TSMC And ASE: World's Largest Foundry And World's Largest OSAT

Summary

• TSMC (53% share) and ASE (27% share) are the world’s largest foundry and OSAT, respectively, with an advantage that extends beyond Taiwan as their positions had strengthened globally.

• Both companies are partners with an integrated supply chain and both companies have similar geographic distribution of manufacturing sites, customers and revenue.

• In advanced packaging OSAT, TSMC (8.5% share) is increasingly competing with ASE directly (24% share) as its advanced packaging capabilities are similar to ASE (2.5D/3D and FO) with larger capex.

SweetBunFactory

In the following analysis, we explore the interdependence of two prominent players in the semiconductor industry: Taiwan Semiconductor Manufacturing Company Limited $Taiwan Semiconductor Manufacturing(TSM)$ and ASE Technology Holding Co., Ltd. $ASE Technology(ASX)$. TSMC and ASE are headquartered in Taiwan and hold the titles of the largest foundry and largest OSAT, respectively. Our focus is on the mutual benefits that the companies derive from each other's leadership in their respective sectors, as well as how Taiwan's semiconductor industry contributes to the country's economy and provides cost benefits to the companies.

To start, we analyze the market shares in the foundry and OSAT sectors, and investigate the partnerships between TSMC and ASE. Additionally, we evaluate the revenue, customer, and facilities breakdown by geographical region. Lastly, we examine whether TSMC's advancements in advanced packaging pose a future threat to ASE.

Taiwan's Advantage in OSAT and Foundry?

We first looked at the contribution of the semicon industry to Taiwan in terms of the semicon industry as a % of its GDP as well as semicon export value as a % of total exports and compared it with the US, South Korea, mainland China and Japan.

Semicon Industry Contribution to the Economy

Source: The Economist, DigiTimes, MOF(Taiwan), Time, SIA, BEA, Yonhap, Statistics Korea, Trading Economics(South Korea), SCMP, Macrotrends, OEC, International Trade Administration, Trading Economics(Japan), Japan Customs, Nippon, Khaveen Investments

From the table, the Taiwanese semicon industry contributes 15% to its region's GDP, the highest among the 5 regions. The US is in second place, contributing 12% to the country's GDP. Japan is in last place, with just 0.9% of the country's total GDP. Moreover, the semicon industry in Taiwan contributed a whopping 36.5% to the total percentage of exports. This is far greater compared to South Korea in second place, whose semicon industry contributed to 20% of total exports. The US and mainland China semicon industries contributed 2.9% and 1.3% respectively to their total export market. In conclusion, the semiconductor industry is very significant to Taiwan and highlights the importance of it to its economy relative to other regions.

SIA

The image above shows the overall semiconductor value chain and the semiconductor consumption for the respective countries from SIA in 2019. Although Taiwan represents 9% of the overall value chain, its semiconductor consumption is just 3%. This is a stark contrast to mainland China, which also accounted for 9% of the overall industry but consumes a whopping 24% of the semiconductor market. The US holds the largest share of the value chain at 38% as well as the largest consumption share at 25%. Overall, the net consumers are mainland China, Europe and the Rest of the World whereas the net producers are the US, Taiwan, South Korea and Japan. Then, we further narrowed down our focus on OSATs and foundries by analyzing below the share of each region by equipment, EDA, materials, IP, chipmakers, OSAT and foundries.

McKinsey

Based on the chart above by McKinsey which shows the breakdown of the semicon industry based on the EDA providers, types of chipmakers (fabless and IDM), equipment makers, material suppliers, foundry and OSAT. US firms lead the overall semicon industry, the US is the leader of chipmakers (both fabless and IDM) as well as EDA software and semicon equipment makers.

In pure-play foundries, Taiwan is the clear leader with a 75% share. As TSMC is the foundry market leader, this could indicate the company benefitted as a Taiwanese company, however, it is the dominant company in Taiwan while UMC only has a fraction of its market share.

In OSAT, Taiwan leads ahead of mainland China in first place with a 52% share. Thus, this indicates that Taiwan has the highest share of foundry and OSAT. To determine whether Taiwan's position as the leader in OSAT and foundries is due to geographical advantage, we examined the cost comparisons between the regions.

Manufacturing Costs

Based on KMPG's CoDB Primary Cost index, mainland China has the lowest score of 2.4 among the regions in the previous diagram which highlights its relatively low manufacturing costs. While Taiwan has a higher score than mainland China, Taiwan's score is lower compared to the US, Korea, Japan and top European countries such as France, Germany, UK. Thus, this indicates cost not being the main factor that explains Taiwan's dominance in OSAT and foundry as it is higher than mainland China.

Furthermore, we compiled in the following section the government incentives for Taiwan and a comparison with other key regions.

