A detailed analysis of Buffett's Taiwanese investment in semiconductors

As you've probably all noticed, Berkshire Hathaway invested an estimated $4.1 billion in Taiwan Semiconductor Manufacturing Co. during the third quarter. Here's everything you need to know about Buffett's latest bet on the Taiwanese chipmaker.

TSMC

The chip shortages that held back supply in 2020 and 2021 are starting to ease as falling demand for consumer electronics and a solid year of production from semiconductor foundries in Asia have begun to rebalance.

We all know Buffett says he doesn't invest in businesses he doesn't understand. He may have missed opportunities, but no doubt he also saved himself losses. Interestingly, the technology sector now accounts for three of Berkshire's top 10 businesses. In the third quarter, Apple was the largest holding with a value of about $123 billion based on average stock prices for the quarter, followed by Bank of America, Chevron and Coca-Cola, while game developer Activision Blizzard and Taiwan Semiconductor $TSM+0.4% itself are also among the top 10 businesses. Smaller stakes in tech companies Amazon and Snowflake are also not missing.

https://youtu.be/vs82xjE9Obk

Theacquisition of Taiwan Semiconductor stock represents an entry into the supply chains of U.S. technology companies. Taiwan Semiconductor makes semiconductors for Apple as well as Amazon Azure cloud servers. It seems like a way to make a bigger bet while diversifying some risk across names.

Buffett's semiconductor history

Buffett has invested in semiconductor stocks before. Most notably, he bought large stakes in Intel in 2011 and 2012, though he didn't hold the stock for long. Intel was once a leading semiconductor manufacturer, but in recent years it has fallen behind competitors because Taiwan Semiconductor can make chips more cheaply and efficiently.

A strong competitive advantage

Buffett is known to favour companies with a sustainable competitive advantage. Taiwan Semiconductor is the world's largest chip maker, according to Statista, and accounts for 54% of the net foundry market. Next are Samsung with 17% and United Microelectronics with 7%. Samsung is thus the only comparable foundry of similar scale.

Taiwan, China and South Korea together account for around 87% of the global foundry market in 2021

TSMC's competitive advantage is its speed of innovation, low production costs and high barriers to entry. It can produce chips that are more advanced than those from competitors, provide them in larger quantities, at lower cost and is well insulated against new players.

Pace of innovation. TSMC has proven to be at the forefront of chip innovation. The company has an incredible pace of innovation and is the leading chip maker for every new version of the iPhone. For example, the chips for the iPhone 12 were based on the 5nm node that TSMC produced and it is producing the A15 chip for the iPhone 13. TSMC can now produce 3nm chips. By comparison, Samsung can currently produce a 3nm chip but with lower capacity, while Intel can only produce even less advanced 7nm nodes.

Low cost manufacturer. To compete in the semiconductor industry, companies need the ability to produce chips at the same price or cheaper than the rest of the industry. Foundries cost around $10-20 billion to build, so there are huge depreciation costs associated with producing them. Companies need to run their foundries at full capacity all year round to make the foundries profitable and to generate enough cash flow for growth and development. TSMC has the world's largest 5nm chip production capacity, giving it a low-cost competitive advantage.

High barrier to entry. Foundries cost around $10-20 billion and take 3 to 5 years to build. In addition, the time and resources needed to create the next generation of chips take years and a huge amount of manufacturing expertise. Even if a competitor was incredibly well funded, it could not produce the same advanced chips at the scale that TSMC has done overnight. While competitors are struggling to move to the next generation of chips, TSMC is already one step ahead in producing a chip that is even more advanced.

TSMC's scale and high-quality technology allow the company to generate solid operating margins. The company has a renowned customer base, including Apple, AMD and Nvidia, who are looking to apply cutting-edge process technology to their semiconductor designs.

Geopolitical risks

TSMC's leading position makes it the object of geopolitical intrigue between the US and China. On the one hand, the US supports the one-China policy, but on the other hand it supports Taiwan with arms and technology and has long since signed a pact to protect Taiwan.

From a geopolitical point of view, the following risks now hang over TSMC:

  • At the 20th Party Congress, Xi Jinping did not reject a military solution to the annexation of Taiwan, although he did identify peaceful reunification as a more desirable option. China could also develop an economic blockade of the island by blocking Taiwan's ports. In that case, TSMC technology chips would not be able to be shipped from the island.
  • The US has tightened restrictions on technology exports to China and imposed a ban on the sale of semiconductors (based on US technology) to the PRC without special permission.

Currently, three companies - Samsung, SK Hynix and TSMC - have received one-year permits from the US Department of Commerce. All these companies have plants in China.

TSMC has a plant in Nanjing that produces 16nm chips. This plant is the most technologically advanced semiconductor manufacturing plant in China. The US approval will allow the Nanjing plant to expand production to 22/28nm process technology.

TSMC's dividend policy

Taiwan Semiconductor also has a solid dividend stock. The stock currently yields 2.21%, which is slightly higher than the market average and well above the yield of many other semiconductor companies. Taiwan Semiconductor's annual payout has fluctuated over time as the company cut its 2020 payout slightly during the COVID-19 pandemic, and its 2022 payout will also be slightly lower than last year. However, the company has paid a dividend for 17 years in a row, and the long-term trend in terms of its dividend payout is up and to the right - the annual payout is now nearly five times higher than the $0.49 per share it paid 10 years ago in 2012. Taiwan Semiconductor's dividend also looks relatively safe with a dividend payout ratio of 33%.

Conclusion

Geopolitical risks have driven down TSMC's share price given the company's financial results have shown steady double-digit growth. The company's long-term outlook is positive and the company itself is a key player across the semiconductor chip industry. TSM currently offers a discounted valuation that is 14 times next 12 months earnings estimates.

Source: Guru Focus, Yahoo Finance, Seeking Alpha, Value Investors Central, Fool

DISCLAIMER: All information provided here is for informational purposes only and is in no way an investment recommendation. Always do your own analysis.

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