TSMC Q3 23’ Investment Thesis Update



Executive Summary


Thesis I: TSMC’s Technological Innovations Position the Business to Drive the Entire Industry

  • Revenue Dynamics: 6.2% sequential decrease due to inventory adjustments.

  • Advanced Technologies: Ongoing investment in N3 and N2 technologies.

  • Resilience in Market: Balancing declining shipments with increased ASP.

  • Segment Evolution: Growth in revenue from advanced semiconductor technologies.

  • Future Vision: Progress in N3 and N2 technologies for HPC and smartphones.

  • Capital Expenditure: Adjustments reflecting strategic planning amidst uncertainties.

  • Balancing Challenges: Navigating short-term market volatilities for long-term trends.

Thesis II: TSMC is Strategically Positioned to Benefit from Trends Across the Economy

  • Revenue Breakdown: Significant contributions from HPC, smartphones, automotive, IoT, and DCE segments.

  • High-Performance Computing: Emphasis on 5G and HPC as growth drivers.

  • AI-Driven Demand: Focus on AI applications, particularly in generative AI.

  • Challenges in AI Applications: Addressing capacity limitations in advanced packaging.

  • Expanding AI Chip Packaging: Preparing for growing AI and computing needs.

  • Market Outlook: Expectations of market normalization and strategic planning for future growth.

Thesis III- Massive and Expanding Semiconductor TAM

  • Ecosystem Influence: Essential role in various industries.

  • Industry Dynamics: Surge during the pandemic and post-pandemic adjustments.

  • Long-Term Growth Outlook: Continuous innovation and application integration.

  • Gaming Hardware Impact: Expected recovery to increase semiconductor demand.

  • Positive PC/Tablet Trends: Higher chip orders for advanced technologies.

  • Server Market and IT Spending: Growth enhancing semiconductor demand.

  • Data Growth in Data Centers: Opportunities in processor and memory chip manufacturing.


TSMC’s strategic investments, market positioning, and adaptability in response to evolving industry trends and economic factors significantly enhance its potential for growth. The company's focus on advanced technologies and readiness to meet future market demands, combined with the expansive semiconductor TAM, solidify its role as a key player in the semiconductor industry. The current market valuation does not fully reflect TSMC's technological leadership, strategic foresight, and growth trajectory, presenting a discrepancy between its business potential and stock performance.


Thesis I: TSMC’s Technological Innovations Position the Business to Drive the Entire Industry


Thesis Summary


  1. Revenue Decrease and Inventory Adjustments:

    • TSMC experienced a 6.2% sequential revenue decrease in Q2 2023 due to customers adjusting inventories post-pandemic demand surge. For example, smartphone manufacturers reduced orders as the extraordinary demand normalized, impacting TSMC’s revenue.

  2. Investment in Advanced Technologies:

    • Despite market contractions, TSMC continued investing in R&D for advanced N3 and N2 technologies, demonstrating a commitment to maintaining technological leadership and preparing for future market recoveries.

  3. Resilience Despite Declining Shipments:

    • A significant -23% drop in shipments was offset by a 12% increase in average selling price (ASP), driven by the demand for TSMC's advanced 5nm chips. This strategic focus on higher-margin products showcases TSMC's ability to navigate market shifts and sustain revenue.

  4. Market Segment Evolution:

    • TSMC’s revenue from 5nm technology grew to 30%, while 7nm dropped to 23%, indicating a market shift towards more advanced semiconductor technologies and TSMC’s alignment with these trends.

  5. Future Vision with N3 and N2 Technologies:

    • TSMC is advancing in N3 (in volume production with significant ramp-up expected) and N2 technologies, targeting volume production by 2025. These developments signal TSMC's pioneering role in next-generation semiconductors, particularly for HPC and smartphone applications.

  6. Capital Expenditure and Investment Strategy:

    • TSMC’s adjustment of 2023 CapEx towards the lower end of USD 32-36 billion reflects a cautious approach amidst market uncertainties. However, a significant increase in depreciation expenses due to 3nm technology deployment indicates ongoing investment in future growth.

  7. Balancing Short-Term Challenges and Long-Term Growth:

    • TSMC is navigating current market volatilities while strategically positioning for long-term industry trends. Their balanced approach in capital allocation and investment in advanced technologies ensure sustained competitive advantage and readiness for market upturns.

 

Source: TSMC

Source: TSMC

Source: TSMC

Source: TSMC

Source: TSMC

Market Dynamics and Strategic Positioning in Q2 2023

In Q2 of 2023, TSMC experienced a 6.2% sequential decrease in revenue, shedding light on its strategic position and the overall market dynamics. This reduction largely stemmed from customers adjusting their inventories as the extraordinary demand surge during the pandemic began to normalize. A typical scenario illustrating this point might involve a major client like a smartphone manufacturer, which, during the pandemic, might have ramped up orders to TSMC for advanced chips to meet the surge in consumer electronics demand. However, as the pandemic effects waned, these clients would have reduced their orders, aligning with the softened demand, thereby impacting TSMC's revenue.

Despite these immediate challenges and the acknowledged cyclicality in the semiconductor industry, TSMC's steadfast commitment to investing in research and development for their cutting-edge N3 and N2 technologies remains evident. Such strategic investment, especially during industry downturns, is crucial. It not only demonstrates TSMC's dedication to maintaining its lead in technology but also strategically positions the company to benefit from potential upturns in future demand.

Consider how this strategy will play out: as TSMC continues to develop these advanced technologies, it remains prepared to quickly meet the needs of emerging markets or new client requirements as the industry recovers. Furthermore, TSMC's approach significantly impacts its entire supply chain and signals pivotal shifts in the technology sector's landscape. By focusing on next-generation technology amidst the current market contractions, TSMC isn't just navigating immediate challenges but is also proactively shaping its path in response to long-term industry trends.

