Taiwan Semiconductor Manufacturing Company (TSMC) has long been recognized for its prudent financial approach, emphasizing business focus and financial conservatism. However, recent years have witnessed a notable shift in this strategy, with TSMC engaging in the corporate bond market and investing in higher-risk U.S. corporate and government bonds.
As a long-term believer in TSMC, holding several hundred shares and committed to further investments, I have recently found myself engaged in discussions with retired TSMC executives who share similar concerns about the company’s performance this year, despite their substantial holdings. Questions regarding TSMC’s current situation and its choices have started to surface.
~Lu Xingzhi
In the past 12 months, TSMC (Taiwan Semiconductor Manufacturing Company) has encountered a confluence of geopolitical factors, prompting clients to advocate for an expansion strategy in high-cost regions such as the United States, Europe, and Japan.
The company has also faced challenges from the devaluation of the Taiwanese dollar and the impact of global interest rate hikes, leading to some foreign investors treating it like a cash dispenser.
Amidst these challenges and concerns regarding weakening end-user demand and escalating inventory in the latter half of the previous year, TSMC began revising revenue guidance cautiously to mitigate potential drastic fluctuations in its and its clients’ stock prices.
Consequently, TSMC’s performance this year has been relatively moderate, surpassing the Taiwan Stock Exchange by a mere 2%.
This departure from their traditional financial conservatism has raised concerns and prompted these 5 questions from financial analyst Lu Xingzhi.
1. Debt Ratios and Corporate Bond Holdings
Lu Xingzhi highlighted a significant change in TSMC’s debt ratios since the retirement of Chairman Zhang Zhongmou in June 2018. TSMC, known for its focus on its core operations and financial prudence, has seen a shift in financial behavior. In recent years, despite having ample net cash (Net cash to equity ratio = 17%) and healthy cash flows (calculated using free cash flows minus cash dividends), the company’s overall debt-to-equity ratio has increased from 11% in 2018 to 30% in June 2023.
During this period, the amount of outstanding corporate bonds surged from 56.9 billion to 901.7 billion TWD, while the cash position escalated from 577.8 billion to 1.277 trillion TWD.
This raises questions about the rationale behind exchanging low-risk, lower-interest corporate bonds for higher-risk, higher-interest US corporate and government bonds, especially given the uncertainties and risks in the bond market.
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2. Risks Associated with US Corporate and Government Bonds for TSMC
The analyst expressed concerns about TSMC’s substantial investments in U.S. corporate and government bonds, which have more than doubled over five years.
Over the past five years, TSMC has significantly increased its investments in US corporate bonds, US government bonds, and other assets that are causing market concerns due to their potential price collapse and default risks. The company’s portfolio of such assets, valued in TWD, has grown from around 120 billion in 2018 to over 270 billion. The composition includes debt instruments measured at fair value (available-for-sale financial assets) and those measured at amortized cost (held-to-maturity financial assets).
How does TSMC account for the market value of these short- and long-term corporate bonds and government bonds each quarter? How does TSMC assess the risks associated with the large US investment banks (purchased more than 150 billion in corporate bonds), ensuring they are “too big to fail,” and the US government’s ability to honor its debt?
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3. Concentration of Financial Assets and Risk Management for TSMC US Bonds
The majority (nearly 70%) of TSMC’s portfolio comprises risk bonds issued by five major US investment banks, measured at amortized cost (held-to-maturity financial assets). How does TSMC diversify the risk associated with these “too big to fail” companies, and how does it ensure that its investment decisions are not influenced by the investment banking divisions of these banks?
Why does TSMC swap its highly rated (30% debt to equity ratio) bonds for higher risk (debt to equity ratio >250%) bonds from investment banks, for a mere 1-2% interest rate differential?
Read More: 3 Reasons Why TSMC Plans to Build Another Fab in Japan After US Friction
4. Strategy for Buying Falling Corporate US Bonds by TSMC
Does TSMC purchase these US corporate and government bonds at face value, or does it actively buy distressed bonds from the market? Does TSMC consider buying back its own distressed bonds? Lastly, given the substantial and diverse nature of the corporate and government bond market, how does TSMC manage and mitigate potential default risks from a financial management perspective? Has TSMC deviated from the “financial conservatism” principle that Chairman Morris Chang emphasized and rigorously upheld throughout his tenure?
5. Adherence to Financial Conservatism Principles
Lastly, the analyst raises concerns about whether TSMC’s recent financial strategies align with the principle of financial conservatism that was emphasized and strictly implemented during Chairman Zhang Zhongmou’s tenure. This principle has historically guided TSMC’s financial decisions, and any deviation should be carefully assessed for potential risks.
Final Thoughts
TSMC’s evolution in financial strategy, particularly in the realm of corporate bonds and investments, is a topic of growing interest and concern. As TSMC continues to navigate these financial shifts, addressing the questions and concerns posed by financial analysts like Lu Xingzhi is essential. Striking a balance between financial growth, risk management, and adherence to established principles is key to ensuring stability and success in a rapidly changing financial landscape.