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Birth of a Hidden Champion: TSMC & Morris Chang

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 1): TSMC and Morris Chang

Welcome to the first issue of the “Birth of a Hidden Champion” tribute series where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On this day on 24 October 1994, a Hidden Champions was born. TSMC (TSEC: 2330) was born as a listed company in Taiwan and, led by billionaire founder Morris Chang, she went on to compound 965% to a market value of over US$203 billion, surpassing Intel.

Without TSMC, smartphones would not have arrived as early as they did which has also drastically changed the daily lives of people and Apple likely would have found more difficulty in delivering its iPhones with the computing power they now boast. TSMC controls 56% of the global market for contract chip production and has helped to spawn the birth of over 450 fabless IC designers who are its customers, including Qualcomm and Nvidia, As Morris Chang commented during his recent retirement in early October 2017: “Since we established ourselves, fabless companies began to mushroom worldwide. Most of the innovations in the semiconductor industry in the last 30 years came from those fabless companies. That’s probably my biggest pride, to have caused a lot of innovations in the industry.” All these are among TSMC’s contributions to the world.

Morris Chang said Intel’s advantage lies in its robust technological power and strong business operation foundation, having maintained No. 1 in the global semiconductor for decades. But its biggest drawback rests with its inexperience in the wafer foundry sector that highlights a service-oriented corporate culture, as Intel’s technology departments have long served the company’s own needs, totally different from the core culture of serving others seen in the pure-play foundry sector. With his 25-year experience at Texas Instruments before founding TSMC, Chang said he realized very well what kind of corporate culture was needed for the foundry sector. He said when establishing TSMC 30 years ago, he was able to easily inject the service-oriented culture into the TSMC at the very beginning.

TSMC is also holding its 30th Anniversary Celebration Forum and Concert in Taipei, Taiwan on October 23, inviting the many customers, colleagues, suppliers, investors, and partners from government and across society to mark the milestone together. Morris Chang commented: “In the last 30 years, we have joined hands with our partners to unleash numerous innovations in the semiconductor world whose products have been pervasively used in all parts of the world and have made many people’s lives more secure, comfortable and convenient. Through the process, we have also established long-term trusting relationship with not only our partners but also many of our major shareholders. At this 30th anniversary celebration for TSMC, we want to show our gratitude for all those who have been a part of our history.” The Hidden Champions Fund sends our heartiest congratulations to TSMC’s 30th anniversary.

Below is an article “Any Benjamin Franklins in Asia?” written back in May 2013 which is still relevant today in understanding why TSMC has succeeded in compounding value while Singapore learnt painfully, through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, that the scalability and resilience of the business model is not about pouring ever more tangible resources and money with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having a culture of values, trust and collaboration to foster innovation and customer service. And this indestructible intangible asset is the essence of deep moat competitive advantage found in the emerging underappreciated Hidden Champions that we invest in.

PS: An update on the 2nd anniversary of our Hidden Champions Fund – our YTD (January to September) 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, please drop us an email at invest@hiddenchampionsfund.com to find out about the subscription process.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund
www.hiddenchampionsfund.com

Any Benjamin Franklins in Asia?

Why is Benjamin Franklin, Charlie Munger’s hero, the ubiquitous face on the hundred-dollar bill, the largest-denomination bill in circulation in the U.S. today? Why not a President – Abraham Lincoln or George Washington? And how does this “uncommon” insight help value investors to identify the resilient compounders globally and in Asia?