Resilience and Strategy Amidst Declining Shipments and Rising ASP

TSMC's recent financial results, characterized by a -23% drop in shipments but mitigated by a 12% increase in average selling price (ASP), present an intriguing scenario in the semiconductor industry, demonstrating the company's resilience and strategic acumen in a fluctuating market. The decrease in shipments, largely due to widespread inventory adjustments after a demand surge during the pandemic, contrasts starkly with the notable increase in ASP. This increase is predominantly attributed to the success of TSMC's 5-nanometer (nm) chips. The move towards these advanced, higher-margin products exemplifies a strategic pivot towards more sophisticated technology, where there is clear market demand despite overall industry challenges.

This increase in ASP amidst falling shipments indicates several key aspects:

Value of Advanced Technology: TSMC's advanced 5nm technology, characterized by smaller, more efficient, and more powerful chips, is in high demand. The market's willingness to pay more for these products highlights the premium placed on advanced technology in semiconductors.

Adaptive Market Strategy: The ability to upscale the ASP in light of declining shipments illustrates TSMC's agility in responding to market shifts. Their strategic decision to focus on high-value, innovative technologies like the 5nm chips allows them to not only stay competitive but also maintain revenue levels even during broader market downturns.

Trend in Semiconductor Industry: TSMC's experience underlines a broader industry trend where innovation and technological leadership are increasingly crucial. In times of market contraction, companies that lead in technology can sustain or grow their revenue, distinguishing themselves from competitors.

A practical example can further illustrate this dynamic: Imagine a smartphone manufacturer facing a global decrease in smartphone demand. However, by focusing on premium models equipped with TSMC’s 5nm chips, the manufacturer not only maintains but potentially increases its profit margins per unit sold. The premium smartphone models, offering superior performance and efficiency, attract customers willing to pay more for advanced features, mirroring the way TSMC has managed to increase its ASP despite lower overall shipments.

TSMC's ability to navigate these contrasting trends — a substantial decrease in shipments but an increase in ASP due to their 5nm chips — showcases their strategic positioning and resilience. It's a testament to their commitment to leading in high-value, advanced technology sectors, highlighting the importance of innovation and market adaptation in sustaining performance in the semiconductor industry.

 

Evolving Market Segments and Strategic Focus in Revenue Breakdown

The revenue breakdown of TSMC for Q2 2023 offers an insightful look into how the company's market segments and strategic focuses are evolving. One of the most significant trends observed is in the technology segment, where the revenue from their 5-nanometer (nm) process technology surged to 30% from the previous year's 21%. This increase is a clear indication of the market's growing preference for more advanced semiconductor technologies. On the other hand, the 7nm technology, which previously held a larger share, saw its contribution to TSMC's revenue drop from 30% to 23%. This shift signifies not just a technological evolution but also highlights TSMC's adeptness in navigating market trends.

The enduring expansion of the 5nm segment, despite its substantial growth in the past year, points to robust market adoption and could suggest that TSMC is carving out a competitive advantage in this high-tech field. One can imagine how this plays out in practical scenarios, like a major technology company choosing TSMC’s 5nm process for its latest high-performance processors, valuing the technology's increased efficiency and power-saving features. Moreover, the overall revenue share of advanced technologies (considered as 7nm and below) experienced a slight uptick to 53% from 51%. This growth further solidifies TSMC’s position as a leader in premium semiconductor manufacturing, a critical aspect for the latest innovations in diverse industries ranging from AI to telecommunications. These shifts not only underscore TSMC's strategic acumen in anticipating and adapting to market demands but also spotlight the company's significant role in powering the next generation of technological advancements.

 

Innovations in N3 and N2 Technologies: TSMC's Future Vision

TSMC's updates on its N3 and N2 technology developments reflect the company's continuous leadership and innovative strides in the semiconductor sector, emphasizing its strategic focus and vision for the future. The N3 technology, touted as the most advanced in terms of Power, Performance, and Area (PPA) and transistor technology, is currently in volume production with satisfactory yield. TSMC's projection of a substantial N3 ramp-up in the latter half of the year, especially targeting High-Performance Computing (HPC) and smartphone segments, not only demonstrates the strong market demand for this technology but also TSMC's adeptness in catering to complex market requirements. The expected contribution of N3 technology to the mid-single-digit percentage of total wafer revenue in 2023 signifies its commercial value and TSMC's confidence in this advanced technology.

The N3 family's evolution is further marked by the launch of N3E, enhancing performance, power efficiency, and yield. The readiness of N3E for volume production, following its successful qualification, is a testament to TSMC's relentless pursuit of innovation and its foresight in key areas such as HPC and smartphone technology. TSMC's positive outlook on its 3-nanometer (nm) technology family, anticipating it to be a significant and enduring node, mirrors the company's strategic expectations of consistent, long-term demand. This view reinforces TSMC's standing as a frontrunner in state-of-the-art semiconductor technologies.

The progress towards N2 technology, aiming for volume production by 2025, showcases TSMC's pioneering spirit. Adopting a nanosheet transistor structure, N2 is designed to optimize performance, cost, and technological maturity. This advancement, particularly important for enhancing energy efficiency, aligns with the growing demands for power-efficient computing solutions. N2's innovative development, incorporating a backside power rail especially for HPC applications, indicates a major leap forward. The projected improvements in speed and logic density from this feature cement TSMC's competitive advantage. The company’s timeline, targeting availability in the second half of 2025 and production in 2026, highlights its detailed planning and commitment to continuous technological evolution.

