“The Apple partner set for strongest 2012

"Urgent Update" teaser from Yiannis Mostrous for "Taiwan Builds Tomorrow" Special Report

By Travis Johnson, Stock Gumshoe, December 7, 2011

This particular ad, or one very much like it with a few edits, has been running for about six weeks — it’s a pitch to get you to subscribe to Global Investment Strategist from Yiannis Mostrous ($497, thanks very much), and it’s all about a key Apple (AAPL) supplier.

Which has been a hot investing theme for a long time — pitch the companies that are component suppliers to Apple’s super-hot iPhone or iPad products (or before that, the suppliers who made key parts for iPods), and sometimes these ideas work out pretty well … though the big bumps tend to be for small companies who get their first contract for an iPhone chip (or something similar) that lets them dramatically ramp up production.

And of course, despite the fact that this ad first ran over a month ago, we get the “Urgent” headline about this stock that will have the “strongest 2012.” Is it urgent? And will it be a good buy for you for the next year? Well, how about we identify the stock for you … and then you can then dig deep into your heart to make your investing decision.

Here’s the meat of the ad:

“I was discussing one of Apple’s new contracts with a friend. Specifically, it was about Apple’s new manufacturing contract for the A6 processor, the next generation in the cutting-edge processor series that powers the iPad and the iPhone. At first, I wasn’t surprised by what I heard; I’ve known since mid-August about Apple’s preliminary manufacturing trials. I’ve spent months profiling this company for our subscribers, and I don’t miss a detail when it comes to the latest news.

“But what my friend said next caught my attention. She lowered her voice and detailed the very latest (but legal) information on this new Apple contract, and how Apple’s recently released iPhone 4S will boost its importance. Her perspective offered an important window into the hidden clockwork of Apple.”

Sounds pretty exciting, right? Here are a few specifics from the ad that we’ll be able to toss into the hopper of the Thinkolator in a moment:

“My new pick is especially strong: They have 30 years of experience in their industry, and they’ve never fallen behind, gaining more momentum and technological experience with each passing year.

“This year has been no exception. They’ve pulled in $13 billion in the last 12 months, profiting at a margin of 38%. Their earnings growth is up over 90% in the last year, but, as I’m about to show you, this is just the beginning…

“My stock pick is run by some of the most competent executives in the world. A group of 870 investment professionals at Institutional Investor recently voted the CEO of my stock pick as #1 in the world, chosen from a list of over 1,000 companies! In fact, my stock pick swept the voting, winning 8 of the 10 categories.”

Why now? In part, Mostrous says that it’s largely because capacity was cut during the recession, but demand didn’t really drop that far — especially for hot products like Apple’s — so this manufacturer had some huge premium-priced rush orders:

“When it became clear that demand for processor-powered devices wasn’t declining—it was, in fact, increasing!—then device companies scrambled to submit rush orders for more processors.

“My stock pick has been working day and night for the last year to fulfill some of the largest rush orders in history, at premium prices. They fulfilled six major rush orders this year alone.”

And it’s not just Apple, they’re a Taiwanese company and they get a lot of business from their neighbors in mainland China:

“My stock pick has become the go-to manufacturing house for the most impressive Chinese contracts.

“Here’s a recent example: One of the largest communications companies in mainland China (think 56% market share) recently completed the design of a special 40-nm chip that only consumes two-thirds of the power of the previous design. My stock pick was chosen to manufacture this ground-breaking technology because they are uniquely positioned to handle the delicate manufacturing process and stream of contracts from China.”

And the catalyst of that new processor?

“The executives of Apple have spent the last few weeks traveling to Taiwan to negotiate with my stock pick. The result is a new contract order for the hotly anticipated A6 processor, which will replace the currently used A5 processor that’s made by a South Korean company. This Korean company wasn’t able to build the technologically complex manufacturing lines that Apple needed. So in short: my stock pick just stole away the most valuable processor contract of the decade….

“Only Apple knows exactly what devices the A6 will power, but the future iPhone 5 and iPad 3 are the most obvious candidates. You don’t need me to tell you the importance and unprecedented market potential here. Apple will need to hire whole police forces to control the crowds of enthusiasts lining up to spend a fortune on these brilliant new products.

“The URGENCY of this information is that this potential has yet to be reflected in the price of my stock pick. The upside is at least 10% right off the bat, with estimates climbing up from there into the triple digits.”

So what is Yiannis’ pick? Well, the hungry Thinkolator has been fed … but frankly, many of you could have solved this one with nothing more than a second hand Cognitation-o-matic or Sleuthanizer, this is clearly Taiwan Semiconductor (TSM)

Taiwan Semiconductor is by far the biggest contract semiconductor manufacturer (also called foundries, in a charming reference to the industrial forebears of these high-tech manufacturing facilities). And they’re not all that small even in comparison to their gigantic customer Apple, TSM has a market cap of nearly $70 billion and is by far the largest component of the Taiwan index ETF. Which puts their $13 billion in sales (up to $14 billion now) in perspective — big, but not shocking.