Even Americans who handled the familiar winking Benjamins daily are puzzled themselves when I asked them and there is no official answer as to why Franklin is honored, like a curious big blindspot. While Franklin is recognized as the only founding father who signed on all four major documents which led to the formation of the United States, including the Declaration of Independence and United States Constitution, Franklin is honored for contributing much to what is deemed most “American” about United States. He was a tireless inventor-entrepreneur solving the nation’s biggest problems and creating innovative solutions mostly from behind the scenes, having created the lightning rod, the first bifocal glasses, odometer, urinary catheter, the Franklin stove and yet he never filed for patent for all his inventions. He believed that “knowledge was not the personal property of its discoverer, but the common property of all.” Dean Kamen, the contemporary American inventor-entrepreneur of the infusion pumps for chemotherapy and treating newborn babies, the world’s first insulin pump, the technology used in portable home-use dialysis machine and many more, believe that solving problems and creating solutions create real wealth and is the essence of what makes America great for over two hundred years: “Real wealth is not a zero-sum game, like moving oil here or moving gold there.” In other words, inventor-entrepreneurs like Franklin and Kamen want to build and scale their ideas and inventions so that they can give or “empty” more. We need to “empty” ourselves before we become open to the possibilities to innovate. Only when we have the desire to “empty”, then can we want to persevere in building something meaningful. This urge to build in order to give is the magnetic north to scale a resilient compounder and they work obsessively to realize this vision. This “emptiness” is akin to the empty hollow center of a bamboo. The vitality and resilience of the bamboo growth revolves around its “emptiness”: the nutrients and moisture that would have been exhausted making and maintaining this empty center can be utilized for growth of other stems. It’s about having an intangible idea that is larger than our own individual self to provide useful products and services to benefit other people and in turn become a resilient compounder – the Bamboo Innovator.

Are there any Benjamin Franklins in Asia? In Part 1, we got acquainted with the insight that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss”. This comment was made by a Chinese entrepreneur who has built an Asian-listed global company that has multiplied over 26-fold in 19 years since its Sep 1994 listing to an all-time-high market value of $100 billion. He started the company at the young age of 55 in 1987 based on a “new idea” that he was laughed at and ridiculed everywhere. He is Morris Chang, recognized around the world as the creator of the world’s first pure-play dedicated semiconductor foundry, TSMC (2330 TT and TSM US [ADR]), the most valuable company in all of Taiwan and possibly the most valuable semiconductor in the world nearly on par with the mighty Intel in market value.

Recall how Franklin astonished the Europeans, who were accustomed to the solemn deliberations of royal academic societies, by venturing into a rainstorm with a kite to prove lightning was electrical, thus proving the resilience of the lightning rod? Without any strength in IP, circuit design, R&D, sales and marketing, Morris Chang also shocked his backers which include K.T. Li, the minister best known as the “Father of Taiwan’s Economic Miracle”, by boldly choosing a pure-play foundry business model that had a fatal problem then: “Where’s the market?” Who is TSMC going to manufacture the wafers for? The Intels and Texas Instruments are also manufacturers themselves and they would let TSMC manufacture their wafers only when they didn’t have the capacity, the leftovers, or didn’t want to manufacture the stuff themselves anymore. As soon as they got the capacity they would stop orders to TSMC, so it couldn’t be a stable market. And when they didn’t want to make the wafers anymore, the chances were that it was losing money for them. And so why would TSMC want to do it? Does TSMC want to take over the loss? And Taiwan is two generations behind in technological capabilities. As Morris Chang recalled, the experts all laughed, “What the hell is Morris Chang – and Taiwan – doing?”

The “lightning rod” that Morris Chang carried with him to bend and not break like the bamboo in the rainstorm with his “new idea” of a pure-play business model was this unusual insight that was a blindspot for everyone else. When he was a longtime executive at Texas Instruments, he saw that a lot of IC designers are unhappy at work and wanted to leave and set up their own business, but the only thing, or the biggest thing, that stopped them from leaving those companies was that they could not raise enough money to form their own company. Because at that time it was thought that every company needed wafer manufacturing and to build a wafer fab was the most capital-intensive part of a semiconductor IC company. With TSMC acting as a pure-play platform since the TIs are not interested in the success of their former employees by providing either fab capacity or important customer support services for them, TSMC could solve a major problem for these enterprising IC designers to strike out on their own. They will become TSMC’s customers, constituting a stable and growing market. Another thread that inspired and formed the foundation of the “new idea” for Morris was his reading of the academic writings of researcher Carver Mead who gave him the idea that the design part could be separated from the technology. CEOs or entrepreneurs or even value investors who pride themselves for being practical often scoffed at the term “academic” or “theory”. As Morris proved, nothing is more practical than “theory”! It is noteworthy to appreciate that Morris Chang returned to Taiwan as a relatively wealthy man and successful executive at 53 at K.T. Li’s invitation to head the think-tank ITRI (Industrial Technology Research Institute) at a much-reduced compensation. Yet his thirst for knowledge and learning never ceases. Morris reflected on his life path, “You need to follow your interests not where you think the big money is. Because, obviously, back in 1985 the big money was thought to be in financial venture capital, or maybe even continuing to manage a company in the U.S., but I felt that the Taiwan opportunity appealed to me from the interest point of view.”

