Episode 28 | Taiwan Semiconductor Manufacturing Company (TSM)

In Episode 28 of Market News with Rodney Lake, Rodney Lake, Director of the GW Investment Institute, analyzes Taiwan Semiconductor Manufacturing Company's (TSM) performance and its critical role in the semiconductor industry. Professor Lake explores TSM's impressive $83 billion in revenue, 55% gross margins, and nearly 40% net margins. He evaluates TSM’s business model, management strategy, and valuation, assigning it an overall score of 8.5. With a focus on the company’s supply chain relationships with giants like Apple and Nvidia, and its position as a leader in AI development, Lake emphasizes the importance of understanding TSM's place in the global economy. Tune in to gain valuable insights into one of the most pivotal companies shaping the future of technology!

Transcript

Thank you for joining Market News with Rodney Lake. This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the director of the GW Investment Institute. Let's get started. Welcome back to Market News with Rodney Lake. I'm your host, Rodney Lake. Today, special day we're talking about Taiwan Semiconductor. And we're coming to you from the GW School of Business Duquès Hall.

And this is a program from the GW Investment Institute. So happy to be back with you again. We're talking about Taiwan Semiconductor. Why is that company important? We're going to get into that. And a reminder disclaimer this is not investment advice, entertainment and educational purposes only. So let's dive in. If you're new to the podcast thanks for joining.

If you're watching on YouTube, thanks for watching. Very much appreciated. If you're coming back, welcome back. If you've been watching, we're going to use the framework to evaluate this company. So Taiwan Semiconductor, if you've heard of it possible that you've heard of it. It's a very big in the news at the moment. We're going to use the framework business management price valuation and balance sheet.

That is the GW Investment Institute framework. If you've been following along, hopefully it's starting to make sense now. How do we break down these companies. We look at the business. We evaluate the management. We look if the valuation is at a fair price and we try to understand what's the risk on the balance sheet, what's the risk? And the capital structure, the mix between equity and debt.

As investors in equities, we have to be really concerned about what debt is ahead of us legally that is ahead of us. So we got to be concerned about that if that's the case. So all right, let's start to work on a Taiwan semiconductor. All right. This is a business that manufactures chips. And you might have heard of this company.

So if you let's just quickly talk about some of the clients, that it has, and I'll get into the business that it's in. So have you heard of Apple? Have you heard of Nvidia? Have you heard of media tech? Maybe not them. Is big. Have you heard of Broadcom? Have you heard of Qualcomm AMD Intel. You probably heard of most of these companies.

These are their biggest customers. So they supply chips to these companies. And so they those companies will be called fabulous. So fabrication less chip producers. So the chips that go into an iPhone, the chips that go into Intel, sometimes the chip and Intel makes its own chips to to get confusing there too. But all the chips that Nvidia makes, for example, they do not produce.

They design in Taiwan semiconductor manufactures these chips. So when they say we're a fabulous chip producer. So Apple produces chips but it designs them, not manufactures them. The manufacturing facilities are handled by for the the chips for Apple and Nvidia are handled by the manufacturing facilities in Taiwan. And now, some are being built, right here in the US.

Okay. So that's happening. And so if you hear about, oh, what's a fabulous, chip maker. Well that's Apple, that's Nvidia. Those two big names, as I mentioned in Qualcomm would be another one. And Taiwan Semiconductor is their partner in this. They don't compete with them. They produce chips for their clients. Taiwan Semiconductor does not produce its own chips.

So that that's a very much a distinction with its business plan, with its relationship with its customers. It, you know, has basically pledged we're not going to compete with our customers. So that makes them a good pie partner. That makes them a good supplier, for these companies. And so you might have also, you know, who do they buy stuff from?

I'll just mention one here, which is ASML, if you're not familiar with them, they make the machines that make the tiny chips possible. And so, and we'll get into that possibly on another, another episode. But Taiwan Semiconductor purchases their machines. They're, they're able to etch very small, things, into these chips, with their technology again for, for another show.

But just so you know, you know, who are they buying from? What are the things that they're producing? The GPUs, for example. And Nvidia, we've talked about that company before. And the output is Nvidia. So let's dive in, to the overall business here a little bit further. Again, they are a, manufacturing facility, a fabrication facility for chips for those types of clients.

And specifically we mentioned, their top clients. And so what type of revenue do they do? They have so they have very significant revenue. And so you're you're in the billions of dollars here. So $2 billion in, in revenue for, the last 12 months. I'm sorry, more than that. And, and again, this is an enormous business.

