How do you make chips when you don't have any factories? Ten years ago, that question was merely hypothetical. All major chip companies, from Intel on down, handed contract work to their own fabrication plants, or fabs. Since then, a rash of fabless chip companies have emerged. They design a chip, find someone else to manufacture it, and then market the product.
It's a great business model: enjoy the high profit margins of selling chips without expending the enormous capital that it takes to build a fabrication facility. According to an April survey by the Fabless Semiconductor Assn., the revenues for fabless companies rose 68% in 2000. That contrasts with a 36.8% annual revenue growth figure for the semiconductor industry as a whole in that same year.
The only problem is finding someone to make quality chips for you. That's where Taiwan Semiconductor Manufacturing Co. (TSM
) comes in. Ten years ago it was a sleepy, low-cost maker of chips for integrated-device manufacturers such as Hewlett-Packard (HWP
) and Texas Instruments (TXN
). TSMC would make chips for these companies when their orders outstripped their capacity.ENTER THE FOUNDRY. But with the emergence of fabless chip companies, TSMC introduced a new business concept to the industry: the chip foundry. Last year TSMC, the leader in the field, had revenues of more than $5 billion, up 120%, from 1999 revenues of $2.27 billion. Its customer list is a veritable Who's Who of hot chip companies that eschew factories: Altera (ALTR
), Nvidia (NVDA
), Broadcom (BRCM
). TSMC produces every type of chip imaginable, from DRAM (dynamic random access memory, used in PCs) to CPUs (central processing unit, the main brain of a computer), to communications chips.
The company keeps costs extremely low while maintaining operating profits in the 35% range. Remember, this is no simple manufacturing process. Even the most basic chip goes through as many as 150 separate complex processes before it is finished. "They have perfected the art of making chips to such an extreme that almost no one else can do it as quickly and as error-free as they can," says Manoj Nadkarni, principal analyst of ChipInvestor.com. From its humble beginnings, TSMC now has a market capitalization of $47 billion and has increased revenue at an annual rate of 50% or greater for the last five years.
That's not to say the company is home free. Like all technology companies, it has been hit hard by the economic slowdown. Its plants are now running at only 40% of full capacity, a historic low for TSMC. That's due primarily to the slump in the chip cycle.LOSING LESS. On the bright side, TSMC's production schedule looks a lot stronger than those of most of its rivals. Chartered Semiconductor (CHRT
), a Singapore-based company that's the world's third- largest chip foundry is using 30% of its plants' capacities, for instance. That's because Chartered, unlike TSMC, has a much higher percentage of integrated chip companies as customers. Those companies are using their own plants to manufacture what few chip orders they're getting. And while TSMC isn't running at full-tilt, it's losing far less money than its competitors.
Another problem: TSMC's low-capacity utilization is affecting the company's ability to expand. At the beginning of this year, TSMC founder Morris Chang expected to spend $3.8 billion on building new plants and upgrading existing ones -- an ambitious capital-expenditure plan. After several downgrades of that plan, the 2001 bill has fallen to $2.9 billion. That means when the chip cycle takes an upward turn, TSMC will be that much less prepared for it.
An upturn will come -- the question is when. Right now, DRAM prices, the best forward indicator for the chip cycle, are close to all-time lows. An average wholesale price for a 128 Megabyte DRAM chip is about $4. At the end of 2000, that same chip cost as much as $6.50. But as DRAM manufacturers throughout the world shut down plants and stop building new ones, the excess supply should dry up within six months.
TSMC hopes the PC cycle will have started its upward turn by then, as computers featuring Intel's new Pentium 4 chip will start appearing. When that happens, the chip cycle will officially be out of its doldrums, and Taiwan Semiconductor should be feeling happy. It the upturn is delayed, then that would mean more suffering for TSMC shareholders.TEMPTING NOW. Analysts expect the company to make 2 cents in earnings per share in the second quarter, which ends in June, on about $1 billion in revenue. That's a 95% drop from the same quarter last year, when the company made almost 35 cents per share, but it's still a profit in undeniably hard times. And for the entire year, analysts expect the company to make 29 cents per share, compared to 92 cents in 2000.
"It's a very profitable, well-run company," says Thomas Weisel Partners' Eric Ross. "It's hard to believe that you'll find a time when you can find it for a cheaper price than now." TSMC's stock price of around $20.50 is touching on all-time lows. Compare that to the beginning of 2000, when the chip cycle was near its top and TSMC's stock price reached $72. Despite his praise for the company, Ross has a hold rating on the stock.
If you subscribe to the investing discipline of buy low, sell high and want to catch the chip cycle on the low side, then now is the time to be investigating TSMC. Also, shares in the company could serve as a stand-in for the entire semiconductor industry, says Ross. "It has the effect in your portfolio of buying a semiconductor mutual fund, rather than just another stock," he points out.
All reasons why gutsy contrarians might want to strike while TSMC is down. By Sam Jaffe in New York