As you may have already seen in Warren Buffett (Trades, Portfolio)'s profile on GuruFocus, Berkshire Hathaway (BRK.A)(BRK.B) invested an estimated $4.1 billion in Taiwan Semiconductor Manufacturing Co (TSM, Financial) in the third quarter of 2022, based on the firm's latest 13F filing. This suggests the guru and/or his portfolio managers might see value in the stock after recent declines. While it's possible thatTed Weschler or Todd Combs may be behind the trade, based on Buffett's past comments, he is likely to have provided his input on a trade this big.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
The chip shortage which held up supply in 2020 and 2021 is starting to ease as declining demand for consumer electronics and a solid year of production from semiconductor foundries in Asia has started to restore balance.
We all know Buffett says he does not invest in businesses that he does not understand. He may have missed opportunities, but no doubt he has saved himself losses too, although in 2017 he said he regretted not buying Alphabet (GOOG, Financial)(GOOGL, Financial) after failing to understand the power of its advertising business.
Interestingly, the technology sector accounts for three of Berkshire’s 10 top holdings nowadays. As of its third-quarter SEC filing, Apple (APPL) was the largest holding with a value of approximately $123 billion based on average share prices for the quarter, followed by Bank of America (BAC), Chevron (CVX) and Coca-Cola (KO), with games developer Activision Blizzard (ATVI) and Taiwan Semiconductor itself also among the top 10 holdings. Smaller stakes in tech companies Amazon (AMZN, Financial) and Snowflake (SNOW) are also present.
Acquiring shares of Taiwan Semiconductor represents an entry into the American tech companies’ supply chains. Taiwan Semiconductor makes semiconductors for Apple as well Amazon Azure’s cloud computing servers. It seems to be a way to make a bigger bet on a theme while at the same time diversifying some risk across names.
Strong business moat
Buffett is known to prefer companies with moats. Taiwan Semiconductor is the world’s largest chip manufacturer, taking 53.4% of the pure play foundry market, according to Statista. Next are Samsung (XKRX:005930, Financial) with 16.3% and United Microelectronics (UMC, Financial) with 6.9%. Samsung is the only comparable foundry at scale.
A pure play foundry is a company that does not design semiconductors but instead makes chips designed by others. Semiconductor supply chains are often fairly complicated; for example, Qualcomm (QCOM) designs chips for Apple and Nvidia (NVDA, Financial) designs chips for the Amazon Azure cloud servers. Both Qualcomm and Nvidia work closely with Taiwan Semiconductor, which manufactures the chips using its best-in-class processes.
Chip manufacturing is so concentrated because it requires a lot of capital investment, precision and knowledge. Even a tiny mistake in the chain can decimate production numbers. Then there's also the economies of scale which are referred to as Wright’s Law, which predicts for a doubling of units produced, costs will fall by a certain percentage. The more chips Taiwan Semiconductor produces, the more efficient it gets. This is shown by Taiwan Semiconductor’s improving operating margins and returns on equity over the years.
This system saves Qualcomm and Nvidia from having to expend their own capital just to get inferior results. It also gives Taiwan Semiconductor a significant moat.
Value
Taiwan Semiconductor doesn’t have a high valuation like most tech stocks. It has a GF Score of 91 out of 100, is significantly undervalued based on the GF Value chart, has a Piotroski F-Score of 7 out of 10 and sports an Altman Z-Score of 6.2. It has a low momentum rank, as its stock has been falling for a while. Its low valuation may in part be due to the notorious cyclicality of the industry. Last year’s shortage seems to be quickly turning into oversupply. In Qualcomm’s recent fiscal fourth quarter results, guidance for 3G/4G/5G handset volumes was “year-over-year low-double digit percentage decline," which doesn't bode well for Taiwan Semiconductor in the near-term.
Taiwan Semiconductor’s CEO C. C. Wei, predicted there would be an overall decline in the industry next year on a recent conference call, but Taiwan Semiconductor’s dominant position in the supply chain gives it some breathing space. Wei said Taiwan Semiconductor’s “longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry."
Geopolitical risks
Another reason Taiwan Semiconductor’s valuation might be cheap is the geopolitical situation between China and the U.S. Out of its 17 semiconductor fabrication plants, two are in China, one is in the U.S. and the rest are in Taiwan. The U.S. government’s passing of the Chips and Science Act on Aug. 9 provides subsidies to companies making chips in America, and more recent legislation prevents American businesses from selling high end chips to China that could be used for military or artificial intelligence ends. This could mean Taiwan Semiconductor will have to stop production on advanced chips designed by Chinese companies, and last year, Taiwan Semiconductor had 10% of its revenue coming from China from companies like Alibaba (BABA, Financial). Taiwan Semiconductor earned 65% of revenue from North American and 6% from Europe last year. We’re already seeing Nvidia designing lower power chips to comply with the sanctions.
That said, Wei on the analyst conference call said “The impact [of regulations] to Taiwan Semiconductor is limited and manageable,” but “for the longer term, it’s too early to really assess all the true impact or influence” (of the sanctions).
The positive side of the U.S. Chips Act is there is nearly $40 billion in incentive payments for chip manufacturing. Taiwan Semiconductor should collect some of these subsidies. That’s because the Taiwanese company is building a $12 billion plant in Arizona that will be ready in 2023. Originally due to produce less advanced chips than those produced in Taiwan, Taiwan Semiconductor has just announced the Arizona facility will make the top-spec 3 nanometer semiconductors. This makes Taiwan Semiconductor more insulated to any future supply chain disruptions.
Buffett's semiconductor history
Buffett has invested in semiconductor stocks previously. Most notably, he bought large stakes in Intel (INTC, Financial) in 2011 and 2012, though he didn’t hold the stock long. Intel was once the leading semiconductor manufacturer, but it fell behind as Taiwan Semiconductor was able to produce chips cheaper and more efficiently.