The market cap is $27 billion. Probably should have started there. Oh, and so a very large business. And so why is this business important to us? Well, if you think about what is sort of the linchpin, in, in the global supply for chips, it really is Taiwan Semiconductor. And you really have to think about, Taiwan Semiconductor and its position in the world.

Now, this could be a big problem if there are disruptions. And because of the tensions between China and the US, as an example, people have grown concerned about this being the single source for so many, you know, of the technology or so much rather of the technology that's coming, out of there. That's for the world, and for things that are up to and including all the things that happen with artificial intelligence.

There's a heavy reliance on that and that that is a huge problem. And so, you know, what are we thinking about in the future? Well, we have to think about, you know, diversified supply chains. If you're, you know, a US, company, if you're the US government, that's going to be something important to you. So you really have to think about.

Okay, well, is there a way for us to think about this and get these redundant, supply chains, happening, in, in other parts of the world? Well, they're bringing those facilities, some to Arizona, as an example. And that's super important. The chips act, you know, possibly made some of that happen. Possibly not. Depends.

We'll see how that all plays out. If you followed some of the politics. So again, a very important company, a strategic company, but a company, that's based in Taiwan but now opening facilities, in that so market cap, you know, closing in on $1 trillion. Get back to the numbers here. $840 billion market cap. So very large company, revenues of $82 billion in the last 12 months through September of 2024.

So very significant, growing at 20%, almost 19%, year over year, their gross profit margins. And you talk about the company, you know, almost 55%. So very good there and very high net margins of 39%. So for a company that's a manufacturing company that produces chips for other people having this high gross margins and this high net margins makes it a very special business.

And again, the reliance on Taiwan Semiconductor from the likes of Apple, Qualcomm, Nvidia, which is the hottest, you know, name to talk about in the semiconductor world. And especially when you talk about AI, they are central to all of this happening. And people do get concerned about okay, we're overreliant on this one company, but it shows you the importance of this company.

Now, this is a position in our portfolio for the GW investment into not a huge position, but it's certainly something that we need to think about because this is the global supplier for chips for people that their designed their chips but don't produce their chips. And in some case, you know, for even people that actually produce their own chips.

But it's really important, I think as an investor, as an analyst, it's important to understand this business because it is so critical. So when you we're walking through the business segment of this, it's important to get a handle on the numbers. But it's also important to get a handle on their their business model. They manufacture these chips and they do not compete with their clients.

So you will not see in the market unless management changes this, a chip that Taiwan Semiconductor produces for itself and its brand, it's producing it for its clients. That's an important distinction in the business model. And I think that engendered this very strong relationship between the designers like Apple and Nvidia, and Qualcomm and Taiwan Semiconductor. So that relationship, is very significant, and is very tight.

So, something to think about on the business side. So let's now move on, to the management. C-suite is the CEO and the man. And so back to the business for one second. So scoring it right now, if you look at the business, with those gross margins and then that margins that we talked about, you know, you're talking 55, and that margins of almost 40 right now closing in on 40 for a manufacturing company.

Really fantastic. And growing, 19% and projected to grow 27, in 26 and 20, you know, and by the end of 24 and, by the end of 25, for those years, respectively. So that's a great business. But given the geopolitical risks around, Taiwan, it's something that has to be, considered as part of this calculation.

So, again, with sort of the revenue growth, with its unique position in the market, with its business model and with these margins in the business and the demand that's coming, from the rest of the world for more and more, semiconductors and especially, from the demand from I well, you have to give them somewhere between an eight and a nine right now, even considering the political risks, geopolitical risk, because, they are a linchpin in this system, they're not to be, lost.

All right, so we move on, to the management team. So the management team has been doing a fabulous job, and we're really not going to, talk, you know, go in depth here on the management team. But CC Lee, is, we is the is the, chairman and CEO. This is a fabulously run company.

So when you talk about, for example, the capital allocation, you've had a strong dividend that's come out of Taiwan Semiconductor because the price, has gone up considerably. You're talking about a 1.4%, dividend yield. But they have been sensational in growing the business, investing in the business, always being on the forefront of the new technology.

Also likely another episode that we'll do is diving a little bit into the technology, but they are on the forefront that the three nanometer, and getting smaller and smaller all the time. This is super important. And then why have they been able to lead on this? It's because they continuously invest in their manufacturing facilities. They're always on the front of this.

And this is where the criticism, and Pat Gelsinger just stepped down from Intel, where we're at the beginning of December here. This was part of the criticism from Intel that they could not keep up with Taiwan Semiconductor, as the chips got the demand, for smaller and smaller, you know, fabrication became more and more important to fit all these transistors, for all this, you know, technology to run, at the speeds, and efficiency that everybody wants.

