TSMC (TSM) to succeed Samsung (KOR:5930) as the king of VWO
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Vanguard announced that it will switch its VWO Emerging Markets ETF from the current MSCI Emerging Markets Index to the FTSE Emerging Markets Index. The key difference will be that all Korean equities will be divested and that means that Samsung (KOR:5930), currently accounting for almost 4%, will leave the ETF.
The new king of VWO will now be Taiwan based TSMC (TSM)
Once the switch is completed, TSMC should account for 2.35% of the ETF. This article gives a brief overview of TSMC to better understand which stock will be leading VWO by mid next year. The table contrasts the current holdings of VWO versus the FTSE Emerging Markets Index, its future reference index:
TSMC and the foundry industry
Taiwan Semiconductor Manufacturing Company was founded in 1987 and is now the largest pure-play semiconductor foundry. A foundry, also known as a fab, is a facility where electronics manufacturers produce the chips they design and sell. Other well known fabs include the likes of UMC, SMIC and Global Foundries (the latter being the result of a merger between AMD’s manufacturing side and Chartered Semiconductor), as well as divisions of larger tech conglomerates such as IBM and Samsung. Over the last ten years the industry has experienced consolidation and several electronics manufacturers have gone “fabless” to reduce R&D costs, relying now on the larger providers such as TSMC and fueling their growth. This trend has boosted the growth of the major foundry players, who have the necessary scale to invest in the development of next generation semiconductor technologies and development tools. Given their role as upstream suppliers in the semiconductor supply chain, foundries enjoy very large margins, with some well over 50% EBITDA margins.
In 2011, TSMC captured a market share of almost half of the $28 billion semiconductor foundry market, a subset of the broader $300 billion global semiconductor market. Its revenues for the 12 months ending June 30, 2012 amounted to $15 billion and earnings generated were over $4.6 billion. TSMC provides essential services to chip designers across the world; in fact, over 70% of its revenue came from companies headquartered in North America and almost a fourth came from AsiaPac. This split of customers follows the geographical distribution of the overall foundry market. The companies served are mainly from the 3C’s of the semiconductor industry sectors: computers (22%), communications (49%) and consumer (10%); the remaining 19% include other categories such as industrial products. This proportion aligns TSMC with the strong growth in the communications hardware market, which is being driven by the explosive sales of mobile handsets around the world.
TSMC is currently trading at a 16x P/E, though given the asset intensity of the industry and its cyclicality, its 3.5x Price to Book ratio is considered a more appropriate measure. Nonetheless, by either measure TSMC seems to be at the higher end of its valuation multiples, though it continues to lead the pack in terms of Return on Equity.
Switching the top holding from Samsung (Korea) to TSMC (Taiwan) may be a negative for VWO because traditionally, Korean equities have been cheaper than Taiwanese equities, and TSMC seems to be trading near the higher end of its industry multiples, despite being a reasonably sound business.