The significant customer interest and engagement in N2 technology across both HPC and smartphone applications underscore the market's eager anticipation for these innovations. TSMC's assertion that its 2-nanometer technology will lead the industry in terms of density and energy efficiency upon its launch, further extending its leadership into the future, showcases the company's strategic dedication to preserving its edge in cutting-edge semiconductor technology. This proactive and forward-thinking strategy not only fortifies TSMC's market position but also readies it to adeptly respond to the dynamic and diverse demands of the semiconductor industry.

Balancing Capital Expenditure and Future Growth Investments

TSMC's approach to its 2023 capital budget and depreciation strategy reflects a carefully calibrated balance between navigating current market uncertainties and investing in future growth. The company's decision to adjust its 2023 capital expenditure (CapEx) towards the lower end of the projected USD 32 billion to USD 36 billion range is a testament to its strategic and cautious stance in the face of a fluctuating economic landscape. This modification in CapEx not only signifies TSMC's acute responsiveness to near-term market volatilities, influenced by global economic uncertainties and the semiconductor industry's variable demand, but also underscores its prudent financial management.

Despite this restrained CapEx, TSMC is set to experience a significant year-over-year escalation in depreciation expenses, anticipated to climb by mid-20s percent in 2023. This uptick is largely due to the progressive deployment of their cutting-edge 3-nanometer (nm) technologies. TSMC's steadfast investment in such advanced technology highlights its unwavering commitment to uphold its leadership and competitive advantage in the semiconductor space, undeterred by short-term hurdles. By pushing the boundaries with their 3nm process, TSMC maintains its lead in powering the next generation of innovations across a multitude of domains including electronics, computing, and more.

This strategic capital allocation, coupled with the continued support for their customers' structural growth despite the prevailing inventory cycle, illustrates TSMC's deep-seated long-term perspective. The company recognizes that the semiconductor industry's growth trajectory is inherently cyclical, marked by periods of fluctuation. Adhering to a disciplined approach in CapEx and capacity planning, calibrated against the forecasted long-term market demand, TSMC skillfully steers through present uncertainties while positioning itself to leverage future market recoveries.

TSMC's ongoing investment in not only leading-edge but also specialty and advanced packaging technologies further affirms their dedication to fulfilling their customers' evolving growth and technological requirements. By aligning their capacity planning and investment strategies with the long-term demands of their clientele, TSMC solidifies its role as a crucial facilitator and beneficiary of the wider industry's growth. This approach is also in harmony with their objective to deliver profitable growth to shareholders, neatly striking a balance between fiscal prudence and commitments to innovation and expansion. In an industry characterized by brisk technological progression and shifting market demands, TSMC's judicious and forward-thinking strategy ensures that it remains a central and influential player in the global semiconductor narrative.


Thesis II: TSMC is Strategically Positioned to Benefit from Trends Across the Economy

Thesis Summary

  1. Platform-Wise Revenue Breakdown in Q2 2023:

    • High-Performance Computing (HPC) contributed 44% to revenues, highlighting robust demand in AI, data centers, and cloud computing.

    • The smartphone segment saw a 9% quarterly decline, reflecting market normalization.

    • Automotive sector's revenue share increased to 8%, driven by the rise of electric vehicles (EVs) and advanced driver-assistance systems (ADAS).

    • Internet of Things (IoT) maintained an 8% revenue share, indicating potential short-term deceleration.

    • Digital Consumer Electronics (DCE) segment grew by 25%, suggesting a growing interest in smart consumer devices.

  2. Strategic Insights on High-Performance Computing and Long-Term Projections:

    • TSMC emphasizes 5G and HPC as critical drivers of long-term growth, aiming for a 15% to 20% compound annual growth rate (CAGR).

  3. Approach to AI-Driven Demand and Market Positioning:

    • TSMC is aligning with the increasing demand for AI-driven applications, especially in generative AI, projecting significant growth in server AI processors.

  4. Challenges and Strategies in AI-Focused Applications:

    • TSMC is addressing capacity limitations in advanced packaging technologies, especially in Chip on Wafer on Substrate (CoWoS), while maintaining collaboration with customers to manage supply constraints.

  5. Expanding Capacities for Advanced AI Chip Packaging:

    • TSMC plans to nearly double the capacity for CoWoS production in 2024, preparing for growing needs in AI and high-performance computing.

  6. Market Outlook for Q3 2023 and Beyond:

    • TSMC forecasts a mid-single digit year-over-year decline in the semiconductor market for 2023 and a mid-teens decrease in the foundry industry. They expect fabless semiconductor inventory levels to normalize by the end of Q4 2023.

 

Source: TSMC

Source: TSMC

Source: TSMC

Source: TSMC

Source: TSMC

Source: TSMC

TSMC's Revenue Analysis by Platform

The platform-wise revenue breakdown of TSMC in Q2 2023 reveals dynamic shifts and enduring trends within the semiconductor market. The high-performance computing (HPC) sector, even with a 5% quarter-over-quarter reduction, witnessed an annual increase, contributing 44% to the quarter's revenues, up from 43% the previous year. This pattern underscores the ongoing robust demand for technologies in AI, data centers, and cloud computing, where HPC plays a critical role. It reflects the sector's resilience and growth momentum, underscoring its importance in the technology landscape.

In contrast, the smartphone segment, marking a 9% quarterly decline and dropping its share to 33% from 38%, appears to mirror a larger, temporary deceleration in the global smartphone industry. This decrease, however, might not indicate a long-term downturn but rather a market normalization or a phase of supply rebalancing after the intense base effects of previous high demand periods. In this sense, such a decline could be seen as a healthy adjustment to more sustainable growth levels.

