TSMC: Absolutely no intention to acquire Intel (FY24Q3 conference call minutes)

Taiwan Semiconductor (TSMC) released its third-quarter financial report for 2024 on the afternoon of October 17, 2024, before the U.S. stock market opened. The key points are as follows:

For a detailed analysis of TSMC's financial report, please refer to " Is ASME Bringing Down AI? TSMC is Here to Dominate! "

I. $Taiwan Semiconductor(TSM.US) Financial Highlights:

II. Details from TSMC's Financial Report Conference Call

2.1. Key Points from Executive Statements:

I. Business Progress

1. Outlook for the Fourth Quarter

TSMC's business in the fourth quarter is expected to continue benefiting from the demand for advanced process technology. It is expected that full-year revenue in USD will grow by nearly 30%.

Revenue from AI processors (including GPUs, accelerators, and CPUs) is expected to triple in 2024 compared to the previous year, accounting for a double-digit percentage of total revenue.

2. Global Manufacturing Layout

1) Arizona, USA: TSMC's first factory in Arizona has made significant progress, with plans to build three factories. The first factory began wafer production using 4-nanometer technology in April 2024, with mass production expected in early 2025.

2) Japan: The first dedicated technology factory in Japan has completed all process certifications and started mass production in the third quarter. Construction of the second factory is expected to begin in the fourth quarter of 2024, with the goal of starting production by the end of 2027.

3) Germany, Europe: TSMC's factory in Dresden, Germany, focuses on automotive and industrial applications, with plans to start production by the end of 2027.

II. Financial Performance

1. Revenue End

Revenue Growth: TSMC's third-quarter revenue was $23.5 billion, exceeding guidance expectations. Revenue in the third quarter increased by 12.8% compared to the previous quarter, driven by strong demand for smartphones and AI, especially the contributions from 3-nanometer and 5-nanometer process technologies.

Process Technology Revenue Contribution: The 3-nanometer process contributed 20% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 32% and 17%, respectively Contribution from Segmented Businesses: High-Performance Computing (HPC) grew by 11% month-on-month, accounting for 51% of total revenue; smartphones grew by 16% month-on-month, accounting for 34%; Internet of Things (IoT) grew by 35% month-on-month, accounting for 7%; automotive grew by 6%, accounting for 5%.

Gross Margin: The gross margin increased by 4.6% month-on-month, reaching 57.8%, mainly due to improved capacity utilization and cost improvement measures.

Operating Profit Margin: Benefiting from operating leverage, the operating profit margin increased by 5% month-on-month, reaching 47.5%.

Earnings Per Share: Earnings per share (EPS) for the third quarter was 12.54 New Taiwan Dollars, with a return on equity (ROE) of 33.4%.

2. Fourth Quarter Guidance

Revenue Expectations: It is expected that fourth-quarter revenue will be between $26.1 billion and $26.9 billion, with a 13% increase month-on-month and a 35% increase year-on-year.

Gross Margin Expectations: The gross margin for the fourth quarter is expected to be between 57% and 59%, with an operating profit margin between 46.5% and 48.5%.

3. Capital Expenditure Outlook

2024 Capital Expenditure Outlook: Capital expenditure for 2024 is expected to be slightly above $30 billion, with 70% to 80% allocated to investments in advanced process technology, 10% to 20% for special technologies, and 10% for advanced packaging, testing, and other facilities.

2.2 Q&A Analyst Questions

Q: Firstly, regarding the return on investment in generative AI, could this potentially become a bubble? Considering TSMC is a major supplier for almost all processing capabilities, how does your company view this trend when planning capacity? How do you ensure this is a longer-term growth opportunity?

Could you also share your views on the current semiconductor upcycle? Do you believe this cycle will continue in the coming years, or do you think we are nearing the peak of the cycle?

A: We believe that the demand for AI is real and sustainable. We maintain close cooperation with customers, including large customers who design their own chips. Almost every innovator in the AI field collaborates with TSMC, giving us the broadest and deepest insights in the industry. Additionally, TSMC extensively applies AI and machine learning in its R&D and manufacturing processes, creating more value through increased productivity, efficiency, and quality. For example, a mere 1% increase in productivity translates to nearly NT$1 billion in revenue for TSMC, providing a quantifiable return on investment. I believe that not only our company but many others are benefiting from AI applications to enhance productivity and efficiency. Therefore, we firmly believe that the demand for AI is real.

