​According to local South Korean press, there was an outbreak of COVID-19 that started with one office worker who tested positive at LG Display’s (LPL) Gumi production complex in South Korea.  That led to further testing which revealed that 7 co-workers and the wife and daughter of the original positive case had tested positive.  The office in which they worked has been closed and all employees moved to remote communication only, and testing all of the 800 employees in the Gumi facility, which houses a number of LCD and OLED lines has been completed.  The company is currently waiting for results and the lines remain open.  Hopefully the infection is limited to the office in which it was originally found.

​We all get them, calls about extending our car warranty, or winning a free trip to somewhere, or the more onerous ones about a relative who is being detained or that someone has been using your social security number.  Scammers are alive and well and don’t care about the US ‘Do Not Call List’, particularly as most are off shore and are likely either paying off local authorities to look the other way, or know that there is little any legal organization is going to do because the sums are relatively small.  Well, a new record was set in Hong Kong, where the number of mobile phone fraud cases increased from 648 in 2019 to 1,193 last year, an infinitesimal number compared to the 2.1m ‘fraud incidences’ reported to the FTC last year in the US, with about $3.3b in losses, although not all of these were from phone scams.  (On-line shopping scams were the largest overall).
An elderly woman living in a residence on the very exclusive ‘Peak’ in Hong Kong, (Christie’s has 19 homes for sale there, with the cheapest a mere $8.2m and the most expensive ~$451m) was contacted by a self-proclaimed government official who stated that she had been involved in a serious case of money laundering on the Mainland.  The scammer went as far as to send someone to the woman’s address to give her a ‘special’ mobile phone for her to use concerning the investigation.  The woman was instructed to send HK$7.9m, roughly $1m US to a particular account so it could be examined to see if it had been involved in the money laundering, which she did.  That was followed by an additional request for a total of HK$2509m ($32.2m US) and the scammer even had the woman’s personal driver bring him and her to the bank together so she could make the transfer.
The woman’s helper was smart enough to call her daughter to report the suspicious transactions who asked relatives to go to the bank to monitor the transaction, however they did not follow up on the issue and the transfers continued until the entire HK$250m had been transferred to the scammers account over a few weeks.  Eventually the daughter followed up and was able to freeze what was left in the scammer’s account, about HK$9m ($1.16m US) and police arrested a 19 year old university student.  Of course this is an unusual extreme (and a new record), but it happens all the time.  There are a few phone tools that can help and a recent FCC ruling makes it easier for carriers to filter out the more obvious scams, but the best way to avoid being scammed is by not answering calls from numbers you do not know.  If they don’t leave a message, it wasn’t important, and if it is an odd sounding one, don’t call back, just call the institution represented to verify the call was real, rarely if ever government agencies call on the phone….