As the fabless IC industry took off from 1991, its enabler TSMC became a powerful value compounder. The success of fabless innovators such as Qualcomm and UK’s ARM to leapfrog over their integrated rivals (known as IDMs, or integrated device manufacturers) such as TI was made possible because of TSMC. As Qualcomm President Steven Mollenkopf said, without ties to TSMC, “We wouldn’t have been here.” The IC designers are not able to trust that their proprietary work will not be copied by the IDMs if they outsourced manufacturing to them or to other foundries; they are able to trust TSMC. And Qualcomm is now as big as Intel in terms of market value, having compounded over 110-fold in 21 years since Dec 1991 to $112 billion! Naturally, the value investor in you might ask, what’s so moaty and innovative about this business model that others cannot replicate? Despite its capex-intensive nature, Bamboo Innovator TSMC has “emptiness” at its core that is rooted in a culture of trust and collaboration. One of the sources of “emptiness” is the indestructible intangibles that stem from having trust and support in the community. The exciting and important exchange at the market peak in Oct 2007 between Morris Chang and JH Huang, the founder of California-based gaming graphic chip designer Nvidia who is a TSMC customer, is worth reading over and over again whenever we are too caught up in the second- or third-order analysis of “technology curve” and geek-speak in looking at TSMC:

Huang: “In retrospect, most of the people who looked at the foundry industry thought that technology and capacity were important. It is important but they really missed what ultimately made TSMC extraordinary and more powerful in the end is this incredible focus on customer service. I remember, when you called and you said, and it was a phrase that I remembered then and that I’ve heard several thousand times since then, ‘We will jump through hoops for you.’ And one of the things that I really admired about that was that it wasn’t just what you told me that day. It was a phrase that drove through all of TSMC. Every employee believed in it and lived by it. People repeated it year over year. How did you do that? How did that start and how were you able to drive that through the culture?”

Morris: “In TSMC, we actually tailored everything in the company, the organization, the compensation system, the evaluation system, we tailored everything to customer service, to jumping through hoops. Let me tell you an anecdote. I was visited by a big company more than 10 years ago, and he was very big and we were still fairly small. We were couple billion dollars maybe and he was a lot more than that. His sales were several times that. He and I had dinner together and this CEO of this big company, he sort of intimidated me by saying, ‘Well, maybe I will go into your business and compete with you.’ So I let that go for the time being. Several minutes later, I asked him, innocently, ‘John, how do you evaluate your fab manager?’ So he gave me the list. ‘Well,’ he said, ‘yield, cycle time, productivity, ability to make billings every month,’ you know, all those things he told me. After he ran through his list of 10 or 12 factors, he said, ‘What else? Don’t you evaluate your fab managers the same way?’ I said, ‘No, no, no, John. I evaluate them according to how much complaints I get from customers about their fab.’ And that’s the honest truth. I really did that, have always done that, the evaluation of the fab managers. We don’t even keep P&L in each fab. We don’t. But we do keep very good track of how satisfied the customers are. If a fab manager has got very unsatisfied customers, he is in big trouble. I don’t care how much money he makes. He is in big trouble.”