Government Incentives

MOEA, EPRS, Economic Times, Supply Frame, Reuters, South China Morning Post, SIA, McKinsey, PWC, Bruegel, ESPAS, Bloomberg, Khaveen Investments

From the diagram above of the compiled government incentives for the semicon industries, Taiwan has the least in terms of monetary subsidies with a $1.3 bln annual fund. This is small compared to mainland China which is providing subsidies worth approximately $450 bln, the US with $53 bln in chipmaking subsidies and South Korea with $450 bln up till 2030. In terms of tax incentives, we can see that Taiwan provides R&D tax credits of 25%, but this figure is similar to the 25% tax credit on investment in semiconductor facilities in the US and lower than the 50% R&D tax credit in South Korea.

Therefore, we believe that Taiwan provides only a slight advantage based on the comparison of its manufacturing costs which is higher than mainland China and modest government incentives relative to other compared regions. Thus, we then examine the market positioning of both ASE and TSMC based on their market shares below.

Market Share

Trendforce, Company Data, Khaveen Investments

In our compiled foundry market share chart above, TSMC dominates in terms of market share with an estimated share of 52.9% in 2022 well above number 2 player Samsung at a 17.4% share. The company's market share has increased in the past 8 years from 48.2% in 2015 to 52.9%.

Yole Development, Company Data, Khaveen Investments

The chart above shows our compiled OSAT market share for each of the top 12 companies. ASE was slightly lower than Amkor in 2017 but managed to take the top spot in 2018 (19.6%) and remained there in 2021 (26.3%). In 2022, we estimated its share to increase to 26.9%. Amkor has consistently been the number 2 player from 2018 (16.1%) to 2021 (13.7%). TSMC has been at number 5 throughout the 5 years, starting at 9.1% in 2017 and ending at 10.2% in 2021. Based on our estimates, TSMC remained in 5th place in 2022 with a 10.7% share.

To conclude, we believe that TSMC and ASE has an advantage not only within Taiwan but the entire world as both companies have leading and firm market positions and have been able to strengthen their positions in the foundry and OSAT market respectively not only in Taiwan but also against global competitors, thus indicating a global company advantage.

How TSMC and ASE Benefit Each Other

We referred to the annual reports of ASE to identify how many times TSMC was mentioned, where we identified that TSMC was mentioned 9 times, and out of the 9 times, 7 were talking about a partnership/collaboration, 1 mentioned competition in the Fan Out packaging segment and the last mention was about an employee that worked in TSMC prior to joining ASE. We also looked at the annual reports of TSMC and there was no mention of ASE. This indicates that ASE regards TSMC more highly than TSMC does to ASE.

Since 1997, TSMC and ASE have had a long-standing relationship as partners. That said, besides ASE, TSMC's OSAT partners also include Amkor under its 3DFabric Alliance which ASE is also a part of with SPIL too. According to ASE, the company has a strategic alliance with TSMC and has designated it as the "nonexclusive preferred provider of packaging and testing services for semiconductors manufactured by TSMC".

The Objectives of Partnership

According to a journal by the National Yunlin University of Science & Technology, from 1998 to 2004, TSMC and ASE...

...jointly completed an e-SCM (supply chain management) project integrating 11 key business processes between these two companies through the internet".

TSMC first introduced the concept of a 'virtual fab' in 1985, which allowed "customers to place orders and inquire about the status of their production orders" through the internet. But in order for the virtual fab to work efficiently there needed to be a strong relationship between the fab and its back-end partners in testing and packaging. This opened the door for the partnership between the two companies due to the dominance TSMC had in the front end (wafer fabrication and wafer probing) and the dominance ASE had in the back end (assembly and final testing). Under this e-SCM project, 11 business processes were related to engineering and logistics, which were split between both companies, and it ensured manufacturing and logistics efficiency in the production of semiconductors.

Furthermore, we compared the two companies in terms of their supply chain by comparing their facilities breakdown by geographic location as well as revenue breakdown and identified the common customers of ASE with Apple's $Apple(AAPL)$ top customers.

Supply Chain

The charts below show the breakdown of TSMC Fabs and ASE Facilities by region. For TSMC's fabs, we referred to our previous analysis where we obtained the total number of fabs and calculated the share breakdown by region. For ASE's facilities, we obtained the information for the total number of facilities currently being used from the company's annual report along with the country and total square ft per facility. We then calculated the percentage share by dividing square ft per country by the sum of the square ft in all regions.

Company Data, Khaveen Investments

Both TSMC and ASE have more than 50% of their fabs and facilities, respectively, in Taiwan. We can also see that ASE has a strong presence in mainland China at 26% which is greater than TSMC at 7%. Although TSMC has 10% of its fab capacity in the US, ASE has only 0.5% of its facilities in the US. Lastly, TSMC has 3% of fab capacity in Japan which is greater than the 0.2% of ASE in Japan.