While display is still the most costly single component in most visual CE products, semiconductors, in a variety of forms, represent an increasing larger basis for BOM and potential pain points as device complexity increases.  Over the last year an unusual spike in certain CE products due to the lifestyle changes wrought by COVID-19, have strained semiconductor capacity, which has little room to adjust to short-term changes such as we have seen.  This has led to high utilization rates at semiconductor foundries, foundry capacity allocation, and most recently wafer price increases or the elimination of more traditional foundry rebates to customers.
Given that Taiwan Semiconductor (TSM) is the largest global semiconductor foundry, we have spent a bit more time looking at 1Q results, and more importantly guidance for some hints as to what to expect for the remainder of this year and next.  Putting aside the typical company-speak, we summarize TSM’s comments and Q&A to give some perspective on what investors should expect from TSM going forward, not only as the largest foundry, but as a company with a large variety of customers.  We refer back to our comments made yesterday for more data.
2Q Guidance
               Revenue flat q/q
                              HPC up, offset by smartphones down – HPC up no surprise given both bitcoin and PC/Notebook demand, but smartphone weakness seems to not be reconciled with recent strong smartphone demand in China, which would likely lead to smartphone brands having more confidence in full year goals.  2Q smartphone foundry weakness could be just a lull before real 2H smartphone production demand sets in, or it could be the ‘Huawei effect’.  If 3Q guidance for the smartphone segment is not better then it would give us doubt as to the conviction smartphone brands have toward the 2nd half.
               Inventories
                              Up in 1Q – Typical seasonality story doesn’t play as well currently because of high utilization rates unless TSM is pre-building against 3Q delivery orders already on the books and is getting compensated for insuring full order delivery guaranties to large customers.
                              Should decline going forward – TSM also expects overall customer inventory levels to be higher than ‘historic seasonality levels’, which is certainly a positive for TSM demand, but also raises the risk  at the customer level if there is any slowing in end-user demand.  While the company was careful to restate how closely it works with its customers on order and inventory management, they did note that they cannot rule out the potential negative effect that overbooking might have, although they were not suggesting that currently.
               Automotive – Expect automotive shortage to be ‘greatly reduced’ by next quarter – A bit hard to imaging how that would be the case unless automotive customers have already agreed to price increases that are higher than other components, or slower smartphone demand has freed up some capacity in 2Q that was not available in 1Q.
               Margins – Pressure from increasing proportion of 5nm business, which currently has higher cost and lower efficiency than more mature nodes.  As they expect 5nm to revenue to be 20% of revenue this year, that would imply considerable strength in the 5nm node for the remiander4 of the tear, as 1Q saw 14% od revenue from 5nm.  Increasing the cost efficiency of the 5nm process will be key in seeing margin improvement since high utilization on other nodes makes it more difficult for TSM to improve process
Full Year Guidance
               Semiconductor Market Growth (ex memory) – up 12%
               Foundry Growth – up 16%
               TSM Growth – up 20%
               Expect overall demand to remain strong and for shortages to continue through this year and may extend into 2022.
               Expect HPC and automotive to be higher than corporate average for 2021 – The company has seen demand strength from both segments over the last 3 months.  As we noted yesterday, HPC strength is relatively easy to understand, but we wonder if automotive strength includes any overbooking as desperate customers vie for capacity.
               Capex up to $30b from $26 previously
                              80% of 2021 capex on 3nm, 5nm, 7nm nodes
                              10% on Advanced packaging
                              10% on specialty technology
               Will spend $100b over 2021 – 2023 period – Unusual in that they gave long-term capex guidance.  Likely due to spending announcements by competitors Samsung (005930.KS) and Intel (INTC).
               Customer interest in 3nm – 7nm nodes is increasing – Regardless of whether that translates into revenue as soon as TSM hopes, they have little choice but to spend on 3nm – 7nm nodes in order to try to stay ahead of Samsung, but moving up the learning curve will determine whether they can continue to generate record sales and profitability id utilization stays high.
All in, it was a good quarter for TSM, who should be generating peak sales and profits, even as 5nm grows.  While the company was obviously optimistic about the next 12 months and the three year period encompassing 2021 to 2023, there were some points that would likely keep expectations from getting out of control.  Aside from the margin pressure from 5nm, the slower pace of overall cost/process improvement because of the high utilization, which is a good problem to have, and a 30% increase in depreciation this year, along with the mention of over-ordering, point to some of the limiting factors that should keep estimates under control.  On the other side of the equation demand remains strong and the positive effect of wafer price increases should allow TSM to meet its 20% growth target this year, barring any further exogenous variables or natural disasters.

LG Electronics (066570.KS) has stated that it will be closing its mobile division by July of this year after 23 quarters of losses.  The company had been in discussions with a number of possible buyers for the division but could not reach terms that were lucrative enough to produce a sale of the division rather than an actual closing.  While the mobile division at LGE has been generating losses for years, we note that in previous years it has been LGE’s 3rd largest division behind the Home Appliance and Home Entertainment divisions, but fell to last place in sales last year, while generating the biggest division operating loss.  The table below breaks out LGE’s divisions in 2020 and shows sales and operating profits in US dollars with and without the mobile division.

LGE’s mobile division has a number of production facilities, primarily in Hai Phong City, Vietnam, Taubate, Brazil, and Qingdao, China.  While we expect all three are for sale, the plant in Vietnam, which is able to produce 10m smartphone/year is the largest production asset, and LGE had been in discussions with Vingroup (VIC.HNX), the largest conglomerate in Vietnam, concerning both the Hai Phong and Taubate plants, but have been unable to agree on a mutually acceptable price.
The LGE Vietnam sub-group, which we expect is primarily the output of the plant, ran a 3.5% operating profit last year, so a brand with a decent share of the APAC market would likely benefit by purchasing the plant, and whatever price could be negotiated would certainly look better on the LGE books vs. a full write-off, but compensation and base salary for existing workers has been a stumbling block for other South Korean foreign plant sales recently, and that could be the problem keeping the facility from being sold currently.  It’s in a good neighborhood….

