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Taiwan Semiconductor Manufacturing Company

Taiwan Semiconductor Manufacturing Company. Analysts: JeBang Ahn, Michael Chen, Brian Chung, Eric Sanchez, Sapan Shah. Agenda. Case Overview Country Risk Analysis Company and Industry Overview Market Analysis Financial Analyses Ratios Discounted Cash Flows Comparable Companies

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Taiwan Semiconductor Manufacturing Company

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  1. Taiwan Semiconductor Manufacturing Company Analysts: JeBang Ahn, Michael Chen, Brian Chung, Eric Sanchez, Sapan Shah

  2. Agenda • Case Overview • Country Risk Analysis • Company and Industry Overview • Market Analysis • Financial Analyses • Ratios • Discounted Cash Flows • Comparable Companies • Black-Scholes Options Pricing • Conclusions • Questions & Answers

  3. Case Overview “Things are not always as they seem”

  4. Managed Funds Performance • Mutual funds investing in technology and science stocks have plummeted 43% in 2002

  5. Case Overview • Assist investment manager in determining whether to invest in Taiwan Semiconductor Manufacturing Company • Is the current stock price an attractive entry level for investors? If so, • Decisions to make – invest in equity (Taiwan or ADR), or wait and purchase call options • Does the Shanghai foreign direct investment add to the Company’s intrinsic value?

  6. Agenda • Case Overview • Country Risk Analysis • Company and Industry Overview • Market Analysis • Financial Analyses • Ratios • Discounted Cash Flows • Comparable Companies • Black-Scholes Options Pricing • Conclusions • Questions & Answers

  7. Taiwan

  8. Country Overview • Taiwan, Republic of China • Governmental System • Multiparty democratic regime headed by popularly-elected president (Chen Shui-bian) • Major Political parties are the Democratic Progressive Party (DPP), Kuomintang (KMT), and People First Party (PFP) • GDP: US$ 281,300 Million • Current Account Balance: US$ 18,861 Million • Foreign Reserves (excl. gold): US$ 122,211 Million • External Debt: US$ 18,900 Million • Inflation Rate: 0.5% - Figures for 2001

  9. GDP Growth

  10. Export Partners

  11. Country Risk Analysis • Political • Alleviated political tension with Mainland China • Government (DPP) strongly advocates for foreign investment • Alliance between Kuomintang and People First Party looks promising in next Presidential election in 2004 • Economic • Strong Current Account Balance and Foreign Reserves • Free and liquid capital market with high trading volume • To stabilize market, daily price fluctuation is limited: • Stocks and convertible bonds: 7% • Bonds: 5% …of the closing price of the preceding business day

  12. Country Risk Analysis • Intangibles • Chairman/CEO Morris Chang • Advice is highly regarded and valued by the government as well as business sphere • In 1985, Taiwanese government recruited him to head its Industrial Technology Research Institute (ITRI) • Ph.D in Electrical Engineering from Stanford University • Masters in Mechanical Engineering from M.I.T. • Board of Directors of Goldman Sachs • Cognizant of corporate governance issues

  13. China

  14. Country Overview • China • Population: 1,273 Million • Governmental System • Communist State • President and vice president elected by the National People’s Congress for five-year terms (President Hu Jintao) • GDP: US$ 1,159,000 Million • Current Account Balance: US$ 17,400 Million • Foreign Reserves (excl. gold): US$ 215,600 Million • External Debt: US$ 147,700 Million • Inflation Rate: -0.8% (2002 E) - Figures for 2001

  15. GDP Growth

  16. Export Partners

  17. Country Risk Analysis • Political • Admittance to WTO has led to further liberalization of rules and statutes • Current President Hu Jintao and his predecessor Jiang Zhemin have embraced western ideals (i.e. FDI) • “Roach Motel” – strict capital controls has created difficulty in ceasing operations if deemed unprofitable • Economic • Utilized considerable foreign reserves in maintaining a constant currency exchange rate • Focus on infrastructure development (soft-budget policy) • Currently improving Mergers & Acquisitions regulations

  18. Exchange Rate Stability

  19. Agenda • Case Overview • Country Risk Analysis • Company and Industry Overview • Market Analysis • Financial Analyses • Ratios • Discounted Cash Flows • Comparable Companies • Black-Scholes Options Pricing • Conclusions • Questions & Answers

  20. Company Overview • Leading dedicated Integrated Circuit (IC) foundry • IC used for microprocessors, graphics chips, wireless communications platforms and programmable logic devices • Currently operates 7 wafer fabrication plants and 3 joint ventures • Major customers include: • Altera, Nvidia, Motorola, Texas Instruments, and others • Listed on: • Taiwan Stock Exchange (TW 2330) • New York Stock Exchange (NYSE: TSM ADR)

  21. Company Overview

  22. Company Overview • Sales • FY 2001 = 125,885 • FY 2002(E) = 158,645 • FY 2003(E) = 192,817 • Net Income • FY 2001 = 14,483 • FY 2002(E) = 22,755 • FY 2003(E) = 33,189 - Figures in New Taiwanese Dollars (Millions)

  23. Regional Sales

  24. Industry Overview • Integrated circuits are semiconductor wafers containing resistors, capacitors, and transistors • Used for a variety of devices, including microprocessors, audio and video equipment, and automobiles • TSMC has grasped approx. 60% of IC market • Pure-play competitors’ market share:

  25. Industry Overview • Current state • Slow growth due to excess production in the late 1990’s, leading to high inventory levels • Scaled back capital expenditures • Pricing pressure due to market over-saturation • A leading source of growth is the wireless communications sector, which is a significant portion of the Company’s revenues

  26. Agenda • Case Overview • Country Risk Analysis • Company and Industry Overview • Market Analysis • Financial Analyses • Ratios • Discounted Cash Flows • Comparable Companies • Black-Scholes Options Pricing • Conclusions • Questions & Answers

  27. 5-Year Stock Chart

  28. Earnings Per Share

  29. Price/Earnings

  30. Market Analysis • Book-to-Bill Ratio has been below one over the past year • Measures the orders shipped to new orders received • However, there are signs of life • Investor Sentiment • Suspicious in regards to high-technology stocks • Poor performance of competitors in the industry • Should the investment manager invest in the Company’s Common Stock or ADR?