Well, Taiwan Semiconductor has been investing, in their facilities has been investing and their people and their talent to produce these things. And so you have to absolutely. On the capital allocation side, where, you know, where this company is growing organically, and where they're investing in their people, where they're investing in their, research and, and development and their facilities.

You have to give the management high marks on that. And so, I think for now, and for paying a very steady dividend, and again, because the price has been up considerably, you're at one even then you're at 1.4%. So there's probably some people that have actually owned this company, for the dividends, because it has been, so strong and it's grown 11%, over the last five years.

So even if you are just owning this as a dividend company, it has been a very strong company for you. And so you, you have to really think about the management, in that 8 or 9 category, because they're so strong and they have been doing so well. They definitely get high marks here. So in the capital allocation, it is an A+.

Investing in their facilities, investing in their people, making sure they're on the forefront of of technology for their clients. And again, that's integrated with their business model, thinking about how management approaches their business model and their tight connection with their clients, not competing with their clients. Super important. Shout out to overlook, who was on this case, long ago.

So congratulations. Overlooked for for finding this, you know, well, in advance of many other people. So management gets super high marks on that. So now let's move on to the balance sheet. So obviously important to think about the balance sheet here. Oh sorry. The valuation. So move on to the valuation first. Excuse me.

And then we'll get to the balance sheet. So this company's not cheap though. And the valuation has crept up over time. So it's trading at 20, you know, nine times effectively right now. Forward. You know, that's not cheap. That's kind of a little bit higher, maybe a slight premium right now. We're right on top of the S&P 500.

So not a crazy premium. And certainly for a company with its metrics. That's not a huge premium. Now you do possibly have to think, well are these margins sustainable for this type of company. It's a manufacturing company. Can they keep these margins up? Well, the the underlying demand has to stay strong. It looks like for the next few years, if you use just the baseline projections, the demand is going to stay strong.

And so you have to think about well should we be paying up for this. Is that going to materialize? What are the risks. The geopolitical is that going to have, you know, some impact on revenue, on growth? Are those concerns going to actually materialize into real problems for the company? Obviously, you know, predicting the future is, fraught with, problems, especially when it's about the future.

So this is hard to know. However, this is not a ridiculous valuation for this, such a great company that, you know, you would say in 8 or 9 for the business, in 8 or 9 for the management team, possibly give this maybe a 6 or 7 on the valuation. Really not, you know, fantastically cheap company. But, you know, when, you know, a company is high quality, the market knows it too.

And the market says, hey, this company is worth paying up for. And right now it's not trading at a huge premium or anything to the S&P 500. So is this company better than the average S&P 500 company? I would argue very strongly that it is. So you could possibly say at this valuation it's fair. It's not overly expensive.

It's not cheap. It's possibly a fair valuation. But Buffett says we would rather, you know, buy a great company for a fair valuation, that that's kind of where Taiwan Semiconductor is right now and paying a 1.4% dividend. While you wait around, now, is that enough compensation to take on all the geopolitical risk? Well, Buffett had bought some Taiwan Semiconductor to talk about Buffett again, and they sold, all of it or most of it.

And so that is, obviously maybe the concerns. I didn't speak to Buffett directly. Happy to take your call. If you're if you're open to talk. Buffett but it looks like that maybe weighed on their decision. And maybe Todd and Ted are part of that decision as well around, you know, the risk are really not, you know, fully addressed, in the valuation, not fully addressed, you know, not being compensated for taking on that risk by owning, the shares here.

So we'll have to see that's important. But the valuation I would call, you know, on the low end, maybe a 5 or 6 or something like that. So again, fair valuation. So 5 or 6 on that. So let's head on to the balance sheet. So let's really think about that. And then once we get to the balance once we cover the balance sheet we'll kind of talk through all the pieces again before we wrap up.

So let's move to the balance sheet. You're talking about cash of about $68 billion, and $32 billion of debt. So you got net cash on the balance sheet? You're really not super concerned right now. There is not a real issue. And they're generating $27 billion in free cash flow. So you're looking at the balance sheet.

Strong cash position. Strong free cash flow. Net cash. Really not an issue. Right. And even if interest rates go down, the cost of that's likely to go down even further. So on the balance sheet, you're you're kind of a nine, very solid. You could even say ten with net cash and generating 27 billion in free cash flow.

Not really worried we could sleep at night with all this money in the bank. So net cash generating 27 billion in cash. Not, you know, almost all of the debt, 32 billion in debt can be generated in one year free cash flow. If it becomes a real problem and you have net cash again, if you had to pay it off today.