The automotive sector, on the other hand, shows impressive growth. Its increased revenue share from 5% to 8% quarter-over-quarter can be largely attributed to the growing importance of semiconductors in modern vehicles, especially with the rise of electric vehicles (EVs) and advanced driver-assistance systems (ADAS). This trend likely reflects an industry-wide shift towards more technologically sophisticated, connected, and automated vehicles.

Meanwhile, the Internet of Things (IoT) sector maintained its 8% revenue share despite an 11% decline quarter-over-quarter, suggesting a possible short-term deceleration in what is broadly considered an expanding field. This temporary slump might be attributed to market adjustments or inventory rebalancing but does not detract from the general upward trajectory and potential of IoT applications.

Finally, the digital consumer electronics (DCE) segment, while still a minor player in TSMC's portfolio at 3% of total revenue, displayed a substantial 25% growth quarter-over-quarter. This significant increase indicates a burgeoning interest in smart consumer devices and home electronics, marking a rapidly evolving sector that could emerge as a key area of growth in the near future. These revenue trends across different platforms highlight the complex and varied nature of demand within the semiconductor industry, reflecting both short-term market adjustments and longer-term shifts towards more advanced, integrated technologies across various sectors.

 

Strategic Insights on High-Performance Computing and Long-Term Projections

TSMC's perspectives on the High-Performance Computing (HPC) sector and its own long-term growth projections offer a clear view into the company's strategic direction and its understanding of industry-wide trends. The company underscores a substantial structural increase in demand for computational power, propelled by key industry megatrends such as 5G and HPC. These developments are spurring a heightened requirement for high-performance, energy-efficient computing solutions, areas where TSMC's advanced technologies and market leadership are particularly pronounced.

The focus on 5G and HPC as critical drivers of TSMC's long-term growth is noteworthy. TSMC identifies 5G not merely as an enhancement in wireless communications but as a pivotal technology that underpins a range of innovations like the Internet of Things (IoT), autonomous vehicles, smart cities, and beyond. These applications need rapid, reliable data processing and high energy efficiency, which are hallmarks of TSMC's semiconductor technology offerings. Additionally, HPC's importance in efficiently managing extensive data sets is essential in various domains including scientific research, financial analysis, AI, and big data analytics.

Despite the challenges presented in 2023, TSMC remains bullish about its growth, aiming for a 15% to 20% compound annual growth rate (CAGR) in U.S. dollar terms over the next few years. This ambitious target, reiterated from their January 2022 investor conference, emphasizes TSMC's confidence in its significant role and expansion within the changing technological landscape. This target reflects TSMC's agility and innovative approach in responding to evolving market needs, as well as its strategic foresight in leveraging long-term industrial shifts.

This projection highlights TSMC's strategic congruence with larger technological trends, suggesting that the company is not just adapting to market shifts but is also actively influencing its path by focusing on projected growth areas. By prioritizing cutting-edge semiconductor technologies for the growing needs of 5G and HPC applications, TSMC is primed to be a crucial contributor to future technological breakthroughs. This approach, coupled with their established track record in technological leadership, places TSMC in a strong position to deal with short-term market fluctuations while seizing extensive opportunities in the long-term progression of the technology sector.

TSMC's Approach to AI-Driven Demand and Market Positioning

TSMC's insights into the burgeoning AI-driven demand, particularly in the realm of generative AI, highlight their acute understanding of evolving technology trends and strategic market positioning. The surging requirement for more powerful computing and enhanced bandwidth, driven by generative AI applications, is notably advantageous for TSMC. Such AI applications, requiring high computational prowess, lean heavily on advanced computing components like CPUs, GPUs, and specialized AI accelerators and ASICs. These components, essential for the effective functioning of generative AI models, necessitate state-of-the-art technology and a solid foundry design ecosystem – areas in which TSMC demonstrates notable expertise.

As an example, the increasing popularity and sophistication of large language models like OpenAI's ChatGPT showcase the type of generative AI demanding such high-performance computing components. These models require massive computational resources for both training and ongoing operations, thus escalating the demand for powerful, efficient semiconductors.

Currently, TSMC derives about 6% of its total revenue from server AI processors, including CPUs, GPUs, and AI accelerators, employed in AI training and inference tasks. The company’s forecast of this segment growing at a nearly 50% CAGR over the next five years, and potentially forming a low teens percentage of their revenue, not only mirrors the strong market demand for these technologies but also signifies TSMC’s ability to effectively harness this burgeoning demand. This expected growth illustrates TSMC's well-aligned strategy with market needs and technological innovations.

TSMC also expects the need for energy-efficient computation to expand beyond data centers to edge and end devices, widening the scope of opportunities across a spectrum of applications. This expansion signifies an ongoing and increasing reliance on advanced semiconductor technologies, from centralized data centers to decentralized computing on various devices.

By incorporating these AI-driven demand projections into their long-term CapEx and growth strategies, TSMC earmarks its High-Performance Computing (HPC) platform as a primary growth engine. This strategic emphasis on HPC aligns with the escalating global focus on AI and machine learning, sectors necessitating the high-performance, efficient computing solutions that TSMC provides.

TSMC's ongoing assessment of the total addressable market in AI, particularly in emerging areas like generative AI and expansive language models, though still in progress, already concurs with their firm conviction in the structural megatrend. TSMC’s approach – vigilantly tracking industry evolutions while strategically positioning themselves to capitalize on these trends – highlights their proactive, forward-looking strategy. This strategy not only maintains TSMC’s leadership position but also propels its growth in the dynamic semiconductor landscape.

