Agenda

1
Taiwan Semiconductor Manufacturing Company
Analysts JeBang Ahn, Michael Chen, Brian Chung,
Eric Sanchez, Sapan Shah
2
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

3
Case Overview

• Things are not always as they seem

4
Managed Funds Performance

• Mutual funds investing in technology and science
  stocks have plummeted 43 in 2002

5
Case Overview

• Assist investment manager in determining whether
  to invest in Taiwan Semiconductor Manufacturing
  Company
• Is the current stock price an attractive entry
  level for investors? If so,
• Decisions to make invest in equity (Taiwan or
  ADR), or wait and purchase call options
• Does the Shanghai foreign direct investment add
  to the Companys intrinsic value?

6
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

7
Taiwan
8
Country Overview

• Taiwan, Republic of China
• Governmental System
• Multiparty democratic regime headed by
  popularly-elected president (Chen Shui-bian)
• Major Political parties are the Democratic
  Progressive Party (DPP), Kuomintang (KMT), and
  People First Party (PFP)
• GDP US 281,300 Million
• Current Account Balance US 18,861 Million
• Foreign Reserves (excl. gold) US 122,211
  Million
• External Debt US 18,900 Million
• Inflation Rate 0.5

- Figures for 2001
9
GDP Growth
10
Export Partners
11
Country Risk Analysis

• Political
• Alleviated political tension with Mainland China
• Government (DPP) strongly advocates for foreign
  investment
• Alliance between Kuomintang and People First
  Party looks promising in next Presidential
  election in 2004
• Economic
• Strong Current Account Balance and Foreign
  Reserves
• Free and liquid capital market with high trading
  volume
• To stabilize market, daily price fluctuation is
  limited
• Stocks and convertible bonds 7
• Bonds 5
• of the closing price of the preceding business
  day

12
Country Risk Analysis

• Intangibles
• Chairman/CEO Morris Chang
• Advice is highly regarded and valued by the
  government as well as business sphere
• In 1985, Taiwanese government recruited him to
  head its Industrial Technology Research Institute
  (ITRI)
• Ph.D in Electrical Engineering from Stanford
  University
• Masters in Mechanical Engineering from M.I.T.
• Board of Directors of Goldman Sachs
• Cognizant of corporate governance issues

13
China
14
Country Overview

• China
• Population 1,273 Million
• Governmental System
• Communist State
• President and vice president elected by the
  National Peoples Congress for five-year terms
  (President Hu Jintao)
• GDP US 1,159,000 Million
• Current Account Balance US 17,400 Million
• Foreign Reserves (excl. gold) US 215,600
  Million
• External Debt US 147,700 Million
• Inflation Rate -0.8 (2002 E)

- Figures for 2001
15
GDP Growth
16
Export Partners
17
Country Risk Analysis

• Political
• Admittance to WTO has led to further
  liberalization of rules and statutes
• Current President Hu Jintao and his predecessor
  Jiang Zhemin have embraced western ideals (i.e.
  FDI)
• Roach Motel strict capital controls has
  created difficulty in ceasing operations if
  deemed unprofitable
• Economic
• Utilized considerable foreign reserves in
  maintaining a constant currency exchange rate
• Focus on infrastructure development (soft-budget
  policy)
• Currently improving Mergers Acquisitions
  regulations

18
Exchange Rate Stability
19
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

20
Company Overview

• Leading dedicated Integrated Circuit (IC) foundry
• IC used for microprocessors, graphics chips,
  wireless communications platforms and
  programmable logic devices
• Currently operates 7 wafer fabrication plants and
  3 joint ventures
• Major customers include
• Altera, Nvidia, Motorola, Texas Instruments, and
  others
• Listed on
• Taiwan Stock Exchange (TW 2330)
• New York Stock Exchange (NYSE TSM ADR)

21
Company Overview
22
Company Overview

• Sales
• FY 2001 125,885
• FY 2002(E) 158,645
• FY 2003(E) 192,817
• Net Income
• FY 2001 14,483
• FY 2002(E) 22,755
• FY 2003(E) 33,189

- Figures in New Taiwanese Dollars (Millions)
23
Regional Sales
24
Industry Overview

• Integrated circuits are semiconductor wafers
  containing resistors, capacitors, and transistors
• Used for a variety of devices, including
  microprocessors, audio and video equipment, and
  automobiles
• TSMC has grasped approx. 60 of IC market
• Pure-play competitors market share

25
Industry Overview

• Current state
• Slow growth due to excess production in the late
  1990s, leading to high inventory levels
• Scaled back capital expenditures
• Pricing pressure due to market over-saturation
• A leading source of growth is the wireless
  communications sector, which is a significant
  portion of the Companys revenues

26
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

27
5-Year Stock Chart
28
Earnings Per Share
29
Price/Earnings
30
Market Analysis

• Book-to-Bill Ratio has been below one over the
  past year
• Measures the orders shipped to new orders
  received
• However, there are signs of life
• Investor Sentiment
• Suspicious in regards to high-technology stocks
• Poor performance of competitors in the industry
• Should the investment manager invest in the
  Companys Common Stock or ADR?

