Download TSMC Case - NYU Stern School of Business

The Case
Taiwan Semiconductor Manufacturing Company
1
John Kim had just been appointed as the fund manager for Bank of Korea’s newly unveiled Emerging
Markets Technology Fund. The management of the Bank had high expectations for both John and the
Fund, considering the lack of performance by the two other funds managed by the Investment
Management Division (IMD), which was based in New York City. With worldwide mutual fund returns
dwindling, management was hoping that strong returns by the Technology Fund would help the Bank
garner larger institutional investors.
John had been a high performer in IMD for some time. Having earned his MBA degree at the prestigious
Leonard N. Stern School of Business at New York University, he had accepted a position as a Research
Associate upon graduation. As an associate, John had a history of identifying and analyzing undervalued
companies in the emerging markets sectors. His work had been instrumental in the investment strategy
of fund managers in the IMD division. But because the two previous funds were devoted more towards
stable growth industries, his analyses had not been maximized. The Bank hoped to leverage his
exceptional skills through the new fund, which would focus on Technology and Biotechnology companies
publicly traded in Emerging Market Countries. Though other Technology Funds managed by other
financial institutions had not faired well since the year 2000, management had different expectations for
this Fund primarily due to John’s history of comprehensive analysis. Though he would have a small staff
under his authority, it was understood that John would have an influential role in the due diligence
process prior to investment.
Over the years, John had been intrigued by the Taiwan Semiconductor Manufacturing Company (TSMC),
which was traded on the Taiwanese Stock Exchange (TW: 2330) and the New York Stock Exchange
(NYSE: TSM) as an American Depository Receipt (Stock Chart: Appendix A). It was widely known that
TSMC was one of the leaders in the manufacturing and testing of integrated circuits. Due to the
technology bubble in early 2000, the Company’s stock price had been depressed both on the Taiwanese
and New York markets. Though he was aware that most research analysts had rated the Company as a
“Buy”, he could not comprehend why the price per share had been less than half of its February 2000
high of NT $111.10. He figured that the price depression was due to investor caution regarding
technology equity and the worldwide economic conditions rather than the Company’s operations itself.
Regardless of consolidation by competitors and decreased demand, the Company continued to hold a
dominant share of the market. Furthermore, John had read in the Wall Street Journal that the Company
had been approved for foreign direct investment in Shanghai, China in the form of a manufacturing
facility, which would surely decrease tariff constraints and lower the Company’s Cost of Goods Sold
margin when operational.
John therefore intended to study the Company in more detail. He would perform valuation analyses to
confirm his premonition that TSMC was indeed undervalued. He was interested in the Shanghai
manufacturing facilities’ implications on operations and cash flows. With an initial capital base of $1
billion allotted to him by the Bank, he hoped to hold a large position in the Company, which would be the
basis upon which he would build the Fund.
Overview of TSMC:
Taiwan Semiconductor Manufacturing Company (TSMC) is the leading dedicated integrated circuit (IC)
foundry. The Company manufactures chips used across the entire IC application spectrum, including
microprocessors, graphics chips, wireless IC communications platforms and programmable logic devices.
The Company offers a broad spectrum of processes, such as logic, mixed-signal/RF (radio frequency),
embedded memory, color image sensor and high-voltage process technologies. These processes are
transferred to volume production, where they are used as platforms for computing, graphics,
communications (network and wireless), industrial and consumer electronics applications. TSMC has
developed a service organization featuring sophisticated design services, mask making and wafer
probing capabilities, as well as third-party alliances that match the Company and its customers with
developers of electronic design automation tools, libraries, intellectual property cores and assembly and
testing services. The Company’s major customers include ATI, Altera, Broadcom, Nvidia, Marvell,
Motorola, Texas Instruments, and VIA.
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TSMC currently operates seven large wafer fabrication plants and three joint-ventures, with a Yr. 2002
expected manufacturing capacity of 3.9 million 8-inch wafers.1 The revenue breakdown, classified in
terms of IC technology and application, is as follows:
1
Merrill Lynch Research Report, Dated March 17, 2003.
3
Source: Company’s Year 2001 20F Statement, Filed With US SEC.
Though the Company is based in Asia, much of its revenues come from other parts of the world, with a
negligible portion coming from Mainland China, as per conversations with TSMC’s investor relations
personnel.
Source: Company’s Year 2001 20F Statement, Filed With US SEC.
The Company also boasts a dominant percentage of the integrated circuits market relative to its
competitors, the largest of whom are United Microelectronics (UMC) and Chartered Semiconductor, both
of whom are listed on the New York Stock Exchange.
Source: Company Website
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The Company’s audited financial statements, constructed in accordance with US General Accepted
Accounting Principles (GAAP) can be seen in Appendix B, along with a summary of recent press releases
issued by the Company.
Integrated Circuits Industry:
An integrated circuit (IC), sometimes called a microchip, is a semiconductor wafer on which tiny resistors,
capacitors, and transistors are fabricated upon. Integrated circuits are used for a variety of devices,
including microprocessors, audio and video equipment, and automobiles.
In the current environment, chip foundries continue to suffer from the excesses of the late 1990’s. With
excess capacity and pricing pressure, no recovery seems in sight. Asia-based foundries supply chips to
the PC, consumer, and communications sectors. In fact, many PC makers have scaled back orders in
order to purge the excess inventory from last year’s sluggish back-to-school and Christmas seasons.
One pocket of strength is the wireless communications sector as demand for wireless LAN chips is still
high. Since it is difficult to determine when the demand will pick up, S&P suggests investors and
speculators to avoid foundry stocks.
According to industry observers, excess capacity is likely to persist and may even get worse, keeping
capacity utilization rates significantly below average. For the first quarter of this year, TSMC expects only
60% of its facilities to be running, compared with 61% in the fourth quarter of 2002 and 79% in the third.
United Microelectronics Corp (UMC), also based in Taiwan, expects capacity utilization of only 60% in the
first quarter of this year, compared with 64% in the fourth quarter of 2002. Furthermore, both companies
have slashed their 2003 capital budgeting plans. TSMC indicated it will invest between US$ 1 billion and
US$ 1.5 billion, down from US$ 1.65 billion in 2002. UMC will cut its budget to US$ 500 million from US$
800 million.2
However, there does seem to be light at the end of the tunnel. TSMC recently said that it remains
confident in the long-term development of the global wafer foundry industry. The world's biggest contract
chipmaker sees a recovery for the industry starting from the second quarter of this year, 2003.