Regarding the second question about the overall demand cycle in the semiconductor industry. I believe the demand for AI is just getting started, as one of our key customers described the current demand as "crazy and in the early stages of a scientific turn to engineering." We believe this demand will continue for many years. Furthermore, in addition to AI demand, the overall semiconductor market demand is stabilizing and showing signs of improvement

Q: Regarding capital expenditures (CapEx). Looking back at past demand cycles, usually when demand experiences strong growth, TSMC's capital expenditures also increase significantly. However, during the period of 2023 and 2024, TSMC's capital expenditures remained relatively stable, with no significant growth. So, looking ahead in the coming years, what are TSMC's plans for capital expenditures? Is there a certain reservation on the growth rate, leading to capital expenditures staying at a lower level? Or will TSMC's capital expenditures start to accelerate with this year's expected 30% growth and strong growth expectations in the coming years?

A: We currently do not have specific numbers to share regarding capital expenditures for 2025. However, TSMC always determines appropriate capacity expansion in a rigorous and systematic manner, and we will continue to review our capital expenditure plans.

For TSMC, higher levels of capital expenditures are usually closely related to higher growth opportunities in the coming years. As long as our growth prospects remain strong, we will continue to invest. Next year, the market conditions seem to be healthier, so it is very likely that next year's capital expenditures will be higher than this year. We will provide more updated information at the meeting in January next year.

Q: Looking ahead to the gross margin for 2025. It was mentioned earlier that overseas factories may reduce the gross margin by 2% to 3%, besides this factor, what are the other factors to consider, especially the impact on depreciation growth.

A: We currently do not have detailed data to provide, but there are several key factors to share. Firstly, we expect that with the increase in N3 chip production capacity, the related dilution effect will gradually weaken. In addition, 2025 is expected to be a year of healthy growth, and the improvement in capacity utilization will be a positive factor.

However, as mentioned earlier, the expansion of overseas factories will result in a 2% to 3% dilution in gross margin as we start to increase capacity. Additionally, to meet the strong demand for N3, we will also convert some N5 capacity to N3. These will bring additional costs. At the same time, N2 capacity is expected to increase in 2026, so there will be some preparation costs in 2025. As each generation of process nodes advances, technology preparation costs will gradually increase.

Furthermore, Taiwan's electricity costs have also risen significantly. Following a 15% increase in 2022 and a 17% increase in 2023, we are facing another 25% increase in 2024. Overall, electricity costs have doubled over the past few years. We expect these rising electricity costs, along with other inflationary costs, to negatively impact our gross margin by at least 1%.

Finally, exchange rate fluctuations are also factors beyond our control. A 1% fluctuation in the USD to TWD exchange rate will have an impact of approximately 40 basis points on our gross margin.

Q: First, regarding the depreciation expense growth in 2025, can we expect a similar increase to this year? Depreciation expenses increased by about 25% this year, will this growth rate continue next year? Also, regarding the 2% to 3% dilution in gross margin caused by overseas factories that you mentioned, can it be understood that the initial gross margin of your new factories in the US and Japan will be close to 0% or at a lower level? Is this assumption currently a more conservative expectation?

A: The profitability of overseas factories will be lower compared to Taiwan factories, mainly due to smaller scale and next year being the initial expansion period with higher costs. Therefore, the profitability of overseas factories will be lower, but will gradually improve in the coming years.

In addition, the expansion of factories in Arizona and Kumamoto is being carried out in stages. When the profitability of the factories in the first phase improves, the second phase will start operations. Similarly, in Arizona, once the profitability of the second factory improves, the third phase will be initiated, and Kumamoto has a similar situation. This is why we expect that in the next 3 to 5 years, overseas factories will dilute the gross margin by 2 to 3 percentage points annually.

Q: How will the pricing power between you and your customers and suppliers affect the long-term gross margin target? Currently, even without considering price adjustments next year, your gross margin has already reached 57% to 58%, much higher than most customers. Based on this, are you concerned that further raising customer prices in the future may seem too aggressive? Secondly, what is the pricing strategy for mature technology nodes, and how does this affect your long-term gross margin?

