Here to stay: Implications and opportunities from Taiwan’s semiconductor edge

Taiwan’s dominance of the global semiconductor foundry industry comes from decades of intentional policy design and private sector entrepreneurship. The winner takes all dynamic within the industry has helped Taiwan develop a thriving eco-system which presents attractive opportunities for the active investor.

Over the past two decades, the mobile phone evolved from being just a mode of communication to today’s personal information platform. Consumers’ increasing demand for more safety, entertainment and navigation features also helped drive a cross generational transformation in the automobile’s interior and control system. The semiconductor chip or Integrated Circuit (IC), the brain behind every electronic device, has been key in enabling these changes.

Thanks for subscribing!

Follow us :

Taiwan’s chip edge is here to stay

Semiconductor chips are manufactured in a foundry, which is also known as a fabrication plant or fab. Taiwan, South Korea and China account for more than 90% of the global foundry1 capacity. The global Semiconductor Foundry market was valued at USD42 billion in 2020 and is expected to reach USD62 billion by 20262. Taiwan by itself controls more than 80% of the market for chips with the smallest and most efficient circuits.

Taiwan’s dominance of the global foundry industry comes from decades of government support, intentional policy design and private sector entrepreneurship. This dominance is unlikely to be easily chipped away (no pun intended). Taiwan’s semiconductor sector started in 1974, when the government was looking for a way out of the economic slump caused by the 1973 oil shock. Taiwan’s first 3-inch fab was built in 1975, and in 1980, Taiwan established its first commercial semiconductor company, United Microelectronics Corporation (UMC). At the start of 1990, the Taiwanese government was still undertaking a significant share (44%) of the Research & Development (R&D) spending in the semiconductor industry. By 1999, that percentage fell to 6.5% with the private sector starting to fund most of the research.3

Today it costs around USD3 to 4 billion to build a fab to produce the chips that car makers need4 but companies need to continue to invest heavily not just in capacity, but also in R&D to develop new technologies to stay ahead. Taiwan Semiconductor Manufacturing Company (TSMC), one of the world’s leading dedicated semiconductor foundry recently announced that it will invest USD100 billion to expand its chip fabrication capacity and address the growing demand for new technologies over the next three years. Even before this, TSMC was already mass-producing chips using the cutting edge Extreme Ultraviolet (EUV) lithography technology which enables it to make smaller and faster chips at a lower cost.

With the rate at which market leaders are innovating, new entrants run the risk of creating a fab that is already behind the technology curve at the point of launch. Due to the high costs, fabs are designed to run at close to maximum capacity to be profitable. New entrants need to ensure that there will be enough demand for their chips on the onset in order to reduce their payback periods. They would also need to collaborate with high tech suppliers such as semiconductor capital equipment manufacturers which may already have established relationships with existing market leaders. Currently, the top five semiconductor capital equipment manufacturers make up 70% of the semiconductor capital equipment market5.

Besides the prohibitive costs, talent is in short supply in the semiconductor industry globally today. In the early days of Taiwan’s semiconductor industry, R&D was largely carried out in the local universities as well as in the Electronics Research and Service Organisation (ERSO) of the Industrial Technology Research Institute. This laid a strong foundation for fostering the engineering talent needed for the industry. For the US and Europe, the shortage of skilled workers for their semiconductor industries is a result of decades of outsourced manufacturing to Asia, the lower number of students in science, technology, engineering, and mathematics (STEM), as well as impediments to high-skilled migration6.

According to McKinsey, the semiconductor industry’s record of steady technological improvement has created a winner-take-all dynamic that extends along the entire value chain, from equipment production to chip manufacture. From their analysis of the economic profit generated by 254 semiconductor companies from 2015 through 2019, the five companies with the largest average annual profit has a larger combined average annual profit than the other 249 companies7. Fig. 1.

Fig. 1. Average yearly profit of semiconductor companies, 2015 – 19 (USD billion)

here-to-stay-implications-and-opportunities-Fig-1

Structural trends drive chip demand

While the current semiconductor shortage is caused by the unexpected rise in cyclical demand for vehicles and the strong work from home demand for electronics, many of the drivers of chip demand are structural, driven by 5G, Artificial Intelligence (AI), ADAS, Electric Vehicles (EV) and Internet of Things (IoT) trends.

The sales of semiconductor chips is expected to grow at a compounded average growth rate (CAGR) of 10.7% p.a. over 2020-2023, almost double its CAGR of 5.5% during 2015-2020. Fig. 2. Demand for semiconductors should also rise as sales of 5G phones and investments in 5G infrastructure accelerate. Globally, the total investment in 5G infrastructure is expected to reach USD350 bn, 30% more than the total global investment in 4G infrastructure8. In addition, with the development of Advanced Driving Assistance Systems (ADAS), the value of semiconductors in each vehicle will increase from USD170 to USD12009. As a result of the rising popularity of EV, the EV-related segment of the automotive semiconductor market is expected to enjoy a compounded annual growth rate of 20% from 2020-2025.10 Meanwhile, the gaming sector’s demand for high performing semiconductor chips has also been rising as 5G, cloud, and virtual reality (VR) lifts innovation and create more immersive games.