Customers

The table below shows the customers that represent a significant portion of revenue for TSMC and ASE. The first 11 companies in the table are the leading customers based on revenue share for TSMC in 2021, which was obtained from an article by Gizmo China. The ASE customers were obtained from an article published by Asia Nikkei.

Source: Asia Nikkei, Gizmo China, Khaveen Investments

It can be seen that 10 out of the 13 companies in the table are common customers for both ASE and TSMC. Those companies include the consumer electronics juggernaut, Apple, as well as the three major players in the CPU and GPU markets which are Intel, AMD and Nvidia.

Geographic Revenues

The charts below show the geographical breakdown of revenues for ASE and TSMC by their reporting segments. For TSMC, the data was obtained from its 4Q22 quarterly management report, whereas the data for ASE was obtained from its 2021 annual report.

Company Data, Khaveen Investments

It is no surprise to see both companies have more than 50% of their sales in North America given that most customers in the previous table of customer breakdown are based in the US. Although ASE derives 16% of its sales from Taiwan, we can see that TSMC does not have at least more than 10% of revenue coming from Taiwan. Based on the previous point, we would assume their revenue breakdown to be similar as they have several common customers.

TSMC and ASE Cross Development

According to TSMC, the dedicated foundry business model was pioneered by the company in 1987. The company claimed that it,

lowered the threshold needed to establish an IC design company by solving challenges of the increased complexity of technology development and the sizable investment for building wafer manufacturing fabs.

Thus, chipmakers could focus on product development and outsource the capital-intensive front-end manufacturing process to foundries.

Moreover, according to MarketResearch, OSATs "come into major play at the end stage of the semiconductor manufacturing process after the wafer fabrication and wafer probe stages" by providing back-end services including packaging and assembly services that form the die protection of the chips and "facilitating electrical connections and heat dissipation".

Both processes are related as the foundry is the front-end and OSATs are the back ends which is the following process. Both processes can be outsourced by chipmakers. This provides "cost-effective and innovative solutions that deliver higher performance, processing speeds and functionality with a reduction in space in an electronic device". In the study of the partnership between ASE and TSMC by the National Yunlin University of Science & Technology, numerous benefits were derived from the e-SCM partnership between TSMC and ASE. Firstly, data transmission time was improved six times from 120 minutes/order to 20 minutes/order. Secondly, the order error rate was reduced 8 times from 12 orders/month to 1.5 orders/month. Lastly, more than $10 mln was created in direct economic benefits through the collaboration of both companies and indirect benefits estimated worth $100 mln, which provided a high ROI when compared with the total investment of $2 mln between 1998 and 2004. If we prorate these values to 2022, this translates to an investment cost of $8 mln and direct economic and indirect economic benefits of $40 mln and $400 mln respectively.

Overall, we believe TSMC and ASE have benefitted by collaborating with each other's foundry and OSAT in terms of order transmission speed which may enable the companies to secure customers fasters and increase customer order rates, another benefit is the reduction in error rates which should provide better product quality and improve customer satisfaction. Also, integration provided benefits through the creation of financial benefits.

Is TSMC Competing with ASE?

While TSMC and ASE have a long-standing partnership as described in the previous point, TSMC has been expanding aggressively in the OSAT market. Thus, we analyze to determine whether the company's expansion into advanced packaging could reduce its dependence on ASE and impact its relationship.

Yole Development, Khaveen Investments

In terms of market share, ASE was the largest company in the advanced packaging market in 2021 followed by Amkor and Intel. TSMC was in 5th place but was the second highest in terms of capex spending for advanced packaging expansion.

Source: Yole Development, Company Data, Khaveen Investments

The table above shows the OSAT revenues for ASE and TSMC for the five years from 2017-2021 as well as our 2022 estimated revenues. ASE has always had the lead over TSMC in terms of OSAT revenue, but that lead was significantly extended in 2019 when ASE completed the acquisition of SPIL in 2018. However, it should also be noted that the growth rate for TSMC has been higher than ASE in 2020, and 2021 and it is expected to continue to have higher growth in 2022. We attribute this growth to the aggressive capex spending by TSMC in the advanced packaging market. According to Yole Development, TSMC was the second biggest spender in advanced packaging capex in 2021. They spent approximately $3 bln, just behind Intel which spent $3.5 bln. ASE came in third place for advanced packaging capex spending in 2021 with $2 bln.

TSMC Packages

TSMC

From the diagram, TSMC's list of advanced packaging technologies includes CoWoS, InFO and TSMC-SoIC.

ASE Packages

According to ASE, its advanced packaging consists of "System in Package (SiP), MEMS & Sensor Packaging, Fan Out Packaging, 2.5D/3D IC Packaging and Embedded Die Substrate Packaging."