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TSM and its competitors (estimates are that TSM has more than 50% of the market) basically take chip designs, both their own and those submitted by customers, and turn them into mass-produced chips. They’re more profitable than you might think, with margins in the mid-30% range these days, but not as profitable as the fab-less chip companies (those are the designers, including all the small cap semi names we hear touted from time to time, that don’t have a foundry or fabrication facility, they outsource manufacturing to Taiwan Semiconductor or one of a handful of other large foundries).

And business has not exactly been spectacular of late — arguably fine and steady, but not spectacular. TSM is currently expected (by analysts) to have a flat year in 2012, so analysts don’t seem to be pricing in any kind of giant pop from the new Apple chip. The analysts at Morningstar, who tend to be fairly sober and value-oriented much of the time, place the fair value for the shares at $13 — right where it is now (that doesn’t mean they call it a buy — they always build in a margin of uncertainty and suggest a buy at a “discount,” in this case about 30% blow fair value, or around $9).

They are the big daddy of the industry, and according to most things I read they are the gold standard, with the best technology and the highest standards, and it’s hard for smaller players to keep up in a sector where having huge economies of scale really helps — but it’s also a very cyclical industry, with a pretty steeply sloping curve of boom and bust cycles. Declining demand for conventional PC chips has led to revenue drops recently after the sharp recovery in 2010, and expectations seem to be that PC chip demand will remain sluggish next year (though other types of chips, in the broad “industrial” and “mobile” categories, are likely to help overall revenues). They’ve been riding a wave of outsourcing demand for decades now, helping to make it possible for small semiconductor companies to be nimble innovators and helping less-efficient chipmakers by taking over their manufacturing, and there is certainly not a world ahead where fewer semiconductors are used — it’s just that the growth might not come from the same chips that provided the last decades of boom for TSM and for other longtime chip titans like Intel (which I own).

And yes, there is reportedly a deal for TSM to build the next ARM-design mobile chip, the A6, for Apple — at least in part because Apple’s other big chip supplier, Samsung, is also a fierce competitor of theirs in the tablet and phone businesses, and a legal antagonist. That new chip is expected probably in the Spring, though Apple is notoriously closed mouthed about new products and timelines … and since both Apple and Taiwan Semiconductor are widely followed, mega-cap companies it’s hard to imagine that investors have wildly misjudged the potential of this deal for TSM, as Mostrous seems to think, but I will stipulate that investors and analysts often make mistakes. Even, I admit abashedly, yours truly.

And TSM does have a very respected management team, at least by big investors — as Yiannis teased, they won a bunch of prizes from Institutional Investor last year, including top CEO.

That’s about all I know about Taiwan Semiconductor — they are big, they pay a decent dividend, they have very nice margins and flat sales recently, and if they were able to put up some substantial unexpected growth numbers due to the A6 or something else, then I presume the markets would be delighted with them (particularly if that jump isn’t accompanied by something bad, like a drop in orders from Qualcomm or Nvidia or any of their other big customers).

Still, if you look at them at arm’s length they are priced at a bit of a premium to some of the other big tech names like Apple itself, or like Intel, which is also heavily levered (of course) to PC chips. I’ve personally chosen Intel for my investment in this sector, with a comparable dividend yield to TSM, a more consistent dividend growth history, and a similar balance sheet (both look lovely), but if you want exposure to the world of chips writ large it may be that TSM is a cleaner play on that trend (and it’s about half the size of Intel). Of course, if it’s the Apple A6 chip that you think will change the world and drive huge revenues, why not buy Apple instead of the supplier that Apple’s probably trying to squeeze on margins? Yes, I’m “talking my book” because I own both Apple and Intel and have not researched Taiwan Semiconductor very thoroughly, so you can take that with a grain of salt.

Of course, I didn’t just charge you $497 either — in fact, you might have noticed that this article is free … though we’re currently having a membership drive in case you’d like to puny up a small portion of that amount and have most of your payment go to charity. Couldn’t resist that little plug, sorry!

So what do you think? Is TSM going to reap a huge 2012 thanks to this misunderstood game-changing deal (Mostrous’ concept, not mine) for the new Apple chip? Or is it just a good company at a decent price, or something else entirely? Let us know what you think with a comment below.

And if you’ve every subscribed to Global Investment Strategist (even under its old name, Silk Road Investor), please click here to share your opinion with a brief review and help your fellow investors — we haven’t heard from any subscribers to this one yet, and inquiring minds want to know.

Full disclosure: I own shares of Apple and Intel. I do not own shares of any other companies mentioned above, and will not trade in any stock mentioned for at least three days.


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