Challenges and Strategies in AI-Focused Applications

TSMC's handling of the robust demand for AI-focused applications illustrates the criticality of AI in the current technological landscape, while also spotlighting the company's capabilities and challenges in this rapidly evolving sector. TSMC's proficiency in front-end manufacturing for AI applications showcases its significant production abilities and reinforces its leadership in the semiconductor industry. However, the capacity tightness, particularly in advanced packaging like Chip on Wafer on Substrate (CoWoS), underscores a notable bottleneck in addressing the full spectrum of client requirements. This limitation in the back-end process, essential for assembling and packaging chips, reveals a stark contrast between existing supply capabilities and the soaring demands, especially in high-performance segments like AI.

The company's open acknowledgment of the challenges in meeting 100% of customer demands in this sphere reflects an honest portrayal of the prevalent industry constraints, underlining the delicate equilibrium required between manufacturing capacities and the escalating technological needs. TSMC’s direct engagement with its customers to mitigate these short-term difficulties demonstrates its steadfast commitment to customer service and adaptability in managing supply limitations.

For instance, imagine a scenario where a leading AI research lab requires a substantial quantity of advanced AI chips for its next-gen AI models. They would typically turn to TSMC for these chips, expecting the cutting-edge performance and reliability synonymous with TSMC's products. However, due to the constraints in CoWoS packaging, TSMC might struggle to fulfill this order within the desired timeframe, potentially hampering the lab's project timelines. TSMC's admission of such limitations and its interactive approach with clients in navigating these challenges would be crucial in maintaining trust and transparency in this high-stakes situation.

TSMC's strategy to ramp up capacity for advanced packaging as swiftly as feasible mirrors its responsive approach to these demand pressures. The target of resolving capacity issues by the end of the next year is not merely a reactionary measure but also a strategic move to gear up for anticipated future demand surges. This tactic reflects TSMC's keen insight into the market's direction and its readiness to invest in pivotal areas for ongoing growth and ensuring client contentment.

Furthermore, the company’s sustained collaboration with customers amidst these challenges underscores TSMC's dedication to preserving robust business relationships and its vital role in the global supply chain for high-tech components. This dual focus on managing current capacity constraints and proactively enhancing future capabilities typifies TSMC's comprehensive strategy to maintain its market dominance and cater to the burgeoning, multifaceted demands of the AI and broader semiconductor industries.

Expanding Capacities for Advanced AI Chip Packaging

TSMC's decision to nearly double the capacity of its Chip on Wafer on Substrate (CoWoS) production in 2024 compared to 2023 is a pivotal strategic action, demonstrating the company's dedication to overcoming existing capacity limitations in advanced packaging. This significant expansion is a direct answer to the earlier highlighted challenges of meeting the increasing demand for AI-related products, a sector where advanced packaging techniques like CoWoS are crucial.

The CoWoS technology is essential in manufacturing complex AI chips, where it allows for higher bandwidth and energy-efficient interconnections between chips and substrates. By ramping up this capacity, TSMC not only aims to alleviate the current bottlenecks but also shows foresight in preparing for the continuously growing needs of AI and high-performance computing sectors.

To contextualize this strategy, consider a leading technology firm developing state-of-the-art AI processors, which depend heavily on sophisticated packaging technologies for optimal performance. Previously, due to capacity constraints, TSMC might have been unable to meet the full demand from this company, potentially slowing down the development and rollout of new AI products. With the planned increase in CoWoS capacity, TSMC is not only addressing these immediate limitations but also preparing to accommodate larger orders in the future. This expansion ensures that TSMC can provide a more robust supply chain support to its clients, thereby enabling faster and more efficient delivery of high-tech AI products to the market.

Furthermore, this expansion can be seen as part of TSMC's broader strategy to stay ahead in the competitive semiconductor industry. By investing in and expanding capabilities in crucial areas like advanced packaging, TSMC is positioning itself not just as a chip manufacturer, but as an integral player in the full spectrum of semiconductor production. This proactive growth strategy reflects TSMC’s understanding of market trends and its commitment to maintaining and strengthening its leadership position in the face of increasing demand and technological evolution.

TSMC's Market Outlook for Q3 2023 and Beyond

TSMC's outlook for Q3 2023 showcases their deep understanding of the semiconductor industry's cyclicality and the changing market dynamics. Despite the increase in AI-related demand, TSMC acknowledges that this uptick alone might not fully offset the overall cyclical downturn in their business, highlighting the intricacies of semiconductor demand where growth in one segment doesn't necessarily compensate for wider market swings. TSMC anticipates their Q3 business to gain momentum primarily through the introduction of their new 3-nanometer (nm) technologies. However, this growth is expected to be partly counterbalanced by ongoing inventory adjustments from their customers, illustrating a product-driven growth strategy that leans heavily on the latest technological breakthroughs.

The company maintains its earlier projection that fabless semiconductor inventory levels would reach a healthier balance by the end of the third quarter, signaling a steady normalization after pandemic-induced disruptions. Yet, the added insight that customers are planning to continue managing their inventories into Q4 2023, due to uncertainties around end-market demand, mirrors the wider, lingering uncertainties in the post-pandemic market. This extra layer of caution reflects not only ongoing global economic concerns but also potential changes in technology consumption trends.

Adjusting to these insights, TSMC now predicts a mid-single digit year-over-year decline for the 2023 semiconductor market (excluding memory), adopting a more guarded viewpoint than previously. Particularly, the foundry industry is expected to experience a mid-teens decrease, with TSMC's full-year 2023 revenue projected to fall around 10% in U.S. dollar terms. This revised forecast is in step with both the prevailing global economic climate and specific hurdles in the semiconductor sector, encompassing variable demand, supply chain complications, and the adjustment of inventories.

