Taiwan Semiconductor Manufacturing Company Analysts Je Bang Ahn
Taiwan Semiconductor Manufacturing Company Analysts: Je. Bang 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 Black-Scholes Options Pricing • Conclusions • Questions & Answers
Case Overview “Things are not always as they seem”
Managed Funds Performance • Mutual funds investing in technology and science stocks have plummeted 43% in 2002
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?
Agenda • ü • • • 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
Taiwan
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
GDP Growth
Export Partners
Country Risk Analysis • Political – Alleviated political tension with Mainland China – Government (DPP) strongly advocates 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
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
China
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
GDP Growth
Export Partners
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
Exchange Rate Stability
Agenda • • ü • • 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
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)
Company Overview
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)
Regional Sales
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:
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
Agenda • • • ü • 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
5 -Year Stock Chart
Earnings Per Share
Price/Earnings
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?
Taiwan Trading Volume
US Trading Volume
Analyst Recommendations
Agenda • • ü 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
Ratios
Industry Sales Growth
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
Pro Forma Cash Flows
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%
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%
International Cost of Capital • Cost of Debt calculated through Altman Z-Score – – – Altman Z-Score: 3. 25+6. 56*X 1+3. 26*X 2+6. 72*X 3+1. 05*X 4 X 1 = Working Capital / Total Assets = 0. 10 X 2 = Retained Earnings / Total Assets = 0. 10 X 3 = EBIT / Total Assets = 0. 03 X 4 = Book Value / Total Liabilities = 3. 11 • Comparable Bond Rating = AA+
Adjustment of Altman Score • No adjustment 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)
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
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%
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
Discounted Cash Flows • Three cases: – Case 1: Precedent Transactions Multiple – Case 2: Technology Industry Multiple – Case 3: Gordon Growth Model
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. 19 x Implied value per share = NT$ 112. 06 Implied value per share (ADR) = US$ 16. 12
Case 2 DCF • Technology industry multiple used to calculated terminal value – Typical PP/EBITDA Multiple = 7. 00 x – Implied value per share = NT$ 75. 95 – Implied value per share (ADR) = US$ 10. 93
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
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
Sensitivity Analyses Case 1: Discount Rate vs. Terminal Value Multiple Case 2: Discount Rate vs. Terminal Value Multiple
Sensitivity Analyses Case 3: Discount Rate vs. LT Growth
Comparable Companies
Conclusion • Multiples serve as a testament to the relative strength of the Company – TSMC at the higher end of each respective multiple – Market price may be high, relative to competitors, as investors recognize: • Robust Cash Flows, Revenues and Balance Sheet • Company as industry leader
Black-Scholes Pricing
Agenda • • • Case Overview Country Risk Analysis Company and Industry Overview Market Analysis Financial Analyses – – Ratios Discounted Cash Flows Comparable Companies Black-Scholes Options Pricing ü Conclusions • Questions & Answers
Insight / Take Home Points • Investors should not be averse towards investing in a particular sector/industry – Due Diligence – Use of various methodologies to evaluate equity • Ride the wave – Investment in technology companies could be a profitable venture in the long run • If there is the potential to make “a killing, ” pull the trigger
Insight / Take Home Points • “…從過去的財報數字中,我們從巴菲特 (Warren Buffet) 選股邏輯的複式篩選,選 出了下列完全符合條件的八檔公司,其中 前五名包括有億豐、中華、台積電、裕隆、 寶成…” • “…By using Warren Buffet’s highly-regarded methodology, TSMC will be selected as one of the eight companies to invest in Taiwan. ” - Taiwan Economic Information Co.
Insight / Take Home Points Taiwan Semiconductor Manufacturing Company “Will Be Back!!!”
Q & A Session
- Slides: 60