Shanghai Manufacturing Facility:
John had completed an extensive, follow-up research analysis on the article he had read in the Wall
Street Journal. TSMC had been granted the manufacturing facility and has been making preparation for
construction by China and Taiwan. Though the respective countries have been rivals since the creation
of an independent Taiwan, back-channels have always remained open between the two countries. Over
the past decade, there has been significant capital inflow into China from Taiwan. Various businesses
from the Island have invested US $50 Billion across the strait, often through third country entities to avoid
legal and political hurdles. In fact, towns up the Pearl River Delta have been nicknamed “Little Taipeis”.
The Taiwanese Government has granted permission for high-tech companies to legally and directly invest
in China, which will directly benefit the Company. The facility will not be devoted primarily to its Chinese
operations, for Mainland sales is currently minimal, at best. China offers the ability to manufacture more
cost-effectively through its surplus of low-cost labor. Current tariffs on semiconductor imports will be
reduced from a rate of 17% for imports to 3% for chips manufactured locally. Unlike some existing
foundries, the facility will be a wholly owned subsidiary, rather than a joint venture with the Chinese
government. The Company will solely hold intellectual property rights and will be able to operate more
efficiently and effectively through its autonomy. Furthermore, the Company would secure the first-movers
advantage and would benefit considerably relative to its competitors (United Microelectronics (UMC),
ProMOS Technologies and Powerchip Semiconductor have indicated interest in direct investment in
China).
2
PlanetAnalog.
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After much research, John had discovered the cost structure for the new manufacturing facility. The total
cost of the facility will be US $898 million, with the funds coming from the following sources:



US $371 million will be taken from the Company’s cash balance;
US $418 million will be provided by financial institutions in the form of debt; and
US $109 million will come from retained earnings.
Investment Environment:
As a seasoned professional in regards to capital investment in the emerging markets, John has some
reservations in regards to the political, economical and social environment of both countries. He is quite
aware that Taiwan is possibly one of the most open and free economies in Asia, but is unsure of the
intricacies of investment in the country. John is unsure of the implications of a large investment in a
national company and whether the economy is liquid enough to handle a position of great magnitude
(capital controls, inefficiencies, etc.). As a fund manager, he must be able to buy and sell positions
readily to maximize returns for investors. He is likewise skeptical of China; though the country has
become a more open economy over the past decade, as evident in its membership to the World Trade
Organization (WTO), there is much uncertainty in regards to the intentions of the Communist government.
He commissions his chief economist to analyze the respective countries on a macro- level so that he may
make a more informed decision. (See Appendices E – G For Economic Data). The report is attached
below.
Taiwan – Macroeconomics:
Asian Financial Crisis and the 1990s The past decade had been a period filled with achievements for Taiwan. Politically, it transformed from
an authoritarian government into a true democracy; economically, Taiwan has prospered into a US $258
billion economy. Taiwan has established itself as the world’s twelfth largest trading power, and currently
has a multi-billion dollar annual trading relationship with the United States, Japan, Germany, Korea,
France and a number of other countries. In addition, Taiwan is a producer of advanced manufactured
products, including semiconductors (TSMC, UMC), computers (Acer, Quanta, Asustek), and steel (China
Steel).
Like most Asian countries, Taiwan could not avoid the effects brought by the Asian Financial Crisis in the
mid-1990s. However, the country fared well during this period of turmoil, and its economic performance
was fairly stable relative to other Asian countries, such as Thailand and Indonesia. Most countries saw
their respective stock indices slip at least 16%; however, Taiwan witnessed an increase in its stock index
(Taiwan Weighted Index) by 9.97% during this period. Aggregately, share prices and currency only
dipped approximately 4.71% in Taiwan, compared to 95.62% in Indonesia and 69.42% in South Korea.
This phenomenon was considered a direct contribution to the region’s stability, and was a result of
several underlying factors.
Taiwan’s economy had robust fundamentals, such as its persistent surpluses on both trade account and
balance of payments. In 1996, Taiwan ran a surplus of US$ 11 billion, or 4.7% of GDP on current
account, though in 1997 it declined to US$ 5.1 billion, or 2.3% of GDP. Moreover, the country has never
relied excessively on foreign capital for economic development (see chart below). The savings rate has
steadily declined from a peak of 38.5% in 1987 to 24.4% 1997, but remained higher than the investment
rate. Public external debt was very limited, less than US$ 100 million at the end of 1997. Moreover,
Taiwan's foreign exchange reserves have been ahead of most countries for many years. Another
important factor is that Taiwan’s financial institutions have been known for their soundness and prudence.
Banks’ exposure to risk has been effectively kept in check with good governance and cautious loan
approvals. In addition, foreign capitals flowing into Taiwan are mostly for direct investment in production
activities, and less into the stock market or real estate (see chart below).
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Sources: Taiwan Institute of Economic Research
Accession Into The World Trade Organization (WTO) Being a strong candidate for WTO membership, Taiwan’s GDP stands at an impressive US $258 Billion,
positioning the country as the world’s 13th largest economy. Taiwan is also the world’s 12th largest
trading power. In 1998, the country’s international trade totaled more than US $216 Billion; import from all
sources was worth US $105 billion. More importantly, from the perspective of the WTO and its trading
partners, Taiwan has proven itself a responsible trading power. In the last decade, the country has
greatly liberalized its trading system; tariffs and non-tariff measures (NTMs) have come down and
protection of intellectual property has improved to a level consistent with other developed countries.
There are still areas in Taiwan’s trading regime which could be improved, but the economy is already
more open than that of most of its Asian neighbors. Unlike the People’s Republic of China (PRC) and
many current members of the WTO, Taiwan’s trading regime is already in compliance with the provisions
of the WTO.