TSMC's expectation that fabless semiconductor inventory will conclude the fourth quarter at a lower, healthier level compared to their estimates three months prior suggests a cautiously optimistic stance towards market normalization. The company's adept management of these industry-wide shifts—marrying the rollout of cutting-edge technology like the 3nm process with strategic inventory and demand management—underscores their adaptability and profound industry insight. By tackling these challenges and adapting its strategies to evolving market conditions, TSMC reaffirms its commitment to preserving its leading status while catering to the needs of its clients and the broader market, navigating through an industry marked by constant change and complexity.


Thesis III- Massive and Expanding Semiconductor TAM

Thesis Summary

1. Semiconductor Ecosystem and Its Influence

  • Pervasive Role: Semiconductors are essential components in various devices and systems, driving applications across multiple industries.

  • Industry Integration: They are integral to consumer electronics, automotive, data centers, industrial automation, healthcare, telecommunications, energy, retail, government, and research sectors.

2. Semiconductor Industry Dynamics

  • Pandemic-Driven Growth: The industry saw a surge during the pandemic due to increased demand for digital services.

  • Post-Pandemic Adjustment: There's a normalization in demand for certain semiconductor types as remote work stabilizes and a cautious enterprise spending approach in 2023.

3. Semiconductor Industry Outlook

  • Long-Term Growth: Despite short-term market headwinds, the industry is expected to see significant growth, driven by continuous innovation and broader application integration.

  • Forecasts and Analyses: Various industry forecasts project robust growth for the semiconductor industry, fueled by demand across a range of applications.

4. Gaming Hardware Industry Dynamics and Semiconductor Impact

  • Market Flux in Gaming Hardware: The gaming hardware sector, including PCs and consoles, is in a contraction phase but expected to recover in the coming years.

  • Impact on Semiconductor Demand: This recovery will likely increase demand for high-performance semiconductors used in gaming devices.

5. Positive Trends in PC and Tablet Shipments

  • Growth Projections: Forecasts indicate an increase in PC and tablet shipments, which will boost semiconductor demand.

  • Implications for Chip Makers: The rise in shipments will lead to higher chip orders and demand for advanced semiconductor technologies.

6. Server Spending and Data Center Investments

  • Server Market Growth: The server market, particularly GPU servers, is witnessing growth, enhancing semiconductor demand.

  • IT Spending Projections: Global IT spending forecasts suggest a resilient demand for technology, benefiting semiconductor manufacturers.

7. Data Growth and Demand in Semiconductor-Dependent Data Centers

  • Data Explosion: The significant increase in data creation and replication boosts the need for data processing power in data centers.

  • Market Opportunities: This data growth presents substantial opportunities for semiconductor companies, particularly in processor and memory chip manufacturing.

Semiconductor Ecosystem

The semiconductor industry is a linchpin of modern technology, its influence permeating every aspect of our digital lives. Semiconductors themselves are vital components embedded within countless devices and systems, powering a myriad of applications across various industries. Their importance cannot be overstated, as they are integral to the functioning of contemporary society.

 

In consumer electronics, semiconductors are the driving force behind devices such as smartphones and laptops, facilitating the computational capabilities and connectivity that have become second nature in our daily routines. These tiny yet powerful chips allow for the sleek, fast, and smart devices that keep us connected to the world and each other.

 

Turning to the automotive sector, semiconductor technology has transcended its role from mere component to central feature, especially in the burgeoning arenas of electric and autonomous vehicles. These advanced chipsets manage a spectrum of functions, from controlling electric motors to processing data from an array of sensors for navigation and safety systems. The result is not just smarter vehicles but a transformation in how we view transportation.

 

Data centers around the globe depend on semiconductors for their very pulse. These chips form the processing core that handles vast volumes of data—facilitating everything from cloud services to enterprise operations. In these hidden behemoths of the digital age, semiconductors ensure that our insatiable demand for data and speed is met with unerring reliability and efficiency.

 

The industrial sector also harnesses semiconductor technology for more than just basic functions. Here, semiconductors are the brains within sophisticated automation systems and robotics, driving forward leaps in productivity and precision manufacturing. Whether it's producing consumer goods or developing new materials, semiconductors play a critical role in modern manufacturing processes.

 

In healthcare, the impact of semiconductors is profoundly felt. Advanced diagnostic imaging, patient monitoring systems, and a host of medical devices rely on semiconductor components. These applications not only enhance the capabilities of medical practitioners but also improve patient outcomes through more accurate diagnostics and monitoring.

 

The telecommunications industry, a cornerstone of global connectivity, operates on the back of semiconductor technology. The chips facilitate high-speed data transfer and reliable communications, without which our networked world would grind to a halt. Meanwhile, aerospace and defense sectors incorporate these critical components into complex systems, ensuring safety and functionality in environments where failure is not an option.

 

Furthermore, the energy sector uses semiconductors to enhance the efficiency and reliability of power generation and distribution systems, including renewable energy technologies. The rise of smart grids and sustainable energy solutions is largely dependent on the continued innovation within the semiconductor industry.

 

Retail, commercial, and government sectors similarly benefit from semiconductors, which are foundational to the systems handling transactions, inventory, logistics, and essential public services. The ubiquitous point-of-sale systems, for instance, are underpinned by semiconductor-based devices that process millions of transactions daily.

 

Finally, in research and development, semiconductors are indispensable in powering high-performance computing systems that enable sophisticated simulations, analyses, and the processing of complex data sets. These capabilities are essential for driving forward scientific discovery and technological innovation, cementing the role of semiconductors as the bedrock of future advancements.

 

Semiconductor Industry Dynamics

In the wake of the pandemic, the semiconductor industry witnessed unprecedented growth, propelled by the accelerated digitization of workplaces, education, and commerce. This digitization surge necessitated advancements in PC capabilities to support work-from-home (WFH) arrangements, leading to a significant uptick in demand for high-performance computing and cloud services. The resulting boom in semiconductor usage underscored the industry's critical role in enabling the digital economy, reinforcing its status as a foundational pillar of modern infrastructure.

