlier announced in November 2020 that they were going to build a
small N5 fab in Arizona. The board allocated some $3.5 billion for this.
Well, this $20 billion in retrospect was far too little. For 2021,
the company announced that that they will spend something in the range of $25 to 28 billion.
A lot of words have been spilled on the internet, trying to figure out why the jump in capital
expenditure. Right now I am just trying to grapple with the sheer size of the number.
$25 billion, the lower end of that number, would represent as much revenue as Mondelez,
the Oreos maker and number 117 on the Fortune 500. It would
be more than Tesla's 2019 fiscal year revenues ($24.5 billion). $28 billion
would be the size of Starbucks ($26.5 billion) or ViacomCBS ($27.8 billion).
In terms of sheer numbers, TSMC’s budget rivals capital expenditures from tech
giants and telecoms. That includes Verizon ($17.9 billion) and Google
($25 billion). Anytime you’re building big data centers and installing new networks,
you are spending billions of dollars on building up things and assets. Oil and energy companies
like Exxon ($25 billion) and Royal Dutch Shell ($20-29 billion) are also peers.
Amazon has a demonstrably higher budget with $32 billion.
But Amazon is also scaling up immensely as it tries to dominate the e-commerce and cloud spaces.
For me, I think you don't spend $25-28 billion
just for one reason alone. There must be a multitude of reasons.
The first has to do with demand from the unprecedented economic environment.
The first wave led to everyone shutting down and the economy crashing hard - but
then it came roaring back faster than people thought was possible.
At the same time, the work from home economy came back harder than ever
after the summer ended and the pandemic surged. You need
chips to fuel all those cloud software services connecting today's companies.
Another source of demand comes from your car. On the earnings call,
TSMC mentioned the automotive industry, where revenue surged 27% from the previous year.
Your car uses a surprisingly high number of chips to help it operate.
The Wall Street Journal recently ran an article noticing that a chip shortage
in the automotive industry has caused some factories to wait for supply to replenish.
Automotive, financial stimulus, a new generation of video game consoles,
lockdowns from the pandemic's second surge. In addition, we have chip demand stemming
from the new crypto surge and the ongoing 5G transition. It's all insanity and craziness.
The second big reason to really push hard has to do with competition. TSMC
is dealing with a challenger unlike few others that it has gone up against.
Samsung Foundry, part of Samsung Electronics
is making a real push into the market - capturing reliable business as a second supplier.
The Korean giant is estimated to spend some $26 billion in capital expenditures for
its own semiconductor business in 2020. There is the caveat that Samsung is also the world's
dominant memory maker and it is assumed that a vast majority of that capital is going into
reinforcing that business. Not all of that can be leveraged for making logic chips.
But that is a lot of money regardless. It needs a response.
But Samsung is really swinging for the fences. For its cutting edge 5 nm process,
the company has collected customers like Ambarella (the image sensor maker and supplier to Hikvision)
and Qualcomm. They have a big Austin semiconductor foundry and are considering a $10 billion Texas
investment, similar to Taiwan's Arizona facility, so to win more American clients.
And then there is the anticipation that Samsung is seeking to implement a brand
new semiconductor structure for its next generation 3 nanometer node; something
called "Gate All Around". TSMC's N3 will not be using this structure, and for this reason Samsung
has been cited as seizing the technology crown upon the release of that 3 nanometer process.
Well, since we have already touched on the topic, let us talk about N3 and beyond.
TSMC's sexiest, most cutting edge process is N5 - the one that Apple calls in its
marketing 5 nanometers. This process entered high volume manufacturing in 2Q 2020 at Fab
18 in Tainan. Through 2020, it was majority booked by Apple for its A14 and M1 chips.
I talked about this in another video. But to match Apple's annual iPhone cadence,
TSMC has a half-step strategy. They debut a new variant of their node every year. For instance,
N5 for the A14 this year.
Next year, they will make refinements and release a "plus" version. A15 will be made
on that N5+. The year after that, N5+ then evolves into an N4 process,
which means further refinements while maintaining backwards compatibility.
Apple moves on to the next major step - an entirely new node, N3.
This follows what TSMC did with N7, which evolved into N7+ and then N6 after that.
It allows customers to deliver improved product year over year without much additional work.
As mentioned, the next big jump from N5 is N3, colloquially called
3 nanometers. And like I mentioned earlier, it will stay with the same
FinFet device architecture that helped TSMC deliver the last few generations.
I have seen some rumors floating around that N3 was going to be delayed.
There was a Digitimes report that said that N3 was being particularly challenging for both TSMC
and Samsung. And that leaves some risk that the Apple A16 might not be fabbed on N3. If
that is the case, the backup plan would probably be to use the evolved N4 node.
But during the conference call, management says that N3 is on track.
The Digitimes report might be wrong. It likely is considering their track record.
But it can also be that TSMC is trying to make up for the lost time with a dump truck of money.
TSMC hasn’t missed a deadline for a node delivery in many years.
So they are pushing super hard to hit that 2022 high volume deadline for the iPhone launch.
As for what happens after N3, the future is hazy. At the TSMC Technology Symposium in
September 2020, the company gave a brief look at the future roadmap beyond N3.
N2 appears to be the next big node. The company appears to be in the early
stages of a massive N2 Fab in Hsinchu. That is going to cost a lot of money.
A lot of financial analysts were watching this. Intel CEO Bob Swan had said that the company
would look at the possibility of outsourcing its high end logic chips to a third party foundry
like TSMC or Samsung. Such a decision would be announced at the Q4 earnings call in Jan 2021.