Upon accession into the WTO on January 1st, 2002, Taiwan agreed to undertake a series of additional
trade-liberalizing measures that will open billions of dollars in new trade opportunities annually for its
trading partners. Taiwan’s largest trading partners, such as the United States and Japan, are currently
enjoying a substantial share of these new opportunities, but the country is a diversified trader that
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maintains substantial trade relationships with many countries. These trade partners, along with countries
not currently trading with Taiwan, will likely enjoy additional export opportunities.
Current Economy Taiwan has a dynamic capitalist economy with gradually decreasing guidance of investment and foreign
trade by government authorities. In keeping with this trend, some large government-owned banks and
industrial firms are being privatized. Real growth in GDP has averaged about 8% during the past three
decades. Exports have provided the primary impetus for industrialization, and the trade surplus is
substantial, while foreign reserves are the world's third largest. Agriculture contributes 2% to GDP, down
from 35% in 1952. Traditional labor-intensive industries are steadily being moved offshore and replaced
with more capital- and technology-intensive industries. Taiwan has become a major investor in China,
Thailand, Indonesia, the Philippines, Malaysia, and Vietnam; 50,000 Taiwanese businesses are
established in China. Because of its conservative financial approach and its entrepreneurial strengths,
Taiwan suffered little compared with many of its neighbors from the Asian financial crisis in 1998-99. The
global economic downturn, however, combined with poor policy coordination by the new administration
and increasing bad debts in the banking system, pushed Taiwan into recession in 2001, the first whole
year of negative growth since 1947. Unemployment also reached a level not seen since the 1970’s oil
crisis.
Financial Environment For the past decade, Taiwan has successfully taken steps to liberalize its economy and improve its
investment environment in order to continue its successful goals as a member nation of the WTO and is
developing the island into an Asia-Pacific regional operations center. Cross-strait tension in 1996 and
East Asian financial turmoil since the middle of 1997 have not deterred foreign investors from coming to
Taiwan, as foreign firms investing in Taiwan are generally accorded national treatment, and trade-related
capital flows are basically unrestricted. Most export-performance and local-content requirements have
been removed, while foreign-ownership limits remain although they have been substantially loosened.
Portfolio investment has been opened to both institutional and individual foreign investors, but foreign
investors are still subject to both restrictions on investment funds and limits to ownership. Taiwan has a
comprehensive legal system that protects foreign investments and property rights and ensures fair
competition.
Taiwan – Political Condition:
Government Taiwan’s government is a multiparty-democratic regime headed by an elected president with a
unicameral legislature. Since 1912, Taiwan has been controlled by the country’s strongest and oldest
party, the KMT (Nationalist Party); however, with Mr. Chen Shui-bian’s victory in 2000 as the second
largest party’s presidential candidate, the DPP (Democratic Progressive Party) has taken over the
government. Not surprisingly, with the Party’s original policy platform calling for the establishment of an
independent Republic of Taiwan, China has been opposing the DPP and is more reluctant to negotiate
with the current government. It was widely feared in Taiwan that the often-tense cross-Strait relationship
would become even more difficult if ever the main opposition DPP were to win power. So it was to the
relief of many that the election in 2000 was not accompanied by a crisis in cross-Strait relations. That
said, modern Taiwan’s first non-KMT government hardly got off to a smooth start—in the second half of
2000 the island suffered from an unprecedented degree of domestic political instability. This was partly
related to the DPP’s lack of experience in possessing national executive power, but was also because the
Legislative Yuan (parliament) remained under the control of the KMT. However, the political instability
has since settled, particularly after the KMT was clearly defeated in the December 2001 legislative
election. But a return to the stability of the past is not expected—although the DPP is now the largest
party in the Legislative Yuan, it still does not enjoy a majority.
Security Risk Mainland China presents the largest security threat to the country. Although the military threat posed by
China is real, most people believe that a full-scale cross-Strait confrontation is not expected to erupt.
China views Taiwan as a renegade province, and its “unification” has been publicly regarded with great
importance, not just by the leadership in Beijing, but also by many people in China. The Chinese
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authorities have refused to rule out using force to achieve this goal, traditionally saying that they would
attack only if provoked by a foreign force invading Taiwan, or if Taiwan indefinitely rejected reunification.
China’s seriousness is evident as it retains missiles aimed at the Island and has built up and armed its
navy. In the run-up to Taiwan’s first direct presidential election in 1996, China undertook extensive
military exercises in the Taiwan Strait, even firing (unarmed) missiles just 40 km off Taiwan’s main port of
Kaohsiung. To defend itself, Taiwan has a well-armed military and may be able to rely on support from
the US in the event of a Mainland attack. Under the terms of the Taiwan Relations Act (TRA) of 1979,
which forms the basis for Taiwan-US relations, any military action, boycott or embargo against the country
would be considered “of grave concern to the US”.
Investment In China Although the government did announce in March of 2003 that it would allow local semiconductor
companies to invest in the Mainland, the liberalization was cautious. Officials have said that they will
approve only three such applications before 2005, with production limited to eight-inch wafer fabs, the
industry standard. Furthermore, firms wishing to establish facilities on the Mainland must show that they
have been producing more advanced 12-inch wafers in Taiwan for at least six months.
China – Macroeconomics:
The Chinese economic momentum over the past decade may be unequalled as compared to other
developing countries in the world. Though the Asian Currency Crisis in the mid-1990s and the current
global economic stagnancy have had its devastating effects, China continues to grow at robust rates due
to the commendable efforts of the political institutions. The past decade has seen the aggressive use of
fiscal and monetary policies, reform of stringent regulations, privatization of previously state-owned
entities (SOEs) and increased emphasis on foreign direct investment to abate much of the effects of
various worldwide shocks. The recent entrance into the World Trade Organization (WTO) has continued
to shape the country from its pre-1990s protectionism. Though exchange rate risk and deflation is still a
major concern, the country has faired well relative to its neighbors and is forecasting continued economic
growth in the foreseeable future. Nevertheless, one must not conclude China as a free economy just yet,
for the government continues to exercise considerable control over private enterprises.
Asian Crisis and the 1990s The dampening of the Asian economies in the mid-1990s could be attributed towards the currency crisis
that had stretched across the continent. Deflation and exchange rate risk in the form of appreciation
relative to other currencies prevailed. For China, reduced competition and demand for products in favor
of other Asian countries resulted in plant closures and widespread layoffs and a high unemployment rate.
