Sony’s Playstation, GM, Ford and Tesla are just some of the high-profile casualties hit by the semiconductor shortage currently plaguing the world’s technology industry.
The demand for semiconductor chips has been dramatically increasing over the past two decades due to digitisation. Then in 2020, COVID-19 saw the acceleration of trends such as e-commerce and cloud computing that has further driven demand.
Semiconductors are in all the smart devices we use, including the one you’re currently using to read this article.
They are small, yet powerful silicon substrates that can contain billions of transistors in which enable the transmission and computation of signals that make electronics do what they are designed for.
Understanding leading-edge semiconductors
When considering investing in semiconductor stocks, investors should distinguish between leading-edge semiconductor foundry manufacturers and the rest. If you’re interested in geeking-out on semiconductors, Semico Research and Consulting Group provides a great overview of the technical aspects that differentiate leading-edge and ‘the rest’ in this article.
At a very basic level, there are three types of semiconductor companies.
- Companies such as IBM that design and manufacture “trailing-edge” chips and other non-leading devices.
- Semiconductor companies such as Qualcomm and Meditek that design and sell leading-edge chips but outsource their fabrication to foundries.
- Companies that own and operate manufacturing plants (known as foundries) capable of manufacturing leading-edge semiconductors for specialist semiconductor designers and big tech firms.
The third is the focus of this article.
What’s important for investors is that demand for leading-edge semiconductors – the smallest and most powerful chips – is skyrocketing.
Much of this demand is coming from innovation in areas such as artificial intelligence, autonomous and smart vehicles and the rise of 5G internet.
Currently there are only two companies in the world operating foundries for the fabrication of leading-edge semiconductors. Both are Asian multi-nationals.
These companies are contracted to fabricate leading-edge chips not only for big tech such as Apple, but also for other semiconductor chip designers such as Qualcomm and Nvidia.
Taiwan Semiconductor Manufacturing Company (TSMC)
TSMC (TPE:2330) is undoubtedly the world’s most powerful and influential leading-edge semiconductor foundry operator.
All of the semiconductor chips inside Apple iPhones and MacBook computers are fabricated at a TSMC foundry. Some of TSMC’s other high-profile clients include Marvel, MediaTek and Advance Micro Devices (AMD).
One major investment fund bullish on this Taiwanese semiconductor giant is Antipodes Partners, which has offices in London and Sydney.
“TSMC has grown its sales by around 14% per annum for the last 15 years – three times faster than the overall industry,” says Antipodes Portfolio Manager, Alison Savas.
“Looking forward over the next one to two years, we see TSMC valued at around 20x earnings, but where the business is compounding those earnings at over 20% p.a.”
“What’s great about investing in a business like this is you’re making a longer-term play on the ongoing digitisation of modern economies as opposed to taking a bet on which individual tech companies will be the future market share winners.”
Antipodes has published this chart, which illustrates just how dominant they expect TSMC to be in the years ahead.
The other leading-edge semiconductor manufacturer to watch is Samsung (KRX:005930).
Along with producing leading-edge semiconductors for its own devices, Samsung’s foundries also fabricate chips for clients such as Qualcomm, Nvidia and IBM.
The Samsung Foundry division has the disadvantage of not being an independent foundry operator like TSMC (smartphone competitors like Apple would not contract Samsung), however the Korean behemoth is aggressively trying to win market share from TSMC and analysts expect further investment.
“We do expect Samsung and other foundries to continue to expand over the coming years to cater to the ongoing demand and I think demand is just going to continue to rise. If we look at the automotive sector as well, with the autonomous electric vehicles – the amount of semiconductors that goes into each car is just going to rapidly increase,” said IDC Asia Pacific senior research manager, Kiranjeet Kaur in a recent interview with Bloomberg.
“Even if we look at smartphones and PCs the amount of semicondutor that goes now into these devices is much higher than it was in the past so with this increased demand, I think the investment into capacity expansion is going to rise.”
Competition for these Asian semiconductor stocks?
With such favourable supply/demand tailwinds currently supporting TSMC and Samsung’s foundry operations, there is no doubt that competitors will emerge.
In the U.S. the Biden administration – concerned about Asia’s dominance in the space – has proposed a US$50 billion investment into semiconductor manufacturing and research on its home soil.
At a virtual CEO summit this week, President Biden held a semiconductor wafer while emphasising the need for investment in foundries to sure up the U.S. economy (you can read a full transcript of his speech here).
“Chips, like the one I have here — these chips, these wafers, are batteries, broadband… it’s all infrastructure. This is infrastructure,” said the President.
“So, look, we need to build the infrastructure of today, not repair the one of yesterday. And the plan I propose is going to create millions of jobs, rebuild America, protect our supply chains, and revitalize American manufacturing. And it’s going to make America research and development a great engine again.”
However, the costs and time required to build leading-edge foundries is significant. Any real development in the U.S. would likely take years.
Mckinsey puts the cost of building a facility capabile of producing leading edge semiconductor at around US$5.4 billion.
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