Fig. 2. Global semiconductor sales (USD billions)

here-to-stay-implications-and-opportunities-Fig-1

Opportunities within the semiconductor eco-system

Taiwan’s leadership position in the semiconductor foundry industry creates a virtuous cycle – market leaders enjoy attractive margins and generate the cash flows needed to fund further R&D investments. Deep pockets and strong balance sheets are key as investments need to continue despite downturns in the industry. A leadership position in the semiconductor manufacturing industry has also created other industry clusters in Taiwan, including chip packaging companies as well as companies that supply substrates, lead frames and chemicals.

We expect the current chip shortage in mature nodes (used for driver IC, power management IC) to last longer than the advanced nodes (used for smartphones, AI, High Performing Computing etc). This is because the key players in the advanced nodes have aggressive capital expenditure plans for the next three years. On the other hand, capacity expansion in the mature nodes is expected to be more disciplined. Understanding these implications helps us to identify potential winners and losers. When assessing the foundries, we examine expected utilisation rates, quality of client base, depreciation policies, profitability and the technology gap versus their competitors.

Taiwan is not only home to Tier one foundries, chip packaging and IC Design companies, it also has other small and mid-cap companies within the semiconductor eco-system which can provide investors with attractive opportunities. As active managers, we benefit from the flexibility of investing in companies that may not be in the indexes or Exchange Traded Funds or in promising companies that still have small exposures within the indexes. We are on the constant look out to identify areas of new value creation within the eco-system in order to deliver alpha for investors. The ability to identify emerging technologies that will ultimately enjoy increasing adoption can produce outsized returns. This however can only be achieved through dynamic analysis, in-depth research and experience.

How to invest in Eastspring's fund(s)

Sources:
1 A foundry fabricates semiconductor chips using the designs of other companies
2 Mordoe Intelligence. Semiconductor Foundry Market – Growth, Trends, COVID-19 impact and forecasts (2021 – 2026).
3 Securing the future. Regional and National programs to support the semiconductor industry. Charles W. Wessner.
4 https://www.bloomberg.com/opinion/articles/2021-02-21/the-chip-crisis-a-new-fab-to-make-what-cars-need-will-cost-4-billion
5 BofA. Semiconductor Primer 2020: At crossroads of secular, geo-political, competitive forces. December 2020.
6 BofA. 2 June 2021. “Talent shortage amid tech competition”.
7 McKinsey and Company. Semiconductor design and manufacturing: Achieving leading-edge capabilities. August 2020.
8 JP Morgan. December 2020.
9 BofA Global Research. February 2021
10 BofA Global Research. Gartner. EV-Volumes. February 2021

This document is produced by Eastspring Investments (Singapore) Limited and issued in:

Singapore by Eastspring Investments (Singapore) Limited (UEN: 199407631H)

Australia (for wholesale clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore, is exempt from the requirement to hold an Australian financial services licence and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Australian laws

Hong Kong by Eastspring Investments (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.

Indonesia by PT Eastspring Investments Indonesia, an investment manager that is licensed, registered and supervised by the Indonesia Financial Services Authority (OJK).

Malaysia by Eastspring Investments Berhad (200001028634/ 531241-U) and Eastspring Al-Wara’ Investments Berhad (200901017585 / 860682-K).

Thailand by Eastspring Asset Management (Thailand) Co., Ltd.

United States of America (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is registered with the U.S Securities and Exchange Commission as a registered investment adviser.

European Economic Area (for professional clients only) and Switzerland (for qualified investors only) by Eastspring Investments (Luxembourg) S.A., 26, Boulevard Royal, 2449 Luxembourg, Grand-Duchy of Luxembourg, registered with the Registre de Commerce et des Sociétés (Luxembourg), Register No B 173737.

United Kingdom (for professional clients only) by Eastspring Investments (Luxembourg) S.A. - UK Branch, 10 Lower Thames Street, London EC3R 6AF.

Chile (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Chilean laws.

The afore-mentioned entities are hereinafter collectively referred to as Eastspring Investments.

The views and opinions contained herein are those of the author, and may not necessarily represent views expressed or reflected in other Eastspring Investments’ communications. This document is solely for information purposes and does not have any regard to the specific investment objective, financial situation and/or particular needs of any specific persons who may receive this document. This document is not intended as an offer, a solicitation of offer or a recommendation, to deal in shares of securities or any financial instruments. It may not be published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments. Reliance upon information in this document is at the sole discretion of the reader. Please carefully study the related information and/or consult your own professional adviser before investing.

Investment involves risks. Past performance of and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the funds managed by Eastspring Investments.

Information herein is believed to be reliable at time of publication. Data from third party sources may have been used in the preparation of this material and Eastspring Investments has not independently verified, validated or audited such data. Where lawfully permitted, Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.

Eastspring Investments companies (excluding joint venture companies) are ultimately wholly owned/indirect subsidiaries of Prudential plc of the United Kingdom. Eastspring Investments companies (including joint venture companies) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America or with the Prudential Assurance Company Limited, a subsidiary of M&G plc (a company incorporated in the United Kingdom).