April 30, 2017 10:00 am JST
Company in focus

TSMC looks to feed AI boom

Making Apple chips puts Taiwanese company on equal footing with Intel

CHENG TING-FANG and KENSAKU IHARA, Nikkei staff writers

Morris Chang, chairman of TSMC (Photo by Shinya Sawai)

TAIPEI -- In late March, Taiwan Semiconductor Manufacturing Co. rose above rival Intel by market value for the first time. TSMC's rise and Intel's stumbling over the past decade reflect how mobile devices have overtaken personal computers as the one gadget people cannot live without.

Yet the world's largest contract chip maker, which currently monopolizes orders for iPhone core processors, is acutely aware of what has happened to Intel -- the once dominant force in the PC market -- and is keen to avoid similar mistakes.

The Taiwanese chipmaker is now looking beyond the slowing smartphone market and working on the development of chips for emerging technologies such as artificial intelligence and high-performance computing.

"We expect high-performance computing to become our major growth engine from 2020. By 2020 to 2025, that's the time the need for high-performance computing products will really pick up," TSMC Co-Chief Executive Mark Liu said during the first-quarter earnings conference in mid-April.

Liu said half of the 30 customers that have placed pre-orders for the advanced 7-nanometer chips currently being developed intend to adopt them for high-performance computing related applications. TSMC is planning to produce the world's first 7-nanometer chips in 2018.

In chipmaking, nanometers refers to the width of the channels etched into the silicon that separate components on the chip. The smaller the number, the narrower the channel, and thus the more computing power can be squeezed into a given space. Making finer cuts raises costs and is technically difficult. The next generation of iPhones is expected to use TSMC's 10-nanometer chips.

Liu said that TSMC had begun to produce data center chips for the high-performance computing sector using structures provided by the SoftBank-owned semiconductor innovator ARM Holding. ARM-based chips dominate the global smartphone landscape with a 95% market share, and the British chip designer now is trying to challenge Intel's dominant status in data center servers.

Data centers, which can offer high-performance computing capabilities, are an essential piece of infrastructure required to develop next-generation technologies such as AI and autonomous vehicles.

TSMC has maintained its competitive edge by heavily investing in research and development. Together with its two major rivals, Intel and South Korea's Samsung Electronics, it is one of only three companies that can afford to spend billions of dollars on pushing chip production technology forward.

The Taiwanese chipmaker, also the most valuable company on the island with a market cap of $5.o4 trillion New Taiwan dollars ($167 billion), has said it will spend about $10 billion in capital expenditure in 2017, the highest in the company's history.

The company has also announced that it could start adopting extreme ultraviolet, or EUV, lithography as soon as next year and begin to make cutting-edge chips with the technology in 2019.

EUV lithography could help make advanced chips more efficiently, but a number of technical issues need to be overcome. No company has successfully adopted the technology so far, according to industry sources.

According to TSMC Co-Chief Executive C.C. Wei, TSMC will roll out 5-nanometer chips that also adapt EUV lithography in small quantities by 2019, and begin mass production in 2020.

Furthermore, the company is looking for a location to build the world's first 3-nanometer chip facility and is considering building a new factory in the U.S.

In contrast, Samsung and Intel have not disclosed any detailed schedule for the development of 7-nanometer chips.

Smartphone remains the cash cow

Despite the pursuit of cutting-edge technologies, the smartphone industry will remain a major source of income for TSMC in the short term.

Apple, Qualcomm, MediaTek and Huawei's chip unit Hisilicon Technologies are among the 30 companies that will adopt TSMC's upcoming 7-nanometer chips, while Nvidia is the most high profile customer on the high-performance computing side.

Over the past few years, TSMC has thrived on booming demand for various chips used in smartphones. The company's sales have grown continuously since 2009.

The company's net income has grown nearly fourfold over the past eight years to NT$334.24 billion, while sales more than tripled to NT$947.93 billion for all of 2016 over the same period of time.

In the first three months in 2017, the Taiwanese manufacturer posted a net profit of NT$87.6 billion, reporting record profit for the fifth consecutive quarter, up 35% form a year earlier. Net profit margin was 37.5%, an impressive level for a manufacturer.

TSMC's lucrative profits have much to do with its core foundry business; its two major rivals adopt a vastly different model.

As a foundry, TSMC has focused on making components, including core processors and graphic processors but not memory chips, for other semiconductor or gadget companies without building its own brand or a full consumer electronics product to compete with its customers.

In 2016, TSMC's top two customers were Apple and Qualcomm, respectively contributing 17% and 11% to the company's revenue. No other customers account for more than 10% of sales.

The company now has close to 450 customers globally and produces more than 9,200 different types of chip each year. It controls 56% of the world's foundry market.

Intel, on the other hand, makes core processors largely for its own use and sales to PC makers, while its foundry business is fairly limited.