Output and income decreased, resulting in a change from pre-Crisis trade deficit to surplus primarily due
to the unwillingness of the public to purchase goods. The government severely reduced insurance
benefits (education, health and retirement expenses), resulting in a need for personal savings, placing
more stress on consumption. The real interest rate rose from –4.8% (1995) to 7.2% (1998), as there was
increased capital outflow to the more developed countries. Investment in China was precluded and there
was a demand for an increased market premium to compensate for the considerable economic risk.
Furthermore, with large liabilities in the form of foreign-denominated debt, domestic firms and institutions
defaulted on payments, placing more burden on the rough conditions.
But China emerged relatively unscathed (though it was hit hard) as compared to its neighbors due to the
various policies that the government enacted. It was decided that currency risk would be reduced
through parity with the US dollar via monetary policy (notice stability in chart below). Foreign currency
reserves were employed to combat currency appreciation. Though there was a decrease in the growth of
the country’s reserves at the time, China’s robust treasury provided the necessary means towards
currency control. Much like the United States in the early portion of the 21st century, the Chinese officials
decreased the interest rates to exert spending. Minimum wages and the salaries of public sector workers
were increased. As part of its fiscal stimulus and soft budget policy, there was increased spending by the
government through infrastructure development (roads, telecommunications, etc.). But government
consumption began to preclude private investment; though the soft budget policy was adopted to fuel
spending, it ironically increased the country’s real interest rates.
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Exchange Rate Fluctuation
(RMB Per Unit Of Currency)
100.25
100.00
99.75
99.50
US Dollar
HK Dollar
99.25
1997
1998
1999
2000
2001
Source: National Bureau of Statistics, China Statistical Yearbook 2002.
The Chinese government soon realized that privatization and foreign direct investment could be the
answer to their economic woes. There was an increased emphasis on reform and a mobilization of
previously public entities towards the private domain, with foreign direct investment increasing
tremendously through the mid-1990s due to the authorization of wholly-owned foreign enterprises in the
manufacturing sector, with much of the capital influx coming from Taiwan (see charts below for foreign
investment in China). Initially, foreign investment was limited to Special Economic Zones (SPZs). The
cities within these SPZs were vested with the authority to approve projects valued up to US$ 30 million,
with the state department reserving the discretionary power to approve investments exceeding the
threshold. The long-term plan of the Chinese was to sell off all, or a portion, of SOEs to the public, with
the Communist Party restricting sales of certain industries posing “national security” issues, such as
telecommunications and mass media. The government established special preferences for projects
involving high technology and export-oriented investments (transportation, communications, energy,
metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment and
electronics, etc.). The housing market was liberalized and the private ownership of property was
sanctioned. The Party retained the ability to approve economic policies and management appointments
of financial institutions and enterprises.
To encourage investment, the governments provided tax rebates and incentives, essentially creating a
two-tiered corporate tax system benefiting the foreign companies over domestic enterprises. The foreign
investments were also rewarded for reinvestment of profits with 40% refunds paid on its share of income
taxes if such profits were reinvested for at least 5 years; special preference entities were able to collect
full rebates. Due to the government’s concentration on attracting the manufacturing sector, China has
become oversaturated and possesses excess capacities in certain industries, leaving the country
relatively underdeveloped in the service sector. But the country has gained competitive dominance in
manufacturing. Due to poor infrastructure and controls, investment tailed off in the latter 1990s, only to
be revived again by the return potential due to China’s entrance into the World Trade Organization, the
relaxing of administrative barriers, and the ability to invest in previously restricted areas. But there still
remains continued opportunities for privatization; of the 171,256 industrial enterprises with sales in
excess of RMB 5 million (US $600,000) registered in 2001, 46,767 are inflicted with some state
intervention either through complete or partial ownership.
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Source: The Economist
Accession Into The World Trade Organization (WTO) Negotiations for China’s entrance into the WTO solidified in 1999. The US-China Bilateral Market Access
Agreement on November 15, 1999 was a landmark treaty that opened the previously protectionist
economy. This event is quite crucial towards the further development of the Chinese economy, for with
the introduction of the rule of law in the multiple trade agreements between member countries, there
could be further liberalization of the economy.
Through the WTO, trade restrictions in the form of import quotas and tariffs have been reduced. The
prohibitive value-added tariff (VAT) is an additional tax levied towards domestic and foreign companies
engaged in the import-export, production, distribution or retail activities. At the current time, the general
VAT rate stands at 17%, with necessities (such as agriculture and utilities) taxed at 13%. Small business
(typically enterprises with production sales of less than RMB 1 million or annual wholesale/retail sales of
less than RMB 1.8 million) are subject to a 6% VAT rate, but unlike the larger business, may not be
entitled to tax credits on such payments. There is hope that the VAT rate could be lowered even further
through discourse and engagements with other nations, enabling increased trade. With a reduction of
protectionist and monopoly-sustaining policies, China could continue to be a dominant competitor in the
international markets, thereby benefiting the people.
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Current Situation The global economic downturn of the 21st century continues to plague China, with demand for domestic
products still low. Deflation carried from 2001 into 2002. The ever increasing income gap between urban
and rural workers pressures consumption and investment. To sustain growth and job creation, monetary
policy continues to control interest rates at reasonable levels. But with strong present and future growth,
estimated conservatively at 8-13%, interest rates should be kept constant at current levels. In July 2001,
the government civil servant wage was increased for a fourth time. As of June 2002, foreign reserves are
estimated to be at US $242.8 billion, enabling the government to minimize exchange rate risk.
Continued soft budget fiscal policies, led by government spending on infrastructure, capital construction,
education, social security and pension payouts, has been the primary means for fiscal stimulus over the
past 5 years. But with decreased governmental revenue from reductions in corporate taxes, tariffs and
stamp duty, there is an increasing strain on the ability for the government to spend. Debt has become the
most effective capital raising instrument. Treasury bonds valued at RMB 592.9 billion and “special bonds”
valued at RMB 140 billion have been issued. As of June 2002, external debt reached US $139 billion, of
which 31% was designated as short term liabilities, presenting further liquidity issues.