​While such metrics leave a great deal to be desired in their ability to be verified, Xiaomi (1810.HK) indicated that on the first day of release, the Mi Mix Fold, sold 40,000 units in the first minute of its availability.  Since this is Xiaomi’s first foldable, there is no comparison to previous Xiaomi models and most reference points for new model smartphone sales are based on one day at a minimum, and usually at least a week or month. As on-line pre-orders can sit in queue until the actual moment of release, trying to judge how popular a new phone might be based on the first minute of sales is a waste of time.  Hopefully Xiaomi will give more relevant data as time passes.

As we have noted, the semiconductor capacity shortage being faced this year has incentivized foundries to increase both short-term and long-term capex, however given that there are only a limited number of key semiconductor tool vendors, all increases in construction cap\ex must be followed by spending for semiconductor equipment, which can have lead times extending to 12+ months.  Tool vendors must be careful not to over promise on delivery dates, which will leave foundries with incomplete fabs, but also face their own limitations on production capabilities.
In order to make sure that there is not a gap between construction and equipment move in, semiconductor manufacturers must work themselves into equipment queues at a number of tool vendors, and during periods of high capital spending in the semi space, this can become contentious.   While constant contact between potential semiconductor producers and equipment vendors is normally expected, when executives get on planes to make visible visits to tool vendors, it tends to indicate the level of competition for tool vendor capacity.
It seems that Samsung executives have been on planes this week, making appearances at Applied Materials (AMAT) and Lam Research (LRCX) after a trip to ASML (ASML) recently.  In fact the Vice Chairman of Samsung Electronics made an unusual and highly visible to ASML last October to maintain a smooth relationship between the companies, given ASML is the only supplier of EUV equipment necessary for production at 5nm and below.  With announcements of new or increased capex spending by Samsung, TSM, and Intel, we expect lots of miles will be flown by managements to keep tool vendors from reallocating resources.  While TSM as the largest foundry has a well-established relationship with primary tool vendors, we give Samsung credit for being an early capex ‘announcer’ and shaking the hands (metaphorically) of tool vendors as others are just announcing and formulating long-term spending plans.

​AU Optronics (AUOTY) has indicated that they will be adding a small amount of capacity to their Gen 6 line in Kunshan, China, which has been built out to 36,000 sheets/month, against a total potential capacity of 45,000 sheets/month.  The increase, which will be put into production in the 3rd quarter of next year, will add another 9,000 sheets/month to the fab’s capacity or 0.45%.  While that is a small amount of additional capacity, that fab is producing IT products, essentially monitor and notebook panels, so 9,000 sheets/month on an annualized basis represents 108,000 additional sheets, and if. For example, that production was split between 27” monitors and 14” notebook panels, at current panel prices that annualized increase in panel sales would come to $138.7m, or a 1.4% increase in sales for a 0.45% increase in capacity, assuming 100% utilization.
While these numbers are assuming panel prices stay at current levels, any further increase in IT panel prices would enhance the improvement, so the risk to AUO, as with all other panel capacity expansions, is when utilization starts to fall, which is usually accompanied by falling panel prices.  Such a double whammy is the bane of panel producers, which is why AUO has almost always taken a more conservative stance toward panel capacity increases, focusing more on improving mix by adding more premium products.  While cyclicality in the industry don’t always allow even this conservative philosophy to produce profits, it is the inverse of China’s panel producers’ philosophy, which is more focused on building share by rapidly increasing capacity.
Right now, given the high utilization rates and panel price increases seen over the last year, the Chinese philosophy wins out, but there is certainly something to be said for a more conservative approach to expansion and a greater focus on profitability.  Last month the AUO board approved capex of NT$455m (~$16m US) for “factory and capacity optimization and adjustments.”  Company management did note that they expected the shortage of key components to worsen in 2Q, as compared to 4Q ’20 and 1Q ’21, citing glass substrates, PCBs, and polarizers more specifically, along with ‘persistent’ IC supply issues, with component and material lead times extending to roughly eight weeks from a pre-pandemic four weeks.
 