A: For TSMC, continuously delivering our own value is an ongoing process. We view all customers as partners, and currently, progress in this area is going very smoothly.

As for your mention of us having stronger bargaining power among equipment suppliers, I prefer to call them partners rather than using the term "bargaining power." We always collaborate with suppliers to drive the next stage of development together. Therefore, the cooperation between TSMC, suppliers, and customers is ultimately aimed at ensuring the success of our customers in the market. This is also my goal - if customers perform well, TSMC will also succeed.

You mentioned that TSMC's gross margin is higher than customers, which is not entirely accurate. For example, some of the largest AI suppliers may have gross margins that I may never reach. However, in any case, we are pleased to see their success. We are in a different industry - a capital-intensive industry. Therefore, we need to maintain a higher gross margin to ensure the sustainable and healthy growth of the company. This is also the reason for our pricing strategy.

Q: Considering your dominant position in the market, how do you deal with potential antitrust risks?

A: TSMC does have a high market share, but the technologies and methods we adopt have not sparked unnecessary competition. We recently proposed the concept of Wafer Foundry 2.0, which includes services such as wafer manufacturing, packaging testing, and mask manufacturing. The growth in these areas is becoming increasingly important, such as packaging and testing, now accounting for over 10% of TSMC's total revenue.

At the same time, many of my competitors, especially integrated device manufacturers (IDMs), also have their own businesses in packaging, testing, and mask manufacturing. Therefore, Wafer Foundry 2.0 better reflects the market TSMC can serve, and our market share is around 30%, not in a dominant position. We do have a large scale, but this is mainly due to our outstanding performance. Concerns about antitrust are not currently within our considerations

Q: Regarding the opportunities for TSMC in outsourcing with IDM, is this also part of the 'Foundry 2.0' strategy? In addition, Intel recently announced plans to spin off its foundry business, does this mean that TSMC will receive more outsourcing orders from Intel? Will TSMC consider acquiring a portion of Intel's wafer fabs in the long term? Finally, please briefly comment on the news about Samsung's IDM outsourcing opportunities.

A: Is there any interest in acquiring any IDM companies? The answer is very clear, we have absolutely no intention to do so.

Moving on to the business aspect. The choice of outsourcing strategy has always been the decision of the customers. As for our cooperation with one of our IDM customers based in California, they have always been one of TSMC's important customers. Truth be told, we have been receiving quite substantial orders from this customer, and the cooperation has been good.

As for whether we will further increase this aspect of the business, it is still too early to answer that question at the moment. We can wait to see how this develops in the coming quarters.

Q: Regarding long-term growth prospects. TSMC previously forecasted a compound annual growth rate of 15%-20% from 2021 to 2026. With the surge in AI demand, are there any updates on revenue expectations beyond 2026? Additionally, TSMC has achieved close to 25% growth almost every year since its 2021 guidance. Therefore, what are the revenue growth expectations for the next 5 years?

A: Apart from 2023, TSMC has achieved very good growth in the past few years, staying between 20% to 30% almost every year. The next 5 years will also be a very healthy growth period for TSMC. While I do not have updated long-term compound annual growth rate figures at the moment, I can assure you that TSMC's growth in the coming years will also be very strong.

Q: Regarding the 2nm process and A16 chip. We have noticed strong demand for this node in high-performance computing (HPC) and more customer participation in the 2nm process. How should we view the capacity construction for 2nm compared to 3nm? Additionally, how do you view the migration of the A16 chip to 2nm?

A: Chiplets have become a major strategy for our high-performance computing (HPC) customers. As for whether this will reduce the capacity of the 2nm process, the answer is no. In fact, many customers have shown strong interest in the 2nm process. We have seen more demand than expected on the 2nm process compared to the 3nm process, so we are preparing more capacity for the 2nm process. Additionally, the A16 chip is very attractive for AI server chips, and the demand is very high. Therefore, we are fully preparing for the production of the 2nm process and the A16 chip.

Q: Regarding long-term AI planning, my question is how TSMC maintains confidence in AI demand after 2025. How does TSMC work with these AI customers to develop long-term capacity plans? What commitments do customers provide? Also, capital expenditures for hyperscale data centers usually go through a digestion period TSMC faces the challenge of reducing capacity planning risks in the AI field in the face of current strong demand.