There were a lot of smoke signals coming up that Intel would be indeed signing on to such
an outsourcing agreement. The stock market ran up TSMC's stock price in anticipation of
it happening. Bloomberg ran an article saying that TSMC and Intel had been in talks, with no result.
Then Bob Swan stepped down and new CEO Pat Gelsinger took up the seat. Intel's first CTO,
Gelsinger has an engineering background and in the
Q4 call emphasized Intel's commitment to its engineering and manufacturing:
> “I am confident that the majority of our 2023 products will be manufactured
internally ... At the same time, given the breadth of our portfolio, it’s likely that
we will expand our use of external foundries for certain technologies and products.”
The stock fell 9%. An interesting response by the market. There is a real argument for semiconductor
foundry work to be done on American soil. One can say that the market is ignoring those national
security arguments and being short term. But one can also care for those arguments and just
instead be saying they don't think Intel should be the company leading that charge.
Putting those questions aside, the Intel and TSMC relationship is going to put itself on
hold for a little bit as management reviews the status of their 7 nanometers process
(roughly equivalent to TSMC's N5).
Tim Culpan for Bloomberg wrote an analysis of the results that I liked.
In it, he cites one reason why TSMC would move so aggressively with the capital expenditure
would be to corner the market and lock in supplier agreements.
Tactics like this would be taking a page out of the Apple supply chain handbook. Apple leverages
its cash reserves and size to secure supply for its products ahead of practically everyone else.
That is why you were able to buy the new iPhones this holiday season with decent wait times
while other consumer electronics companies like Sony struggled to fulfill demand.
And Apple sells something like 75 million units a quarter during the holidays.
I've touched on TSMC's business tactics in prior videos I've done on Chartered and SMIC. My
feeling coming out of that is that they will not hesitate to throw their weight around. Like Apple,
they are going to try to muscle their way to the front of the line
so to get whatever supplies they need to fulfill demand.
And based on supplier ASML’s recent quarterly earnings call, TSMC's supply chain right now
seems to be in a bit of a dizzy spin. ASML - TSMC's critical EUV supplier - is only
capable of delivering a limited number of said EUV machines in a single year. And its big customers'
projections had moved around a lot throughout 2020 - causing a backup in the supply chain.
ASML's CEO and president Peter Wennik said in the call:
> I think our capacity ... in the Netherlands, in Veldhoven, is to build 50 systems ... Now we have
to build those systems out of modules, which we don't produce. It's in the supply chain ...
He then talks about two customers moving their spend around.
> What happened last year in Q2 and Q3 ... our key foundry customer came back and said,
listen, our key customer for N3 is now blacklisted.
So we cannot ship. So we need to adjust our 2021 outlook for EUV systems.
Peter is probably referring to TSMC and Huawei/HiSilicon. Huawei has long been a leading
edge customer alongside Apple. They got banned from using EUV tech by the Trump administration.
> Which was followed by another customer and said,
well, we're going to delay the roadmap ... pushed back one year, which actually led
to a situation where we actually reduced the number of planned system 2021 for EUV
This customer is probably Intel, and it matches up with how Intel in July
2020 announced that their 7 nm process (which uses EUV) got delayed 6 months.
But at some point between Q2 2020 and Q4 2020, TSMC and the rest of the foundry
industry realizes that they are way under capacity. Like I said earlier,
astounding demand in everything that has to do with semiconductor chips.
So TSMC and I presume other foundries in the industry go back to ASML to put
those orders back on the menu. But ASML can't just ramp up on demand because just
seven or eight months earlier they told their entire supply chain to ramp down.
Peter did hint that Intel's delay let them transfer Intel's EUV orders over to TSMC and
Samsung. Despite that, my guess is that for the next few quarters (per the CEO there is about 20
months between module production and EUV tool installation),
EUV machine supply is going to be super tight.
Project this out to the rest of the foundry supply chain - it's not just
ASML, you know - and you get the feeling of a massive oil tanker trying to turn on a dime.
You can get things done right, done fast, or done cheap. Pick two out of the three. TSMC
is apparently picking done right and done fast. Damn the cost, they're going to buy everything.
For what it is worth, Wennik warns us about the folly of using those TSMC capital expenditures
to project ASML's 2021 revenue. This is due to the supply issues mentioned above:
> Yes. TSMC gave a range, $25 billion to $28 billion. Hey, great. We plan our business
based on what they ask us. And as you know, TSMC has been asking us in 2020, on several
occasions to ship very different numbers for 2021 ... So I don't think you can draw any
direct conclusion from the TSMC capex numbers. Directionally, yes, but not in absolute terms.
I am reminded of a story published back in April 2001
when Morris Chang still ran the company as its founder and CEO.
In it, TSMC was a few generations behind Intel but doing their best to catch up.
2001 is a year after the tech bubble crash and the electronics space in general was
suffering. But regardless, TSMC is pushing ahead with investments. This means not only
building more foundries but also investing in being able to provide better services to
their customers. Chang saw an opportunity and poured in the money to service it.
I get the sense that TSMC is a company that likes to take big swings at things. Unlike Chartered
and SMIC, they have the power of the purse and they leverage it like few other companies can.
A famous investor once said that their entire job is to stand at the batter's box
and wait for a fat pitch that they can swing at as hard as they can. Hit one big home run and it
does not matter that you missed a bunch of little things. I think TSMC thinks a fat pitch is coming.