Taiwan Semiconductor's Ties to Apple Are a Double-Edged Sword

NEW YORK (TheStreet) --Taiwan Semiconductor (TSM) reported strong results this week, and yet its shares fell. The reason? It turns out its close ties to Apple (AAPL) cut both ways.

TSMC's second-quarter earnings beat expectations, coming in at $2.30 vs. the consensus of $2.17. The company also beat on revenue, with NT $183.02 billion versus the NT $182.25 billion consensus.

However, investors were expecting a big quarter and now are selling on the news. The stock was trading at a 52-week high on strong expectations for Apple orders. All those Apple orders might be part of the problem. There is a concern that TSMC is so focused on Apple as a customer that other customers might look elsewhere for capacity and TSMC will lose its market dominance.

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Indeed, on the earnings call, TSMC's founder Morris Chang admitted to investors the company will be second in market share, presumably to Samsung (SSNLF) and GlobalFoundries, in 14/16nm in 2015, but expect to regain its market-leading position in 2016-2017.

Due to Apple-related supply constraints, TSMC has also lost orders from Qualcomm (QCOM). Digitimes reported that Qualcomm and MediaTek (among others) are looking to secure 28nm capacity from SMIC (SMI), UMC (UMC), and GlobalFoundries due to TSMC's constrained capacity. There is concern that capacity constraint issues could spill over to newer chips as well. According to Digitimes, Qualcomm has placed orders with Samsung and Globalfoundries for their next-gen 14nm process set to go live early in 2015.

TSMC recently traded around $20.50, up 17.5% for the year to date.

Rising Competition

Several key competitors, including Samsung and Intel (INTC), have made significant changes to their foundry management and accelerated the pace of their technology offerings to capitalize on TSMC's constrained capacity. For better or for worse, since grabbing Apple as a client form Samsung, TSMC's order flow is becoming Apple-centric. Ultimately TSMC is expected to land 60% to 70% of Apple's total 14/16 nm chip orders over the next few years, with the remainder going to Samsung.

Concerns about TSMC's order momentum and increased competition is the main reason the stock traded down on the earnings results. But none of this is news is really new. A few analyst downgrades also contributed to the sell-off. Interestingly enough, Apple just surged toward all-time highs. It remains to be seen how Apple will allocate its orders for its new processors, but TSMC is sure to be a big part of the mix going forward.

Taiwan Semi stock traded off around 6% after its earnings release. The company's earnings were good and the valuation remains reasonable with a forward P/E of 12.54.

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I am holding on to my position for now, as Taiwan Semi does not fall far from the Apple tree.

At the time of publication the author had positions in AAPL and TSM.

TheStreet Ratings team rates TAIWAN SEMICONDUCTOR MFG CO as a Buy with a ratings score of A+. TheStreet Ratings Team has this to say about their recommendation:

"We rate TAIWAN SEMICONDUCTOR MFG CO (TSM) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, solid stock price performance, growth in earnings per share and increase in net income. Although the company may harbor some minor weaknesses, we feel they are unlikely to have a significant impact on results."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • TSM's revenue growth has slightly outpaced the industry average of 2.9%. Since the same quarter one year prior, revenues slightly increased by 9.3%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • TSM's debt-to-equity ratio is very low at 0.26 and is currently below that of the industry average, implying that there has been very successful management of debt levels. To add to this, TSM has a quick ratio of 1.77, which demonstrates the ability of the company to cover short-term liquidity needs.
  • Investors have apparently begun to recognize positive factors similar to those we have mentioned in this report, including earnings growth. This has helped drive up the company's shares by a sharp 28.64% over the past year, a rise that has exceeded that of the S&P 500 Index. Regarding the stock's future course, although almost any stock can fall in a broad market decline, TSM should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.
  • TAIWAN SEMICONDUCTOR MFG CO has improved earnings per share by 15.4% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, TAIWAN SEMICONDUCTOR MFG CO increased its bottom line by earning $1.18 versus $1.10 in the prior year. This year, the market expects an improvement in earnings ($1.46 versus $1.18).
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and the Semiconductors & Semiconductor Equipment industry average. The net income increased by 18.4% when compared to the same quarter one year prior, going from $1,327.64 million to $1,572.11 million.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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