ASML Gets TSMC To Sign On The Dotted Line

By Stephen D. Simpson, CFA | August 06, 2012 AAA

So far, it looks like ASML's (Nasdaq:ASML) unconventional customer investment plan is shaping up as an offer that the biggest semiconductor companies can't refuse. Intel (Nasdaq:INTC) already committed to purchase as much as 15% of ASML's shares and invest over $4 billion, and now huge semiconductor fab Taiwan Semiconductor (NYSE:TSM) (aka TSMC) has chosen to join in as well.

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Familiar Terms, Familiar Rationale
Given that ASML laid out the terms for these investments ahead of time, there really wasn't much uncertainty about the terms of the deal - it was a question, rather, of whether TSMC would decide to join Intel in the program. The company has chosen to do so, agreeing to take a 5% stake, spending over $1 billion in ASML's research and development (R&D), mainly to support ASML's development of extreme ultraviolet (EUV) technology.

TSMC is joining in for the same basic reason as Intel - TSMC badly needs better semiconductor equipment to continue to meet the ever-rising standards and complexity demands of its customers. Consider the company's relatively recent issues with 28nm production - apparently TSMC has only been able to meet about 70% of customer demand for 28nm chips, and customers including Qualcomm (Nasdaq:QCOM) and Nvidia (Nasdaq:NVDA) have made it pretty clear that they are not pleased with the situation.

SEE: A Primer On Investing In The Tech Industry

As a participant in ASML's development program, TSMC can not only play some part in acceleration of technology development, but also perhaps help guide and design technology to meet its anticipated needs. At a minimum, it would seem that Intel's participation made it all but essential for TSMC to join in as well.

Will Samsung Be Behind Door No. 3?
With Intel now signed up for 15% of ASML's shares and TSMC coming in for 5% that leaves one more 5% slot. The analyst community pretty much universally expects Samsung to be the third company to join, though ASML has indicated that it has had discussions with other potential partners.

SEE: Should You Have A Business Partner?

This will be an interesting decision to watch. Samsung has about two weeks from the time of this writing to decide, and it would seem that the odds favor their participation. By the same token, Samsung has something of a reputation for zigging while others zag, so I wouldn't say their involvement is fait accompli.

That said, I don't think Samsung's involvement really matters much unless ASML rivals Canon (NYSE:CAJ) or Nikon start a similar program and coax Samsung into joining. Samsung is a large chip company, twice the size of No. 3 Texas Instruments (Nasdaq:TXN) in terms of shipment market share, but other parties could step up and get involved if Samsung elects not to do so.

SEE: Can Samsung Compete With Apple's Retail Stores?

The Bottom Line
This still seems like a smart and bold move from ASML. These R&D commitments will go a long way towards covering the company's R&D needs, and will allow the company to hire more engineers and accelerate development of EUV products. At the same time, the company and current shareholders lose little as the shares involved in these deals carry very limited voting rights.

The only downside of this situation, such as it is, is that the Street has pretty much baked in the economic benefits. ASML shares have been quite strong in a generally weak tape for semiconductor equipment stocks and there doesn't look to be a lot of undervaluation left. I wouldn't look to sell ASML shares if I owned them, but I'm not sure I'd make these shares my top pick in the equipment space given today's valuation.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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