TSMC’s Q3 revenue beat forecasts amidst AI boom

Taiwan Semiconductor Manufacturing Co. (TSMC) reported strong financial results for Q3 2023:

• September sales reached NT$251.87 billion ($7.82 billion), a 39% year-over-year increase
• As per Reuters calculation, Q3 revenue totaled NT$759.7 billion ($23.6 billion), surpassing analyst projections of NT$748 billion
• This performance indicates ongoing demand for high-tech chips, driven by the artificial intelligence (AI) boom

Uncertainty Around Future AI Demand

While TSMC’s quarterly performance has been robust, there are differing views on the long-term sustainability of AI-driven demand. There are concerns that AI companies such as Meta, Google, Microsoft may not continue their heavy infrastructure investments if AI use cases do not become more monetizable. These concerns have contributed to recent pullbacks in AI-related stocks, including Nvidia.

However, in July, TSMC revised its 2024 revenue growth outlook upward, indicating confidence that AI infrastructure spending will remain high. The company has doubled its revenue in the last 4 years.TSMC’s market capitalization briefly exceeded $1 trillion earlier this year, driven by the surge in AI demand.

TSMC’s Global Footprint and Market Share

Founded in 1987 and headquartered in Hsinchu, Taiwan, TSMC has grown into one of the world’s leading semiconductor manufacturers. In 2023, TSMC produced 12,000 different products for 528 clients worldwide, demonstrating both the breadth of its capabilities and the depth of its customer relationships.

TSMC’s market dominance is evident in its 62% share of the global semiconductor foundry market as of the second quarter of 2024. This leadership position has allowed TSMC to benefit significantly from the AI-driven demand surge, with its stock price rising over 87% in the past year.

Geographically, North America stands as TSMC’s largest market, accounting for 65% of its revenue. China follows as the second-largest market at 16%, with the remaining 19% distributed across other regions including Asia-Pacific, Europe, and the Middle East.

The Foundry Model

TSMC’s success stems from its foundry model, a business approach now adopted by other semiconductor manufacturers. Unlike companies that produce chips for general sale, TSMC operates as a contract manufacturer, producing chips tailored to the specific needs of its clients. This model allows TSMC to serve a diverse range of industries, creating chips for smartphones, cars, graphics processing units (GPUs), and numerous other technologies integral to daily life.

The foundry model proves particularly advantageous in the current tech landscape. As global tech companies increasingly seek to develop their own custom chips, they turn to TSMC for manufacturing. While these companies may have the resources to design their chips in-house, the complex and capital-intensive nature of chip manufacturing makes outsourcing to specialized foundries like TSMC an attractive option.

TSMC’s Role in the AI Revolution

The global race to develop AI services has altered TSMC’s business dynamics. Previously, TSMC’s business was heavily influenced by a handful of top customers, with cyclical sales often tracking new product launches from major clients like Apple. However, the AI boom has diversified TSMC’s customer base and stabilized demand.

An increasing number of cash-rich clients now require a steady supply of chips as they upgrade data centers and integrate AI functions into their products. Apple incorporates AI capabilities using advanced chips in its latest laptops. Mobile chipmaker Qualcomm recently announced a chip for laptops with features to run Microsoft AI services. TSMC also manufactures chips for Nvidia’s closest competitor, Advanced Micro Devices (AMD).

Moreover, tech giants like Google, Microsoft, and Amazon are all developing custom processors, either for sale or internal use. This trend translates to more orders for TSMC. These advanced chips, using 7 nanometer and below technology, account for two-thirds of TSMC’s total sales and represent high-margin products. The high-performance computing business, which includes chips for AI applications, now makes up nearly half of TSMC’s total revenue.

TSMC’s position in the AI chip market seems secure, especially as more companies seek to produce their own AI chips to avoid the high costs of Nvidia’s GPUs. More companies are opting to work directly with foundries to produce their own AI chips, aiming to bypass high-cost suppliers like Nvidia, which charges over $30,000 per unit for its latest AI GPUs. For instance, ByteDance, the owner of TikTok, has recently partnered with TSMC to manufacture its own AI chips. This shift not only presents an opportunity for TSMC to gain incremental revenue and enhance gross margins through custom chip production but also allows the company to diversify its customer base

Challenges and Uncertainties

Despite TSMC’s strong performance and optimistic outlook, the company faces several challenges and uncertainties:

1. Sustainability of AI-Driven Demand: While the current demand for AI chips remains robust, questions arise about its long-term sustainability. Some investors worry that major tech companies may scale back their infrastructure investments if AI applications don’t become more readily monetizable. These concerns have contributed to recent fluctuations in AI-related stocks, including TSMC’s clients like Nvidia.
2. Geopolitical Risks: TSMC’s production capacity remains heavily concentrated in Taiwan, with 80-90% of its manufacturing occurring on the island. China’s claims over Taiwan and increasing military exercises in the region pose a significant risk to TSMC’s operations and global supply chains.
3. Market Dynamics: The semiconductor industry’s cyclical nature means any signs of weakening demand or declining pricing power could impact TSMC’s financial performance. The company must navigate these cycles while continuing to invest in advanced technologies to maintain its competitive edge.
4. Customer Concentration: While TSMC has a broad customer base, it still relies heavily on a few key clients. For example, Apple, TSMC’s largest customer which contributed more than a quarter of TSMC sales, has recently experienced weaker-than-expected demand for its latest iPhone series. Such fluctuations in major clients’ performances can significantly impact TSMC’s revenue.
5. Competitive Pressures: Although TSMC currently leads the market, competitors like Intel and Samsung are investing heavily to catch up in advanced chip manufacturing. TSMC must continue to innovate and improve its processes to maintain its technological lead.

Future Outlook and Strategies

TSMC has revised its 2024 revenue growth outlook upward, signaling confidence in sustained demand for its advanced chips. To address some of the challenges it faces, TSMC is pursuing several strategic initiatives:

1. Technological Advancement: TSMC continues to push the boundaries of chip manufacturing technology. The company is working on accelerating the mass production of 2-nanometer chips, which would further cement its technological leadership.
2. Capacity Expansion: To meet growing demand and mitigate geopolitical risks, TSMC is expanding its manufacturing footprint beyond Taiwan. The company is building new fabrication plants in various locations, including the United States, to diversify its production base.
3. Advanced Packaging: TSMC is also expanding its capabilities in advanced chip packaging technologies. This move could open up new growth opportunities and further differentiate TSMC from its competitors.
4. Diversification of Customer Base: The AI boom has already helped TSMC diversify its customer base beyond traditional smartphone and consumer electronics manufacturers. The company continues to court a wide range of clients across various industries to reduce its dependence on any single market segment.

As the AI revolution continues to unfold, TSMC’s performance will likely remain a key indicator of the semiconductor industry’s health and the broader tech sector’s trajectory. The company’s ability to navigate geopolitical tensions, cyclical market dynamics, and intense competition while continuing to push the boundaries of chip manufacturing technology will shape its future in the industry

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