To encourage more foreign investment, the government is taking on corporate governance and mergers
& acquisitions regulation reforms. The Chinese Association of Certified Public Accountants is developing
greater controls in the accounting industry to raise the quality of service and instill confidence in figures
reported by the companies. Even the banking industry is changing structure with the June 2002
regulations enacted to facilitate joint ventures in fund management. BNP Paribas Peregrine has already
set up China’s second joint venture investment bank, and such combinations are expected to continue.
With the abundance of both skilled and unskilled labor (unemployment rate at a functional 10-15%), there
remains huge potentials for profit and growth in China.
China – Political Condition:
Chinese Government China has had a Marxist-style party-state for the past 54 years. It has been controlled by the Chinese
Communist Party since the inception of The People’s Republic of China in 1949. Though it remains a
communist country, it has adopted free-market economic reforms since 1978, which transformed the
economic structure of the country and raised the living standards of the people. The National People’s
Congress (legislature) is the state organ that passes laws, treaties, nominates the executive officers, and
approves the constitution. The 2,989 members are replaced every five years and they are elected by
lower-level people’s congress. In the past they have voted against appointees to top leadership and have
registered protest votes against reports of the procurator-general mainly due to corruption. China also
has the Chinese People’s Political Conference which is a powerless forum that provides consultation
between ruling parties and other social and political organizations. Taiwan forms part of this entity but as
mentioned before it is powerless. The State Council, or the cabinet, is elected by the NPC.
In recent years China has moved toward opening trade with Taiwan. In 1993, China began to move
towards improving cross-strait relationships by promulgating the procedures for the administration of
small-volume exchange of goods between the Mainland and Taiwan, which was a big step given that
trade had not occurred between the two for 20 years. In 1997 Deng Xiaoping died, leaving Jiang Zemin
as the new head of China. His government was moving forward towards China’s acceptance into the
WTO but the bombing of the Chinese Embassy in Belgrade by NATO stopped this progress. In 2001 the
NPC revealed an economic plan with acceptance into the WTO as its main goal and achieved this in
December of 2001. In 2002 Jiang retired and Hu Jintao, who is the first senior Chinese official to visit the
Pentagon, has assumed office.
Many specialists believe that Taiwan will, in some form, be united with China. Despite a tense war of
nerves being waged between the two governments, some sort of adjustment seems inevitable. According
to even Taiwanese executives and local residents, from a macroeconomic point of view Taiwan cannot
afford being outside of China. Economically and culturally, the merger is already occurring.
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China – Social Condition:
People China has the largest population in the world, which is considered to be its greatest asset. However, the
government has pursued a rigorous ‘one-child policy’ in order to decelerate the population growth to an
economically manageable level. And this has caused China’s population to age fast—25% of the world’s
population on pension is expected to live in China by 2020. Additionally, the income disparity between
the urban and the rural population is increasing rapidly, despite the government’s effort to hamper such
disparity.
Education In year 2000, the number of illiterate people had fallen to 85 million, or 6.7% of the total population, down
from 180 million (15.9%) in 1990. Though there are great strides toward establishing higher education,
the supply of teachers and other academic personnel is far behind the demand, mainly due to funding
shortages, as illustrated by China’s diminished spending on education which hovers around 2.55% of its
GDP. In contrast, an average developing country spends about 4.1% of its GDP on education.
Health Like income disparity, health conditions vary greatly between urban and rural areas. In the rural areas,
this poses a serious threat as no more than 10% of the people have access to public medical facility.
Though the conditions are much better in urban areas, only half of urban population is covered by health
insurance systems. Recently, reported cases of AIDS/HIV infections have been rising rapidly due to lack
of public awareness in the dangers of using contaminated blood.
Infrastructure China’s infrastructure is in the middle of a very rapid transition. There is a great deal of effort in
expanding the railway, the highway, and the waterway. According to the 10th five-year plan, a further
200,000 kilometers of roads will be built, which will connect 93% of villages across China. Additionally,
China’s telecoms sector is booming—China now boasts more subscribers for cable television (100
million) and mobile phones (145.2 million at end-2001) than the US. By as early as 2010, all urban
households will have access to broadband multimedia.
Natural Resources Despite its enormous land mass, there is a severe scarcity of arable land. The availability of cropland per
capita remains below the world average, due to the loss of land to urban construction needs. However,
China ranks top in world production of certain minerals, including phosphate, tungsten, molybdenum and
titanium. The country is also the world’s largest producer of coal.
Considerations:
Having received an extensive report on the macro-environment of China and Taiwan, John focuses his
attention on the valuation analyses for TSMC. Because of his many responsibilities as the fund manager,
he calls into his office his financial analysts. John prefers to have much information before his final
decision; therefore, he asks his analysts to perform as many analytical procedures at their disposal. In
addition to determining the intrinsic value of the Company on a stand-alone basis, John would like to
assess the Company’s value relative to competitors in the integrated circuits market. Because the
financials have been constructed with US GAAP, the integrity of the figures should not be an issue. He
intends to use the analysis in making an informed decision on whether to invest in the Company.
However, he warns his analysts not to make the assumption that he would purchase equity in the
Company based on pure numbers. Though John is bullish on TSMC, unlike his peer fund managers, he
values alternative investment strategies. He indicates that he is willing to purchase derivatives, in the
form of call options, to hedge the risk of purchasing the Company’s equity shares in an uncertain and
volatile economic and capital market. John considers the current market value of July options too high,
rationalizing that the uncertain markets have led interested investors to purchase option rather than the
equity shares.