A: First, we have extensive communication with many customers, almost every AI innovator is collaborating with us, including customers from super large-scale data centers. By studying the long-term market structure and demand trends, we already have a certain judgment and maintain rolling cooperation with customers. We have a disciplined and systematic approach to plan appropriate capacity to meet customer needs and maximize shareholder value. This is the goal we always keep in mind.

Q: During the construction of 2-nanometer factories in Hsinchu and Kaohsiung, does TSMC face challenges in power supply? Additionally, considering that large-scale data center companies in the United States are planning to use nuclear energy, does TSMC also have plans to introduce nuclear power as part of its energy supply for its factories in the future?

A: We have built many factories in Taiwan, which indeed require resources such as electricity, water, and land. We have always maintained close communication with the government, clearly expressing our needs and plans. The government has also assured us that they will fully support TSMC's growth. As for the source of power supply, whether it comes from nuclear power or other green energy sources, we cannot provide specific details at the moment. But what can be confirmed is that we have received assurances from the government that full support will be provided in terms of electricity, water, and land.

Q: Regarding non-AI demand, I would like to know your views on wafer demand in the PC and smartphone markets for 2025. Have you observed any significant increase or decrease in this demand?

A: Currently, the unit growth of PCs and smartphones still remains in the low single digits. However, what is more important is the content of these devices, as we are now incorporating more AI technology into them, thereby increasing the demand for chips. Therefore, the growth rate of silicon wafer usage area exceeds the unit growth. Overall, the business in the PC and smartphone markets is gradually growing, and with the increase in AI-related applications, we expect the performance in this area to remain healthy in the coming years.

Q: In the field of packaging, especially advanced packaging as part of non-wafer revenue, how do you view the revenue growth of advanced packaging in the next few years? Do you believe that in the next few years, advanced packaging can reach the company's overall gross margin level? Or will it always be below this level?

A: In the next few years, especially in the next five years, the growth rate of advanced packaging will exceed the company's average level. This year, advanced packaging accounts for approximately high single-digit percentage of our revenue. As for gross margin, although the gross margin of advanced packaging is continuously improving, it has not yet reached the company's overall gross margin level, although it is approaching, there is still a gap.

Q: Considering the significant growth in free cash flow in the recent quarter, is it possible for TSMC to consider increasing cash dividends in the near future? Additionally, how do you view the balance between shareholder returns and continued investment in advanced technologies such as 2-nanometer and 3-nanometer in capital allocation? A: Regarding dividends, as we mentioned before, our dividend policy is sustainable and will steadily increase. As we start reaping the benefits of past investments, dividends will gradually increase. With the increase in free cash flow, this means we are reaping the benefits of past investments, so dividends will steadily grow.

As for the balance sheet, our primary goal is to use our balance sheet or cash resources to drive organic growth, which will bring the maximum return to shareholders. Afterwards, the remaining free cash flow will be partially returned to shareholders. This has always been our policy.

Q: Can you share more details about the implementation of Foundry 2.0? Additionally, can you provide insights or forecasts on the growth prospects for different market segments regarding traditional logic foundry business, advanced packaging technology, and collaboration with IDM customers?

A: Under the Foundry 2.0 model, leading process nodes and advanced packaging technologies have shown stronger growth. As for mature nodes and traditional packaging technologies, the growth prospects are not as optimistic as advanced packaging and leading process nodes.

Q: Can you update this year's semiconductor industry forecast, especially regarding memory chips? Has the previous forecast of around 10% been updated? Also, could you share a preliminary outlook for next year?

A: TSMC's performance is slightly better than our previous estimate, but the overall industry is basically in line with the forecast from the previous quarter. As for the overall outlook for 2024, it is still early to tell, and we will provide more detailed information in the next quarter's financial report.

Q: Can you share the status of CoWoS capacity construction for this year and next year? I know you have adjusted the related plans multiple times, can you provide us with the latest updates?

A: In fact, we are vigorously increasing CoWoS capacity. The current situation is that customer demand far exceeds our supply capacity. Even though this year's capacity has more than doubled compared to last year, it is expected to double again next year, yet it still cannot meet the demand. Nevertheless, we are working hard to try to meet customer needs.

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