31
Taiwan Trading Volume
32
US Trading Volume
33
Analyst Recommendations
34
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

35
Ratios
36
Industry Sales Growth
37
Sales Growth Determination

• Used a 4.70 growth rate for 2005-2007
• 2002-2004 I/B/E/S estimates relatively high, as
  Company benefits
• Status as industry leader
• Continued trend towards outsourcing
• Businesses expected to replace information
  technology components
• High growth rate is not expected to continue
• Company already possesses a sizable portion of IC
  market
• Industry consolidation is expected, increasing
  competition for a currently stagnant industry

38
Pro Forma Cash Flows
39
Shanghai Mfg. Facility

• Will be used to manufacture 8-inch wafers
• Cost of Goods Sold Implications lower direct
  labor costs, tariff reductions and tax breaks
• Cost of Factory NT 31,214 Million
• Sources of Funds
• Cash NT 12,896 Million
• Leverage NT 14,530 Million
• Retained Earnings NT 3,789 Million
• Exchange Ratio 34.8 NT/US
• Assumptions
• Interest rate Companys Cost of Debt
• Tax Rate 15

40
International Cost of Capital

• Goldman Integrated Model for Cost of Equity
• US Risk-Free Sovereign Yield Spread Beta
  (World Historical Risk Premium)
• Beta (ADR relative to SP 500) 0.9
• US Treasury 10-Yr Bond Yield 3.96
• Taiwanese Government 10-Yr Bond 2.16
• SP 500 Historical Returns 8.00
• Cost of Equity 5.80

41
International Cost of Capital

• Cost of Debt calculated through Altman Z-Score
• Altman Z-Score 3.256.56X13.26X26.72X31.05
  X4
• X1 Working Capital / Total Assets 0.10
• X2 Retained Earnings / Total Assets 0.10
• X3 EBIT / Total Assets 0.03
• X4 Book Value / Total Liabilities 3.11
• Comparable Bond Rating AA

42
Adjustment of Altman Score

• No adjustment for foreign currency fluctuation
• Low vulnerability of revenues (73.3 of revenues
  outside Asia)
• No adjustment for industry risk
• Very low leverage industry
• No adjustment for competitive position
• Leading player, but not considered dominant due
  to competition
• 2 adjustment for Market vs. Book Value
• Market Cap (NT 875,275 Million), Book Value (NT
  295,853 Million)

43
Adjustment of Altman Score

• No bond specific adjustment
• Some unsecured debt outstanding, but unsure about
  contingencies (collateral, guarantees)
• No sovereign risk spread adjustment
• Taiwanese yield slightly lower than comparable US
  Bond yield

44
Debt Rating Conclusion

• EM Adjustment suggests AAA
• Company Rating on Taiwan Ratings Agency
  (Affiliate of Standard Poors) AA
• We, conservatively, used AA as the credit rating
  for the Company
• Cost of Debt 3.06
• Taiwan Government 10-Yr Bond Yield 2.16
• Bridge spread for AA Bond .90

45
WACC Assumption

• Weighted Average Cost of Capital 5.28
• Assumptions
• Constant Debt/Equity Ratio of .19
• BV of Equity (from Company) NT 295,853 Million
• Projected Debt NT 56,343 Million

46
Discounted Cash Flows

• Three cases
• Case 1 Precedent Transactions Multiple
• Case 2 Technology Industry Multiple
• Case 3 Gordon Growth Model

47
Case 1 DCF

• Used 3 mergers acquisitions transactions to
  determine EBITDA Multiple to be applied
• Target companies integrated circuits
  manufacturers
• Min PP/EBITDA Multiple of 12.19x
• Implied value per share NT 112.06
• Implied value per share (ADR) US 16.12

48
Case 2 DCF

• Technology industry multiple used to calculated
  terminal value
• Typical PP/EBITDA Multiple 7.00x
• Implied value per share NT 75.95
• Implied value per share (ADR) US 10.93

49
Case 3 DCF

• Gordon Growth Model to calculate terminal value
• TV FCF /(WACC LT Growth)
• LT Growth Rate 2
• Implied value per share NT 223.43
• Implied value per share (ADR) US 32.24

50
DCF Conclusion

• DCF Range of Values
• Based on Taiwanese Stock NT 75.95 223.43
• Based on US ADR 10.93 32.24
• Current Price Per Share
• Taiwanese Exchange NT 47.00
• New York Stock Exchange 8.18
• The Force is strong with this one
• - Star Wars

51
Sensitivity Analyses
Case 1 Discount Rate vs. Terminal Value Multiple
Case 2 Discount Rate vs. Terminal Value Multiple
52
Sensitivity Analyses
Case 3 Discount Rate vs. LT Growth
53
Comparable Companies
54
Conclusion

• Multiples serve as a testament to the relative
  strength of the Company
• TSMC at the higher end of each respective
  multiple
• Market price may be high, relative to
  competitors, as investors recognize
• Robust Cash Flows, Revenues and Balance Sheet
• Company as industry leader

55
Black-Scholes Pricing
56
Agenda

• Case Overview
• Country Risk Analysis
• Company and Industry Overview
• Market Analysis
• Financial Analyses
• Ratios
• Discounted Cash Flows
• Comparable Companies
• Black-Scholes Options Pricing
• Conclusions
• Questions Answers

57
Insight / Take Home Points

• Investors should not be averse towards investing
  in a particular sector/industry
• Due Diligence
• Use of various methodologies to evaluate equity
• Ride the wave
• Investment in technology companies could be a
  profitable venture in the long run
• If there is the potential to make a killing,
  pull the trigger

58
Insight / Take Home Points

• ?????????,?????? (Warren Buffet)
  ?????????,????????????????,???????????????????????
  
• By using Warren Buffets highly-regarded
  methodology, TSMC will be selected as one of the
  eight companies to invest in Taiwan.
• - Taiwan Economic Information Co.

59
Insight / Take Home Points

• Taiwan Semiconductor Manufacturing Company
• Will Be Back!!!

60
Q A Session