Source: TSMC, ASE, Electropages

From the table above, TSMC is present in two advanced packaging segments (2.5D/3D and FO) whereas ASE is present in three segments (SiP,2.5D/3D, and FO). Hence, they overlap in two advanced packaging segments which are 2.5D/3D and FO. According to Yole Development, TSMC is the FO segment leader with a 66.9% share, whereas ASE is second with a 20% share. The main reason for TSMC's lead within the FO packaging segment was the penetration of its InFO technology in Apple's iPhone in 2016. Till now, Apple is still utilizing TSMC's FO technology for its latest iPhones. TSMC is also pushing its InFO technology into the High Computing segment with companies like Nephos, among others.

ASE has also highlighted this competition in the FO segment in its annual report stating that "InFO is expected to further intensify the competition in the packaging and testing industry". In response, ASE is also working on "industrial applications where the use of FO is expected to increase". When coming to the 2.5D/3D segment, it is unclear as to who is the segment leader, but according to TSMC, 'TSMC-SoIC' technology has greater bonding density by bringing chiplets closer together, greater speed as well as lesser power consumption compared to traditional 2.5D/3D packaging.

Yole Development, Khaveen Investments

Source: Yole Development, Khaveen Investments

Yole Development projected the advanced packaging market to grow at a CAGR of 10.11% through 2027 and reach $57.8 bln. This is higher compared to the market forecast CAGR of the total packaging market which is forecasted by Yole Development at 4%. The market size for the total IC packaging market was $85 bln in 2021. Therefore, both TSMC and ASE appear to be competing in the market segment with the highest growth (2.5D and 3D) with the highest market forecast CAGR as well as in FO which has the third highest CAGR behind FCCSP.

Still, ASE joined TSMC's 3DFabric Alliance which was launched recently in 2022 and claims that it would allow the company to optimize its advanced packages together with TSMC.

ASE is excited to be part of the TSMC 3DFabric Alliance, which will allow us to optimize our advanced packaging technologies together with other best-in-class partners within the 3D IC ecosystem, - Mike Hung, senior vice president of central engineering, ASE Inc.

All in all, TSMC's expansion into OSAT with advanced packaging has been aggressive as it is the second highest spender for advanced packaging OSAT and does compete with ASE in 2.5D/3D segments as well as FO. Thus, we believe this could increase the competition between the two companies but the recently launched 3D Fabric Alliance could provide opportunities for ASE to collaborate with TSMC but remains unclear to the exact details of how they could optimize their solutions together as we believe they are competing products. We believe that ASE could end out worse off as TSMC expands in advanced packaging as TSMC now has both complete foundry and OSAT capabilities while ASE is only limited to its OSAT capabilities as it does not have any presence in the foundry market.

Valuation

We updated our revenue projections for ASE and TSMC from our previous analyses with their full-year 2022 results. For ASE, we maintain our previous forecasts for the company which show its revenues to slow down to a growth of 3.1% in 2023 following a strong performance in 2022. Whereas for TSMC, we updated our forecasts for its Wafer Revenues growth to be flat in 2023 at only 1.7% as we assumed a conservative assumption of 0% for ASP given the challenging outlook cited by management. Overall, we estimated a 5-year forward revenue growth of 6.1% for ASE and 14.8% for TSMC.

ASE

Source: ASE, Khaveen Investments

Khaveen Investments

TSMC

Source: TSMC, Khaveen Investments

Khaveen Investments

Verdict

In summary, we believe that TSMC and ASE have a competitive edge not only in Taiwan but also in the global semiconductor industry due to their prominent positions in the foundry and OSAT markets, respectively. Their collaboration has yielded benefits such as improved transmission speed, lower error rates, and revenue synergies, demonstrated by their integrated supply chains. Our analysis of their supply chains, customers, and geographic revenues further supports their close integration.

TSMC's entry into the OSAT market through advanced packaging has been aggressive, with the company now the second-highest spender in this area, and competing directly with ASE in 2.5D/3D segments as well as FO. We believe this could potentially increase competition between the two companies, although there may be opportunities for collaboration through the recently launched 3D Fabric Alliance. However, given that they offer competing products, we see the exact nature of any potential collaboration is still uncertain.

For TSMC, our updated valuation shows a 69% upside at a price target of $143.72 with a lower discount rate of 7.1% (compared to 10.5% previously) and a slightly lower 5-year forward average growth rate of 14.8% (compared to 21.3% previously), which supports our Strong Buy rating for the company.

For ASE, we obtained a price target of $9.05, which indicates an upside of 27%, with a lower discount rate of 5.4% (compared to 8% previously) and a lower average OSAT EV/EBITDA of 4.23x (compared to 6.6x previously), and we rate the company as a Buy.

Source: Seeking Alpha