13
Appendices:
14
Appendix A – Stock Chart:
15
Appendix B – Financial Statements:
Consolidated Balance Sheet (In $NT millions) Year Ended December 31,
1999
2000
2001
CURRENT ASSETS:
Cash and Cash Equivalents
Pledged time deposits
Short-term investments
Receivables - net
Receivable from related parties
Inventories - net
Deferred income tax assets - net
Prepaid expenses and other current assets
Total Current Assets
Long-term investments
Property, plant and equipment - net
Goodwill
OTHER ASSETS:
Rental Assets
Deferred income tax assets - net
Deferred charges - net
Refundable deposits
Assests leased to others
Miscellaneous
Total Other Assets
TOTAL ASSETS
29,517.7
3,161.0
965.4
13,322.0
340.9
7,104.0
2,616.6
2,630.0
59,657.6
38,840.2
2,351.6
27,055.5
948.7
12,785.7
8,178.0
3,034.6
93,194.3
37,556.3
1,398.1
16,452.2
494.7
9,828.3
2,350.1
2,721.4
70,801.1
16,164.7
150,059.9
-
9,814.3
244,747.9
11,531.0
11,599.2
251,287.6
11,437.6
7,006.7
2,380.8
59.4
106.4
9,553.3
625.6
6,629.8
3,335.7
979.1
28.3
11,598.5
16,245.8
3,769.8
784.1
555.1
37.4
21,392.2
235,435.5
370,886.0
366,517.7
Year Ended December 31,
1999
2000
2001
CURRENT LIABILITIES:
Short-term bank loans
Commercial paper payable
Accounts payable
Payable to related parties
Income tax payable
Payables to contractors and equipment suppliers
Current portion of long-term liabilities
Accrued expenses and other current liabilities
Total Current Liabilities
5,026.6
94.8
3,273.9
1,036.4
155.1
12,593.7
1.0
4,208.9
26,390.4
3,833.8
8,507.8
2,606.3
3.3
25,550.3
51.1
6,872.4
47,425.0
6,269.2
1,397.9
1,048.3
12,867.2
5,000.0
6,746.4
33,329.0
LONG-TERM LIABILITIES:
Long-term bank loans
Long-term bonds payable
Total Long-term liabilities
22,743.5
20,000.0
42,743.5
23,339.4
29,000.0
52,339.4
22,399.3
24,000.0
46,399.3
1,013.8
4.4
5,188.7
6,206.9
1,511.3
434.2
3.3
7,097.4
9,046.2
1,856.6
268.2
75,340.8
108,810.6
89,207.3
7,524.2
321.7
120.2
OTHER LIABILITIES:
Accrued pension cost
Deferred gain on sale - leaseback
Lease obligation payable
Guarantee deposits
Others
Total Other Liabilities
TOTAL LIABILITIES
MINORITY INTEREST IN SUBSIDIARIES
7,212.7
141.5
9,479.0
SHAREHOLDERS' EQUITY:
Capital Stock - $10 par value
Issued Preferred
Issued Common
Suscribed Capital
Capital Surplus
Retained Earnings
Unrealized loss on long-term investments
Cumulative translation adjustments
Total Shareholders' Equity
85,208.8
13,118.0
23,951.4
31,382.4
(1,090.1)
152,570.5
13,000.0
116,893.7
57,089.0
75,121.0
(71.6)
(278.4)
261,753.7
13,000.0
168,325.6
57,128.4
37,507.5
1,228.7
277,190.2
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
235,435.5
370,886.0
366,517.7
16
Consolidated Income Statement (In $NT millions) Year Ended December 31,
1999
2000
1998
NET SALES
COST OF SALES
GROSS PROFIT
2001
50,524.5
33,009.3
17,515.2
76,305.1
46,237.4
30,067.7
166,197.6
89,681.7
76,515.9
125,884.9
92,228.1
33,656.8
OPERATING EXPENSES
Research and development
General and administrative
Marketing
Total Operating Expenses
2,314.0
2,128.2
767.5
5,209.7
3,090.8
2,845.3
1,861.6
7,797.7
5,131.5
7,408.1
2,681.6
15,221.2
10,649.0
7,939.9
2,290.1
20,879.0
INCOME FROM OPERATIONS
12,305.5
22,270.0
61,294.7
12,777.8
NON-OPERATING INCOME
Gain on sales of short-term investments - net
Interest
Royalty Income
Insurance compensation - net
Premium income-net
Gain on sales of long-term investments - net
Technical service income
Gain on sales of property, plant, and equipment
Reversal of allowance for losses on shoter-term investment - net
Foreign exchange gain - net
Other
Total Non-Operating Income
11.9
1,111.9
8.3
781.6
3.3
59.6
1,976.6
48.6
1,114.5
184.6
63.8
67.8
4.0
140.1
58.9
1,682.3
1,060.9
1,679.7
1,623.8
640.5
15.1
138.5
62.9
0.7
828.0
177.8
6,227.9
1,619.1
1,486.7
1,301.6
860.8
234.7
105.4
55.1
52.4
759.8
6,475.6
NON-OPERATING EXPENSES
Investments loss recognized by equity method - net
Interest
Foreign exchange loss - net
Loss on sales of property, plant, and equipment
Amortization of issuance costs of bonds
Premium expenses - net
Permanent loss on long-term investments
Provision for loss in short-term investments
Other
Total Non-Operating Expenses
1,400.0
1,191.7
259.5
4.4
143.7
5.8
121.9
99.9
3,226.9
288.5
2,417.0
119.1
164.4
114.8
86.8
31.6
101.8
3,324.0
187.2
2,717.0
114.7
32.7
108.1
461.4
3,621.1
3,959.0
3,144.1
695.6
235.6
12.5
420.1
8,466.9
11,055.2
2,318.4
13,373.6
20,628.3
2,382.8
23,011.1
63,901.5
1,167.9
65,069.4
10,786.5
3,740.7
14,527.2
1,015.6
515.9
36.8
14,389.2
23,527.0
65,106.2
14,483.2
1.35
6.75
2.21
11.04
5.71
28.55
0.86
4.17
10,656.0
2,131.2
10,656.0
2,131.2
11,400.9
2,280.2
16,832.6
3,473.2
INCOME BEFORE INCOME TAX
INCOME TAX BENEFIT
INCOME BEFORE MINORITY INTEREST
MINORITY INTEREST IN LOSS (INCOME) OF SUBSIDIARIES
NET INCOME
EARNINGS PER SHARE
EARNINGS PER EQUIVALENT ADS
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
WEIGHTED AVERAGE NUMBER OF EQUIVALENT ADS OUTSTANDING
(44.0)
17
Consolidated Cash Flows Statement (In $NT millions) -
1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income
Adjustments To Reconcile Net Income To Cash:
Depreciation and amortization
Deferred income tax
Investment loss recognized by equity method - net
Gain on sale of long term investments
Loss on sale of properties - net
Reversal of provision for losses on short-term investments - net
Permanent loss on long term investments
Accretion in redemption value of bonds
Accrued pension cost
Allowance for doubtful receivables
Allowance for sales returns and others
Transfer property into expenses
Minority interest in loss of subsidiaries
Changes In Operating Assets and Liabilities:
Short-term investments
Forward exchange contract receivable
Receivables
Receivables from related parties
Inventories
Prepaid expenses and other current liabilities
Accounts payables
Payables to related parties
Income tax payable
Forward exchange contract payable
Accrued expenses and other current liabilities
Net Cash Provided By Operating Activities
Year Ended December 31,
1999
2000
2001
14,389.2
23,527.0
65,106.2
14,483.2
15,522.0
(3,007.9)
1,400.0
(781.6)
1.1
5.8
875.8
264.3
(10.0)
(93.2)
(1,015.6)
25,197.9
(2,481.8)
288.5
(67.8)
160.4
31.6
585.6
260.4
148.6
402.1
39.1
(515.9)
41,446.1
(956.1)
187.2
(15.1)
51.8
370.3
524.5
1,679.3
(36.8)
55,323.0
(3,788.1)
3,959.0
(105.4)
183.2
(13.2)
345.3
153.8
123.3
44.0
(124.8)
1,640.5
215.6
537.5
221.8
(929.0)
(46.8)
746.8
318.4
30,129.9
5,049.7
(6,391.8)
(273.2)
(2,765.2)
(1,278.1)
985.9
878.4
(622.3)
6.1
2,137.2
45,302.4
(1,373.6)
(113.7)
(15,428.2)
(737.1)
(4,033.8)
352.0
3,170.7
2,334.2
(151.8)
(987.6)
2,024.1
93,412.6
49.5
10,326.2
454.0
2,957.4
202.3
(7,109.9)
(1,558.0)
218.1
(430.0)
75,817.7
18
Consolidated Cash Flows Statement – Con’t (In $NT millions) Year Ended December 31,
1999
2000
1998
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (Increase) in short-term investments
Acquisitions Of:
Long-term investments
Properties
Proceeds From Sales Of:
Long-term investments
Properties
Decrease (Increase) in restricted cash
Decrease (Increase) in pledge time deposits
Increase in deferred charges
Decrease (Increase) In refundable deposits
Decrease (Increase) in other assets - miscellaneous
Decrease in minority interest in subsidiaries
Increase in goodwill
Cash of TASMC as of July 1, 2000
Net Cash Used In Investing Activites
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds From Issuance Of:
Short-term bank borrowings
Commercial paper
Long-term bonds
Long-term bank borrowings
Capital Stock
Payments On:
Short-term bank borrowings
Commercial paper
Short-term notes
Long-term bank borrowings
Increase (Decrease) in guarantee deposits and other liabilities
Issuance costs of financing
Cash dividends paid on preferred shares
Bonus to directors and supervisors
Net Cash Provided By Financing Activites
Effects Of Changes In Foreign Exchange Rate
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
BEGINNING BALANCE - CASH AND CASH EQUIVALENTS
ENDING BALANCE - CASH AND CASH EQUIVALENTS
-
-
-
2001
117.1
(1,555.8)
(55,780.5)
(10,057.9)
(51,459.1)
(2,107.3)
(103,761.9)
(5,120.6)
(70,201.2)
1,523.5
3.5
(7.3)
(209.6)
(1,187.5)
(9.7)
(0.8)
(86.6)
150.0
413.1
7.2
(2,290.0)
(1,179.3)
61.4
13.5
(1,660.8)
49.4
364.9
3,161.7
(1,793.2)
(915.6)
77.4
(15,386.9)
(57,310.8)
(66,001.9)
736.6
(119,574.9)
559.1
301.4
(1,805.2)
195.0
(9.1)
(249.2)
(1,019.2)
(77,231.9)
2,109.2
98.2
9,772.5
6,903.8
530.0
2,917.4
9,450.6
7,997.6
20,618.0
9,000.0
39,204.5
2,435.4
-
(2,318.9)
(78.3)
(161.6)
16,854.9
(253.4)
(1,010.4)
(63.3)
(138.1)
39,518.4
(8,592.8)
(4,241.0)
(2,648.9)
2,977.9
(118.3)
(215.1)
35,366.3
(657.6)
(173.1)
(10,983.6)
21,855.5
10,871.9
18,645.8
10,871.9
29,517.7
(940.1)
75.0
(47.7)
(41.1)
(584.3)
897.2
118.5
(766.9)
9,322.5
29,517.7
38,840.2
(1,283.9)
38,840.2
37,556.3
19
Appendix C – Company Press Release Summary
February 13, 2003: Taiwan Semiconductor January Sales Rise 9 Percent
Taiwan Semiconductor, the world’s largest supplier of made-to-order computer chips, said that sales rose
9% in January to NT$ 13,130 million from a year earlier.
February 13, 2003: Altera Boosts Taiwan Semiconductor Orders
Altera Corp., the world’s second-largest designer of programmable chips for other companies, has
boosted orders at Taiwan Semiconductor Manufacturing Company. In 2000, Altera was one of Taiwan
Semiconductor’s biggest customers. In making the announcement, Altera said it would resume orders
with the chipmaker at levels comparable to 2000.
February 8, 2003: Taiwan Semiconductor Gives Gov't China Project Plans
Taiwan Semiconductor has given Taiwan’s government information about its plans to invest in a plant in
China. The Ministry of Economic Affairs will examine the information before giving final approval. If
approved, it would allow Taiwan Semiconductor to build a plant in Shanghai, China. The company will
borrow $418 million from Chinese banks to finance the $898 million plant. The Chairman of Taiwan
Semiconductor said that production at the plant would not start until the end of 2004 at the earliest.
Taiwan has restricted certain technological investment in China on fears it may lose part of this business
to its political rival.