The intense focus on providing superlative customer support services by jumping through the fire hoops for them is embedded into its open innovation business model. “Open innovation” is another source of “emptiness” in Bamboo Innovators as shared earlier. As demonstrated by the stunning success of Qualcomm, the largest fabless company, the chip industry is re-integrated in terms of knowledge flows rather than through integration within a single company. One industry insider puts it, “Design for manufacturing is a contact sport. You’ve got to be communicating closely, effectively, and systematically.” TSMC has become steadily involved with design. Although most of its customers rely on their own design teams or those at service providers allied with TSMC, the foundry has found it increasingly necessary to develop in-house expertise in order to help its customers create manufacturable designs and fill TSMC’s fabs. TSMC would develop and acquire technology files, process design kits (PDK), interface IPs, ERP and a rich portfolio of open libraries for use not only by its engineers but also by its customers. These reusable building blocks are essential for many design projects to help its customers complete their designs successfully and in less time, at lower cost. For instance, UK smartphone chip designer ARM and TSMC celebrated the completion of the implementation from RTL to tape out of the world’s first 20nm ARM Cortex-A15 MPCore processor in 2011 in six months, indicating the readiness of TSMC’s Open Innovation Platform® (OIP) 20nm design ecosystem. Thus, although ARM has 2,300 employees, it has a market cap of $23 billion and there are more than 35 billion ARM-based chips out there with the open innovation platform provided by TSMC.

Morris Chang was worried about being delayed by traffic in the TSMC’s shareholder meeting so the punctual down-to-earth Morris took the High Speed Rail from Hsinchu Science and Industrial Park to Taipei with the public in a photo taken in Oct 2012. Because a ‘big boss riding the train’ is truly too difficult to imagine, the photo was suspected to be doctored but later it was proven to be true. The female pictured in the photo sitting next to Morris was immersed in her study on the train and netizens jokingly said that if she would just raise her head and talk to Morris for ten minutes, it would be worth ten years of study.

The competitive edge in these design enablement via the open innovation technology platform is made sustainable because of focus on customer’s success carefully cultivated by Morris Chang: “All through the 1990s, and even now, really, the biggest joy I get out of this job was to see my customers grow and make money and succeed.” Interestingly, with the rise of the ARMs, once-proprietary chip design is increasingly commoditized. After all, nearly all mobile chips these days are centered on the ARM architecture. For the cost of a license fee, companies such as Apple can create their own modifications and hire a foundry to manufacture the resultant chip. The keen observers in the tech space would have noticed that the profits in the value chain, where the hockey puck is going as hockey legend Wayne Gretzsky would say, is shifting to manufacturers and there are only three or four manufacturers – Samsung, TSMC, Intel, GlobalFoundries – who have the capability and capacity to build the chips that are in every mobile device today and in everything tomorrow. Foundry price is about one-third of the final chip value. TSMC controls about half of the $39 to 40 billion market for contract-chip manufacturing. Morris Chang said that today about a third of industry sales is outsourced, a ratio that will continue to rise.

That’s why Intel, who prides itself as a design company, is eager to scale up its foundry business especially when Apple is dying to diversify out of Samsung’s supply chain in its smartphone and tablet chips. Apple’s transition will be complicated, because Samsung is involved in part of the processors’ design, in addition to fabricating the wafers that foundries normally handle. Intel has also recently promoted its COO Brian Krzanich to CEO in an apparent move to focus on manufacturing. It is noteworthy that Intel’s wafer cost is similar to TSMC’s wafer price and Intel’s fab arrangements is not as efficient as TSMC’s “mega fab” strategy. Intel’s fab ops are used to serving only internal customers and its corporate culture would have to change to a 24-hour customer service oriented one to compete effectively. Qualcomm, Nvidia, AMD, Altera, and Xilinx are currently the top five early adopters of technology at TSMC. Since Intel competes directly with Qualcomm, Nvidia, and AMD in PC microprocessor, smartphone, and tablet, Intel is unlikely to offer its leading-edge manufacturing technology to help these competitors. The exclusive contract between Intel and Altera also excludes Xilinx as a potential Intel customer. This leaves only Apple as the potential significant foundry customer for Intel. Yet, even Apple competes with Intel indirectly; Intel’s advanced technology could enable Apple’s SOC to replace Intel’s CPU on MacBook Air; and Intel is improving its own SOC to enable Apple’s competitors. The silent wisdom of Morris Chang in his “new idea” of building a pure play business model 25 years ago to be a partner to its customers and not a competing rival starts to ring louder, given the contradictions and limitations that Intel would face in its existing business model when it embarked upon scaling its internal foundry business for external customers. Interestingly, since the October 2007 market peak, TSMC is up 77% while its Taiwanese foundry rival UMC is down 37% and Intel is still down 5% as compared to the 20% rise for the Nasdaq index.