Samsung mostly depends on its memory chips for a large chunk of profits, while the scale of its foundry business for core processors is also significantly smaller than TSMC's, with its own smartphone unit being a major customer.

TSMC is deeply involved in the growth of both its suppliers and customers.

"We do business with Intel and Samsung Electronics, but no companies help us train ourselves as much as TSMC," a top executive from a Japanese semiconductor company told the Nikkei Asian Review.

"With TSMC making our chips, we are able to save more time for marketing and promoting our products and our customers are also more willing to buy from us," said David Chang, founding chairman and CEO of Goodix, China's no.1 fingerprint chip designer. "TSMC is not God and we also need to work hard to finalize our own design. But it's a trustworthy company and it can make a chip designer's life a lot easier."

TSMC's business model to provide services, as well as its key strategy to never compete with its customers by rolling out products under its own brand, have helped the company attract first-tier clients globally that are willing to invest in the latest technology but do not want to spend huge amounts of money to buy expensive semiconductor-making equipment and worry about production risks.

Its efforts to build the most leading-edge chips have led to its hard won status as the sole core processor supplier for the iPhone 6, iPhone 7 and the upcoming iPhone 8, a dramatic reversal of its initial struggle in the early days of the mobile age to win major orders when the iPhone first came out in 2007.

Back then, Samsung was the exclusive core processor supplier for iPhones before TSMC gradually began to win orders later on.

The company now employs around 47,000 with most of the staff and its advanced chip facilities based in Taiwan.

TSMC owns two 8-inch wafer factories in the U.S. and Shanghai and a joint-venture plant in Singapore.

It is building a 12-inch wafer plant for the advanced 16-nanometer chips used in the iPhone 7 in the eastern Chinese city of Nanjing. The new facility, aimed at serving rapidly growing demand in the 1.3 billion-strong mass market, is expected to enter production in the second half of 2018.

Heir inapparent

Many attribute TSMC's success to its 85-year-old founding Chairman Morris Chang, who started the company in 1987, for his long-term perspective and his ability to sustain growth and ensure the expansion of capital, technology and orders.

Management transition has been of growing interest for market watchers and investors, but has been the elephant in the room for company staff. Few, if any, are bold enough to express views on the matter, even though it is now widely speculated the octogenarian will pass on the baton when the company elects a new board in 2018.

Wei and Liu, the two co-chief executives, have emerged as the mostly likely candidates, but nobody can say for sure who will gain control of the company.

Both executives have been with TSMC for a considerable amount of time. Wei has a doctorate in electrical engineering from Yale, Liu got his at UC Berkeley.

When he promoted Liu and Wei to be co-CEOs in late 2013, Chang said he expected his successor to be more of a "good businessman," not merely a capable engineer. Back then, he said both executives were still more like engineers and that their business acuity needed time to be cultivated. He added that a CEO must be open-minded, worldly and wise enough to develop strategies for the company.

On April 26, TSMC board members approved a motion to nominate Wei and Liu as two additional directors to stand for election at the shareholders' meeting in early June.

Two days earlier, the company disclosed a succession plan for the first time in its latest annual report, saying that both have actively participated in all of the earnings conferences since they assumed duties as co-chief executives in November 2013 and earned shareholders' and market confidence in their ability to lead TSMC.

"These accomplishments demonstrate that TSMC's succession plan is being implemented seamlessly and continuously. Chairman Chang anticipates retiring as Chairman after our succession plan has operated for several years," TSMC said in the report, without giving any indication on which of the two would become the heir apparent.

Industry executives and investors all agree that to take the reins from such a legendary leader as Morris Chang will be extremely challenging, and the succession could be one of the most vulnerable moments in the company's history.

"Morris Chang is considered the most important asset of the company, and we don't think anyone could replace him or do as well as him. ... We think TSMC will definitely experience some impact when Chang announces his retirement someday in the future and the whole industry is concerned about this for sure," one chip industry executive told the Nikkei Asian Review.

Nikkei staff writers Debby Wu in Taipei and Kotaro Hosokawa in Tokyo contributed to this report.

Asia300

Taiwan Semiconductor Manufacturing Co., Ltd.

Taiwan

Market(Ticker): TAI(2330)
Sector:
Industry:
Electronic Technology
Semiconductors
Market cap(USD): 178,296M
Shares: 25,930.4M
Asia300

Samsung Electronics Co., Ltd.

South Korea

Market(Ticker): KRX(005930)
Sector:
Industry:
Electronic Technology
Telecommunications Equipment
Market cap(USD): 298,653M
Shares: 149.31M
Asia300

MediaTek, Inc.

Taiwan

Market(Ticker): TAI(2454)
Sector:
Industry:
Electronic Technology
Semiconductors
Market cap(USD): 12,057.1M
Shares: 1,581.6M

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