 

As the acute phase of the pandemic transitioned into a new normal, the incremental year-over-year demand for certain types of semiconductors, such as those in PCs, naturally tapered as the initial rush to equip remote workforces stabilized. Concurrently, a cautious approach by enterprises towards capital expenditure emerged in 2023, reflective of a broader sentiment influenced by recessionary narratives. This conservatism, however, is indicative of a strategic recalibration rather than a long-term decline in semiconductor requisites.

While there have been cross currents affecting the industry this year, these are largely attributable to the realignment of supply and demand dynamics, not a downturn in the semiconductor trajectory. Even amidst these fluctuations, the aggregate demand for semiconductors remains robust, outstripping pre-pandemic levels. Looking ahead, the underlying demand trajectory for semiconductors is poised to maintain its strength, driven by continuous innovation and the integration of semiconductor technology into an ever-widening array of applications and sectors.

 

Semiconductor Industry Outlook

The semiconductor industry, a critical driver of technological progress, is navigating a complex landscape marked by both challenges and opportunities as it moves toward the next decade. As per ASML, a bellwether for the industry, there's an expectation of substantial growth for 2023, estimated at around 30%, despite current market headwinds. This optimism is rooted in a formidable backlog worth €38 billion, which cushions the impact of macroeconomic uncertainties and customer cautiousness. ASML's confidence is bolstered by "global megatrends in the electronics industry," projecting a steady 7.4 percent annual growth for chipmakers, with ASML positioned to capture a significant share of this expansion. Looking ahead, ASML's revised forecasts promise an 11% annual revenue growth through 2030, underpinned by soaring demand for its cutting-edge chipmaking equipment.

 

  • Fitch's broader industry analysis aligns with this optimistic long-term view, predicting that semiconductor revenues will double to reach USD 1 trillion by 2030, translating to a robust CAGR of over 9%. This growth trajectory is anticipated to be fueled by the persistent demand for semiconductors across an array of applications, from consumer electronics to industrial automation.

 

  • Contrastingly, Gartner presents a more conservative outlook for the immediate future, anticipating an 11.2% contraction in global semiconductor revenue for 2023. This projection, reflecting a downturn to $562.7 billion from 2022's $599.6 billion, is attributed to a cooling market and pervasive economic headwinds.

 

  • Industry body SEMI provides a silver lining, suggesting that the sector's slump is temporal, with recovery expected to gain traction in the latter half of 2023 and gathering momentum into 2024. All market segments are projected to bounce back, with electronics sales potentially surpassing their 2022 peak. SEMI also underscores the record $73 billion revenue hit by the semiconductor materials market in 2022, and forecasts global semiconductor equipment sales to reach $87 billion in 2023, with a rebound anticipated in 2024.

 

  • Semiconductor Trade Statistics forecasts a significant rebound for the global semiconductor industry in 2024, estimating growth of 11.8% to $576 billion, with the memory segment potentially witnessing a surge of up to 40% from the previous year.

 

  • In the United States, Statista expects semiconductor spending to dip by 13% in 2023, following robust growth in the preceding years. Yet, the sector is predicted to recapture momentum in 2024 with an anticipated rebound of 10%.

 

Looking at the broader horizon, the industry is projected to grow at a CAGR of 10.86% from 2023 to 2028, according to insights from Mordor Intelligence. This expansion, expected to surge the market size from an estimated $0.65 trillion in 2023 to $1.09 trillion by 2028, is propelled by the proliferation of consumer electronics, AI, IoT, and machine learning technologies. The evolution of multi-chip packages, high-capacity memory solutions, and system on a chip (SoC) technologies, famed for their high integration levels and efficiency, are key contributors to this growth.

This patchwork of forecasts paints a picture of an industry at the inflection point of its growth cycle. While short-term headwinds have led to conservative spending and a cautious approach from enterprises, the long-term prospects remain vibrant. Driven by relentless innovation and an expanding repertoire of semiconductor applications, the industry's future is one of robust growth, with temporary fluctuations viewed as recalibration rather than regression.

 

Gaming Hardware Industry Dynamics and Semiconductor Impact

The gaming hardware industry, encompassing PC gaming rigs and consoles, is experiencing a cyclical flux that presents both challenges and opportunities for the semiconductor ecosystem. After a period of explosive growth, the market is currently in a contraction phase, with the PC gaming hardware market having receded from $68.5 billion in 2021 to an expected $37 billion in 2023. However, projections indicate a recovery on the horizon, with forecasts suggesting a rebound to $41 billion in 2024 and further growth to $47 billion by 2025.

 

TechSpot's analysis concurs with this outlook, predicting the PC gaming hardware industry will regain its footing to hit revenues of $47.1 billion by 2025, marking a notable resurgence from the $42 billion recorded in 2022. This anticipated recovery is reflective of a broader trend within the gaming sector, suggesting a transient downturn rather than a prolonged slump.

 

Looking at the global gaming hardware market, which includes peripherals like controllers, headsets, and gaming-specific cameras, a steady CAGR of 5.5% from 2022 to 2030 is expected. This growth trajectory is propelled by a robust appetite for gaming content, the escalating popularity of eSports, and technological advancements in gaming devices.

 

The sustained interest in eSports, coupled with the cultural entrenchment of gaming as a mainstream form of entertainment, ensures that the underlying demand for advanced semiconductor technology remains robust. As the market recovers and expands, semiconductor companies with a stake in gaming hardware can expect renewed opportunities for growth, innovation, and revenue generation. This positions the gaming sector as a significant contributor to the semiconductor industry's long-term growth narrative.