When fab managers at TSMC are measured and empowered to focus on customer service rather than P&L as Morris Chang shockingly points out, it rooted the corporate culture to treat employees as intangible assets to enable innovation at the customer level rather than as expenses to efficiently manage by the HQ “leaders”. As Singapore learnt painfully through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, the scalability and resilience of the business model is not about pouring tangible resources with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having “emptiness” at the core that is rooted in a culture of values, trust and collaboration. Nvidia’s founder JH Huang recalled with fondness that the first time when he visited Morris Chang in Taiwan, instead of a presentation about all the capabilities of TSMC, Morris gave him a brochure of the core values of TSMC. And Morris said, “And I do the same thing with a lot of visitors, with every customer, every potential customer.”

“I had decided at the start what the values of the company should be. Those values were very important to us, not only in the first phase of survival but from there on. We have maintained them. We have actually followed them. They are our compass, really. The values are pretty simple. At first, there were just three: integrity was number one; commitment, we really wanted our employees to be totally committed to TSMC but, in return, the company is committed to the employees, too. Also, commitment applies to customers. We want the customers to be committed to TSMC but we, in return, are totally committed to customers. Integrity is pretty simple, self-explanatory. Commitment works between employees and the company and between customers and the company. And then the third one is innovation. We knew that we couldn’t compete at all without constantly innovating. Those were our three values. The three values that we had at the beginning are still values today. Political candidates usually, before they start their campaigning, would call me so the presidential candidate came and told me all his big vision about Taiwan and I handed him our values: integrity, commitment and innovation. The presidential candidates from both parties saw that. In fact, I thought that I detected in each of them a little surprise? They don’t know what to do with it.”

Besides enabling the $300 to 400 billion fabless industry to sit on top of its resilient business model, TSMC has also played a pivotal role to Taiwan’s economy. As Acer’s founder Stan Shih commented in the Nov 2012 Forbes article on Morris Chang titled “Ageless and peerless in an era of fabless”, “TSMC buttresses Taiwan’s global competitiveness in industries ranging from machinery to auto parts because of the importance of chips in those businesses.” If all this is not enough, Morris Chang is also a bridge player who expresses a longtime interest to play with Warren Buffett and Bill Gates – and Nvidia’s JH Huang teases Morris jokingly that “he has quite a bit of confidence he would prevail.”

Sadly, if the comments by Morris Chang that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss” were shared with a number of wealthy and property-rich Asian and Singaporean businessmen without them knowing they were made by someone who built a $100 billion market-cap company and who started the firm at the age of 55, they are likely to react with scorn and disgust. “What new ideas?” Entrepreneurship to them is about “Can make money or not?” (a popular phrase in our local colloquial Singlish language which has deliberate grammatical errors). “If inventors were entrepreneurs, Thomas Edison would not have died a poor man,” a local expert commented in our local press two years ago in defending against well-intentioned observations on the award of the “Entrepreneur of the Year” to wealthy businessmen who can make good money largely for themselves but might not possess the “X-factor” in creating larger-than-self new business models or new ideas to benefit others.

At its best, entrepreneurship entails something far more important than mere money. The December 1949 issue of Fortune with the feature essay titled, “The Moral History of U.S. Business” was inspiring in its description of entrepreneurship: “An enterprising man not in haste to get rich, willing to run some risks, yet not willing to risk in hazardous enterprises the property of others entrusted to his keeping, careful to indulge in no extravagance and to be simple in his manner and unostentatious in his habit, not merely a merchant but a man, with a character to form, a mind to improve, and a heart to cultivate.” Ben Franklin, Charlie Munger, Morris Chang, Qualcomm’s founders Irwin Jacobs and Andrew Viterbi and ARM’s Warren East would add, “… and a new idea to innovate”.

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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