February 6, 2003: Taiwan Semiconductor, United Micro Slide
Taiwan Semiconductor said that demand may not improve in the first three months of 2003 as “CEO’s of
technology companies are being very conservative about 2003”. Also, the company said that capacity
utilization would be 60% in the first quarter of 2003 compared to 61% in fourth quarter of 2002 and 79% in
the third quarter. In addition, fourth-quarter income fell because of new equipment costs and lower
demand.
January 28, 2003: Fujitsu, Taiwan Semiconductor See No Improvement in Chip Demand
Taiwan Semiconductor expects the average selling price of chips to drop 7% in the first quarter of 2003
compared to the fourth quarter of 2002.
January 23, 2003: Taiwan Semiconductor Shares Rise on Approval of China Project
The Taiwanese Government gave Taiwan Semiconductor preliminary approval for its investment in
China. If approved, Taiwan Semiconductor would be the first Taiwan Chipmaker to open a factory in
China.
January 9, 2003: Taiwan Semiconductor Begins Work on 1st China Plant
Taiwan Semiconductor has begun construction on its first plant in China because it expects approval from
the Taiwanese Government.
December 28, 2002: Taiwan Semiconductor to Offer Stock Options
Taiwan Semiconductor will eliminate is bonus-only incentive system for one that offer bonuses as well as
stock options.
December 12, 2002: Taiwan Semiconductor’s China Plant Nod May Be Delayed
Taiwan Semiconductor planned to win approval for its plant this year but that goal may be delayed as
officials reviewing the application have asked for more information.
November 30, 2002: Taiwan Semiconductor Sees Capacity Glut
Taiwan Semiconductor said that even if chip demand increases in 2003, it wouldn’t be able to absorb
excess worldwide capacity.
20
November 22, 2002: Taiwan Semiconductor Sharply raises Q4 Wafer Shipment/Capacity Forecast
on Increased Demand
Taiwan Semiconductor said that it now expects wafer shipment in the fourth quarter to be equal to thirdquarter levels, as compared to previous guidance of a 10-14 percent sequential fall. It also expects
capacity utilization to be closer to 60% as opposed to its guidance of low to mid 50%.
October 22, 2002: Taiwan Semiconductor Third Quarter Report
Net Sales for the third-quarter reached NT $39,835 million, a 47.9% increase over the third-quarter of
2001. Net income was NT $3,160 million or NT$ .16 per share, a 155.5% increase over the same period
a year ago.
September 9, 2002: Taiwan Semiconductor Files Application for IC Fab Facility in Mainland China
Taiwan Semiconductor filed an application with the Investment Committee of Taiwan’s Ministry of
Economic Affairs for approval for an investment project in Mainland China.
August 6, 2002: Taiwan Semiconductor Board of Directors Approves Capital Appropriation for
90nm Copper Processes
Taiwan Semiconductor’s Board of Directors approved appropriation of capital for the increase of capacity
for one of its processes. In addition, even with this appropriation, the Company does not expect capital
expenditures to exceed US$ 2 billion for the year 2002.
July 25, 2002: Taiwan Semiconductor Second Quarter Report
Taiwan Semiconductor reported second quarter revenues of NT$ 44,182 million and net income of NT$
9,130 million or NT$ .49. For the first six-months of 2002, net income per share was NT$ .84. Also,
during the second quarter operating margin increased to 27.1% from 22.9% in the first quarter. In
addition, capacity utilization increased to 85% due to an increase in demand from 67% in the first quarter.
June 6, 2002: Taiwan Semiconductor Announces Limited Stock Dividend Details for its Common
Shares and ADSs
The Company announced a 10% stock dividend for both its TSE-listed Common Shares and for its
NYSE- listed American Depositary Shares.
May 7, 2002: Taiwan Semiconductor’s Board of Directors Approves Capital Appropriation for
Projects
The Board of Directors approved expenditures of NT$ 69,275 million to expand capacity for several of its
processes. The board also approved the investment of US$ 20 million in Extreme Ultra Violet LLC, a
consortium led by AMD, IBM, Infineon Technologies, Intel, Micron Technologies and Motorola.
April 25, 2002: Taiwan Semiconductor First Quarter Report 2002
The Company announced revenues of NT$ 35,790 million and net income of NT$ 6,588 or NT$.39. The
company also said that it expects earnings and orders to exceed the levels achieved in he first quarter of
2002.
January 25, 2002: Taiwan Semiconductor Fourth Quarter Report 2001
Revenues for the fourth quarter of 2001 reached NT$ 33,130 million and net income was NT$ 4514
million or NT$ .26 per share. For fiscal year 2001, net sales totaled NT$125,888 million and net income
totaled NT$ 14,483 million or NT $.83 per share for 2001. Capacity utilization reached 50% in the fourth
quarter from 41% in the third. These results slightly exceeded the Company’s own expectations for 2001.
January 3, 2002: Taiwan Semiconductor Named Best Managed Company between 2001 and 2002
by AsiaMoney Magazine
Taiwan Semiconductor was named the best-managed company from 1991 to 2001 by AsiaMoney
Magazine. It was also ranked number one by fund managers in the same category.
21
October 26, 2001: Taiwan Semiconductor 2001 Third Quarter Report
Sales for the third quarter of 2001 reached NT$ 26,940 million and net income totaled NT $1,237 million
or NT$ .06 per share.
October 10, 2001: Taiwan Semiconductor Appoints Sheldon Wu to Liaison Office in Mainland
China
Taiwan Semiconductor has said that the liaison will be responsible for exploring and building relationships
with vendors and suppliers on the mainland.
July 26, 2001: Taiwan Semiconductor 2001 Second Quarter Report
Revenues for the second quarter reached NT$ 26,298 million and net income totaled NT $312 million or
NT$ .01 per share.
22
Appendix D – Service Provided To Customers:
Source: Company’s Year 2001 20F Statement, Filed With US SEC.
23
Appendix E – Country GDP Growth
Taiwan's GDP Growth
18.0
16.0
14.0
12.0
Percentage
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
-4.0
China's GDP Growth
16.0
14.0
Percentage
12.0
10.0
8.0
6.0
4.0
2.0
0.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Sources: Mellon Economics.
24
Appendix F – Taiwan Economic Summary
25
Appendix G – China Economic Summary
26
Appendix H – Supplementary Material


Additional Press Releases
Analyst Reports
27