  31. Taiwan Trading Volume

  32. US Trading Volume

  33. Analyst Recommendations

  34. Agenda • Case Overview • Country Risk Analysis • Company and Industry Overview • Market Analysis • Financial Analyses • Ratios • Discounted Cash Flows • Comparable Companies • Black-Scholes Options Pricing • Conclusions • Questions & Answers

  35. Ratios

  36. Industry Sales Growth

  37. Sales Growth Determination • Used a 4.70% growth rate for 2005-2007 • 2002-2004 I/B/E/S estimates relatively high, as Company benefits: • Status as industry leader • Continued trend towards outsourcing • Businesses expected to replace information technology components • High growth rate is not expected to continue: • Company already possesses a sizable portion of IC market • Industry consolidation is expected, increasing competition for a currently stagnant industry

  38. Pro Forma Cash Flows

  39. Shanghai Mfg. Facility • Will be used to manufacture 8-inch wafers • Cost of Goods Sold Implications – lower direct labor costs, tariff reductions and tax breaks • Cost of Factory = NT$ 31,214 Million • Sources of Funds: • Cash = NT$ 12,896 Million • Leverage = NT$ 14,530 Million • Retained Earnings = NT$ 3,789 Million • Exchange Ratio = 34.8 NT$/US$ • Assumptions: • Interest rate = Company’s Cost of Debt • Tax Rate = 15%

  40. International Cost of Capital • Goldman Integrated Model for Cost of Equity • US Risk-Free + Sovereign Yield Spread + Beta (World Historical Risk Premium) • Beta (ADR relative to S&P 500) = 0.9 • US Treasury 10-Yr Bond Yield = 3.96% • Taiwanese Government 10-Yr Bond = 2.16% • S&P 500 Historical Returns = 8.00% • Cost of Equity = 5.80%

  41. International Cost of Capital • Cost of Debt calculated through Altman Z-Score • Altman Z-Score: 3.25+6.56*X1+3.26*X2+6.72*X3+1.05*X4 • X1 = Working Capital / Total Assets = 0.10 • X2 = Retained Earnings / Total Assets = 0.10 • X3 = EBIT / Total Assets = 0.03 • X4 = Book Value / Total Liabilities = 3.11 • Comparable Bond Rating = AA+

  42. Adjustment of Altman Score • No adjustment for foreign currency fluctuation • Low vulnerability of revenues (73.3% of revenues outside Asia) • No adjustment for industry risk • Very low leverage industry • No adjustment for competitive position • Leading player, but not considered dominant due to competition • +2 adjustment for Market vs. Book Value • Market Cap (NT$ 875,275 Million), Book Value (NT$ 295,853 Million)

  43. Adjustment of Altman Score • No bond specific adjustment • Some unsecured debt outstanding, but unsure about contingencies (collateral, guarantees) • No sovereign risk spread adjustment • Taiwanese yield slightly lower than comparable US Bond yield

  44. Debt Rating Conclusion • EM Adjustment suggests AAA • Company Rating on Taiwan Ratings Agency (Affiliate of Standard & Poor’s) = AA+ • We, conservatively, used AA+ as the credit rating for the Company • Cost of Debt = 3.06% • Taiwan Government 10-Yr Bond Yield = 2.16% • Bridge spread for AA+ Bond = .90%

  45. WACC Assumption • Weighted Average Cost of Capital = 5.28% • Assumptions: • Constant Debt/Equity Ratio of .19 • BV of Equity (from Company) = NT$ 295,853 Million • Projected Debt = NT$ 56,343 Million

  46. Discounted Cash Flows • Three cases: • Case 1: Precedent Transactions Multiple • Case 2: Technology Industry Multiple • Case 3: Gordon Growth Model

  47. Case 1 DCF • Used 3 mergers & acquisitions transactions to determine EBITDA Multiple to be applied • Target companies integrated circuits manufacturers • Min PP/EBITDA Multiple of 12.19x • Implied value per share = NT$ 112.06 • Implied value per share (ADR) = US$ 16.12

  48. Case 2 DCF • Technology industry multiple used to calculated terminal value • Typical PP/EBITDA Multiple = 7.00x • Implied value per share = NT$ 75.95 • Implied value per share (ADR) = US$ 10.93

  49. Case 3 DCF • Gordon Growth Model to calculate terminal value • TV = FCF/(WACC – LT Growth) • LT Growth Rate = 2% • Implied value per share = NT$ 223.43 • Implied value per share (ADR) = US$ 32.24

  50. DCF Conclusion • DCF Range of Values: • Based on Taiwanese Stock: NT$ 75.95 – 223.43 • Based on US ADR: $10.93 – 32.24 • Current Price Per Share: • Taiwanese Exchange = NT$ 47.00 • New York Stock Exchange = $ 8.18 “The Force is strong with this one” - Star Wars

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