On Monday we noted that Chinese OLED panel producer Visionox (002387.CH) had received a substantial order from Honor (pvt), the former Huawei sub-brand that was recently separated from its founder in order to avoid the trade restrictions placed on Huawei by the US government.  While the order we mentioned was for flexible displays and touch components, we expect that the relationship between the two companies will continue, as Honor is expected to source foldable displays from Visionox for its first entry into the foldable device market. 
Honor is expected to release the “Magic X”, its first foldable in the 2nd half of the year, one of a number of smartphone brands that have either indicated that they have such products under development or are in the process of qualifying components.  Currently 5 smartphone brands have released foldable smartphones, with Samsung the leader, heading into the release of its 3rd generation Galaxy Fold later this year.  While Motorola has focused on the more compact '‘flip” type foldable, (Samsung also has such a device), others have taken more of a ‘phablet’ approach, with what are normal sized smartphones when closed, opening up to tablet size.
Among those that have yet to release a foldable smartphone is China’s TCL (000100.CH), who has shown a wide variety of demos and prototypes as part of their ‘fold and roll’ development project.  TCL has developed an unusual hinge system that it combines with a rollable OLED display, which allows the phone to be unfolded and then further expanded by pulling out the rolled portion.  The concept here is that while this is a bit thicker than a normal smartphone, it allows a normal sized phone to expand to 8.85 inches, but can expand further to become a full 10” tablet, larger than any existing smartphone foldables.  TCL has also shown a 3 way folding device, using the same proprietary hinge system, and while the company has not promised to convert any of these demos into actual products (in our lifetime), they are quite adamant about entering the foldable space.  As TCl is the parent of Chinastar (pvt), we would expect they would at least have a pole position as a supplier for such a product.

As the world’s largest semiconductor foundry, Taiwan Semiconductor (TSM) is a harbinger of the health of the industry and at the least an anecdotal source of the structural issues that face the industry currently.  While we are not going to go into great detail as to the nuance in TSM’s 1Q results, there are some points that should be recognized by investors in the CE space.   While sales were up only 1% q/q in US dollars, on a y/y basis they were up 24.7% and continue the trend of expanding semiconductor demand and high utilization that has been seen since 3Q of last year.  Aside from the standard rhetoric about the new digital age and seasonality, HPC (High Performance Computing – ASICs, GPUs, and AI processors) continues to grow as a percentage of TSM’s business on a q/q basis, a good portion of which is being driven by crypto-mining, while the smartphone segment seems to be growing, but at a slower space.
Embedded in the HPC gains is the rise in the price of bitcoin, making mining a more lucrative endeavor, but that demand is also competing with demand for graphics components that are actually being used in consumer devices.  Most of the other platform categories are seeing modest q/q revenue growth, but when growth on a y/y basis is examined (Fig. 3), slowing smartphone growth is even more pronounced, taking seasonality out of the mix.  Here’s what the 1st quarter y/y results looked like by platform for this year and last year.
 

​All in, it is difficult to remove the effects of COVID-19 from TSM’s quarterly results, but comparing against the pre-COVID y/y performance does give some indication as to where a longer-term baseline should be drawn for each platform.  While automotive is still a relatively small portion of TSM’s wafer business, it seems to be growing more consistently than the others, as the only segment that saw higher y/y growth this year over last year, even considering the constant stories about how foundries have allocated less resources to the automotive space and more to higher margin components, which seem to be primarily in the HPC category.  Huawei (pvt) is also a factor in the slower smartphone growth at TSM, but given how strong overall demand has been in recent quarters, the order reductions from Huawei that are a result of US trade restrictions, are likely easily made up by others.  More on TSM to follow…

​Yesterday we noted that a power outage at TSM’s Nanke plant caused at least part of the line to shut down, putting ~30,000 wafers at risk, and while the plant is now operational, the company is still evaluating what portion of those wafers on the line could have to be scrapped.  Industry estimates are for up to $35m in potential losses from the outage.   It seems that the problem was caused by a contractor working at the nearby Wistron (3231.TT) plant, which is undergoing expansion.  It seems that the contractor accidentally cut the 161KV underground powerline, which caused systems to trip at a number of locations.  While details are not known yet about the impact on other manufacturing facilities sourced by the same cable, it seems that voltage drops at Innolux (3481.TT), UMC (UMC), Corning (GLW) and others were part of the same issue, although the extent of any damage is still being evaluated.
For whatever reason, the semiconductor space seems to be having a bad run of luck, at a time when the industry is seeing great demand.  Just yesterday, a fire broke out at a plant in Taiwan that makes copper-clad substrates, which shut down the entire facility, following a string of natural disaster occurrences that have caused production problems at various fabs around the globe, along with an unusually large water shortage in Taiwan that has caused 7 of Taiwan’s primary reservoirs to be at less than half of capacity, causing certain regions to reduce water consumption by 7% to 10%, although the government insists that such shortages have not affected companies in its many science parks.  TSM has begun to transport water to some of its facilities by truck.