For semiconductor manufacturers, particularly those producing high-performance chips for gaming PCs and consoles, these projections signify a potential tailwind. While the short-term contraction may lead to cautious inventory management and a temporary dip in demand for gaming-specific semiconductors, the anticipated rebound in gaming hardware spending bodes well for the industry. This expected increase in demand will likely be driven by the next generation of gaming consoles and the continuous need for powerful GPUs and CPUs in PC gaming.

 

Positive Trends in PC and Tablet Shipments Boost Semiconductor Demand

The forecasts from IDC and Gartner for PC and tablet shipment growth in 2024 signal a positive trend for high-performance semiconductor demand. IDC's projection of a 3.7% rise in PC shipments to 261.4 million units and tablet growth of 4.4% to 135 million units, coupled with Gartner's estimate of a 4.9% increase in the PC market, points to a substantial rebound for chip manufacturers.

 

The key implications for semiconductor demand include:

Higher Chip Orders: More PC and tablet shipments will lead to a greater volume of semiconductor components being ordered, particularly CPUs and GPUs.

Demand for Advanced Chips: Newer, feature-rich PC and tablet models will drive demand for high-performance chips.

Diverse Market Demand: Growth across consumer and business segments suggests increased spending on both standard and premium devices.

Supply Chain Adjustments: Semiconductor suppliers will need to optimize production to meet demand without risking excess inventory.

R&D and Innovation Focus: Chip makers may accelerate R&D in advanced semiconductor technologies to stay competitive.

Overall, these projections indicate a robust recovery for the semiconductor industry, especially for high-performance chip makers, as they prepare to meet the rising demands of 2024's PC and tablet markets.

 

Server Spending and Data Center Investments Propel Semiconductor Growth

The latest forecasts for server spending and data center investments indicate a significant tailwind for the semiconductor ecosystem, suggesting resilience and growth potential despite broader economic uncertainties.

 

According to IDC, the server market saw a 3.4% year-over-year increase in the second quarter of 2023, mainly attributed to higher average selling prices (ASPs). This increase has been significantly propelled by the demand for GPU servers from hyperscale operators, who continue to invest in data center capabilities to support intensive workloads like AI and machine learning.

 

The 5.5% rise in global IT spending for 2023, as predicted by Gartner, despite the looming recession concerns, further solidifies the narrative of a tailwind for the semiconductor sector. The consistent growth across all regions not only points to a sustained investment in IT infrastructure but also to a long-term strategic commitment to digital transformation, which is intrinsically linked to semiconductor usage.

Gartner's projection of an 8% expansion in worldwide IT spending in 2024, with the market reaching $5.1 trillion, underscores the robust momentum in technology investments. This broad IT market growth, inclusive of data center systems, software, devices, IT services, and telecom services, with AI investments playing a substantial role, reflects a healthy demand environment for semiconductors, particularly those that enable advanced computing and data processing.

 

Focusing on server sales, IDC forecasts a remarkable 18.2% growth for non-X86 servers and a 4.9% increase for X86 server spending in 2023. The robust growth in non-X86 server spending, although starting from a smaller base, indicates a diversifying market and potential for semiconductor suppliers beyond the traditional X86 architecture. The steady growth in X86 servers, expected to reach $117.8 billion, remains a significant driver for semiconductor demand, given the pervasive use of X86 servers in enterprise and cloud environments.

 

Data Growth Driving Demand in Semiconductor-Dependent Data Centers

The exponential growth in data creation and replication, with an expected compound annual growth rate (CAGR) of 23% from 2020 to 2025, sets the stage for a significant surge in demand for data center processing power. The projection of 175 zettabytes of global data by 2025, nearly half of which is anticipated to be stored in public cloud environments, underscores the need for robust data processing and storage capabilities.

This trend is a substantial tailwind for the semiconductor industry, especially for manufacturers of high-performance processors and memory chips that form the backbone of data centers. The growth of data from IoT devices, which is expected to reach 90 zettabytes by 2025, will further bolster this demand, as processing this data in real-time requires substantial computational resources.

 

The financial forecasts for the data storage market, expected to reach USD 777.98 billion by 2030, and the public cloud services market, which is projected to constitute over 45% of all enterprise IT spending by 2026, highlight the vast market opportunity for semiconductor companies. The cloud storage market's estimated growth to USD 472.47 billion by 2030, with a specific CAGR of 25.18% from 2022 to 2028, indicates a robust expansion of infrastructure that is heavily reliant on advanced semiconductor technologies.

As the need for cost-effective, high-capacity, and secure data storage rises, so does the demand for semiconductors that enable these services. This environment presents a fertile ground for innovation, investment, and competition within the semiconductor industry, positioning it as a critical enabler of the digital economy's data-centric future.


Forecast and Valuation

The market currently undervalues TSMC's potential for substantial growth and industry dominance. Despite a recent 6.2% sequential revenue decrease in Q2 2023, largely attributed to post-pandemic inventory adjustments by customers like smartphone manufacturers, TSMC’s strategic positioning and technological advancements hint at a robust future. The company's continued investment in cutting-edge N3 and N2 technologies, resilience amid declining shipments balanced by increased average selling prices, and significant contributions across various market segments, including High-Performance Computing (HPC) and automotive, underscore its market agility and potential for long-term growth.

TSMC's forward-looking strategies, such as expanding capacities for advanced AI chip packaging and preparing for normalized semiconductor inventory levels by Q4 2023, further reinforce its potential for sustained growth. These factors, combined with the massive and expanding global semiconductor Total Addressable Market (TAM), position TSMC favorably for future market upturns, making its current stock valuation a likely understatement of its true business potential.

 

Source: Internal Forecast

 

Source: Internal Forecast