So not necessarily concerned about that. So you're giving the balance sheet a nine. So now let let's pull it all together. And let's really think about this or try to think about this more holistically. So when you're talking about Taiwan Semiconductor and you talk about again the business who are their clients. Their clients again are Apple, Nvidia, MediaTek, Broadcom, Qualcomm, AMD, Intel.

These are big players right? These are people that need to buy, a lot of chips from them, to supply for example, Apple on the phones for for Qualcomm. They're chips that go into phones for Nvidia. All the GPUs that they are producing for the world. And all the people buying these to set up all these training center AI training centers, Taiwan Semiconductor is supplying all of these people.

So do they have good customers. When we talk about the business, they have great customers. Do their customers have cash? Most of their customers are also in a net cash position and growing. And by the way, which of their customers would like to lose the I raise the answer is none. None of those companies would like to lose that race, and so unlikely that the demand in the short term is going to subside.

Now, there could be some segments of the business that could fall by the wayside. There could be some slack in demand for CPUs. You know, that's not necessarily connected to building out the big data centers. Maybe there's a slowdown in the PC market, for example, the laptop market, the refresh maybe is a little bit slower right now so that the number of chips that they're going to produce that go into those markets might be slower, but it seems like more is made up on the demand from AI and the push from the clients around that.

You think about the iPhone coming out, the 16, you know, with the new chips that go into that, that's likely going to be a big push, right? If there's a big refresh cycle that's going to be a big win for Taiwan Semiconductor and so on. The business model, they don't compete with their clients. Those clients that I mentioned are called fabulous because they don't have fabrication facilities.

They design these chips. And Taiwan Semiconductor owns those fabrication facilities, principally and especially the most high-tech ones in Taiwan. And again, that's why people are concerned on the geopolitical side. But they're moving some facilities to the US, namely in Arizona. But those take time to build, their manufacturing those chips, and supplying the world.

So far it's been a really great business model. They've been doing super well. And again, when you talk about the revenue and 82 billion, just to recap, they're almost 83 billion last 12 months September 30th, 2024. You're talking about gross margins of 55%, nearly an almost 40% net margin. So this is a fabulous business. You factor in the geopolitical risk that makes it a tougher business.

So something to think about. But again, as an analyst thinking about the broader world and all the things that are happening in business, you have to think about technology. You have to think about what's going on in AI. Taiwan Semiconductor is a company that you should understand even if you're not going to own it, but especially if you're going to own it.

What's its position in the world? How is it supplying these other great companies like Apple, like Nvidia, and like Qualcomm? You got to think about the connections there. What's the connective tissue? Why is this company important? Well, it is the principal supplier to all these fabulous chipmakers. And so really thinking about that again, strong business.

You're talking 8 or 9 on the business side and maybe you ding it down one to a 7 or 8 because of the geopolitical risks in the world. Next up again, the management, fabulous 1.4% dividend yield, capital allocation, reinvesting its facilities, protecting those margins. It's done a great job keeping up with the cutting edge of technology, which they have done in spades.

So congratulations to them. That's an 8 or 9 right there. You move on. Again, to the valuation, 28 times forward earnings. That's not cheap. It's not expensive. It's a fair valuation. As Buffett said, I'd love to buy a great company at a fair price than vice versa. So, right now, you know, you're kind of there but Buffett did buy and sell this company.

So maybe there's something that we're missing that we should be concerned about, the geopolitical risks included. So we have to consider that. So I would call it a fair valuation to slightly lower. So 5 or 6 on the valuation and back to the balance sheet. Then to wrap it up, you're talking about, you know, net cash in the balance sheet, 68 billion in cash, 32 billion in debt generating 27 billion in free cash flow.

We can all sleep at night with that type of balance sheet. Not concerned. That's an 8 or 9, possibly even a 10, depending on how you want to call it. So overall, you're talking about a company that's, you know, you can, you know, if you really, you know, get conservative. You're talking about an 8 or 9 for this company.

Right. Depending on how you score each of the components. But let's say it's an eight and a half overall. Let's get maybe a little bit aggressive here. The geopolitical risk is real. It's something that we have to think about. But at an eight and a half for a company that is critical to supplying the next wave of AI and that's doing it currently, this company is it: Taiwan Semiconductor.

So I encourage you as an analyst to pay attention to this company, even if you don't own it. Certainly if you own it, you should be paying attention to it. Our analysts definitely at the Investment Institute will be doing that. I think it's a fabulous company to try to understand and understand the broader world of semiconductors by understanding Taiwan Semiconductor.

That's where we'll leave it today. We'll wrap it up with that. So thank you very much for tuning in. We'll look forward to seeing you on the next episode of Market News with Rodney Lake. Thank you.

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