Tower Semiconductor Ltd

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Tower Semiconductor Ltd. (TSEM) is a global specialty foundry, providing advanced analog integrated circuits and related services primarily for the mobile, industrial, automotive, medical, and aerospace & defense markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Tower Semiconductor operates as a pure-play foundry, meaning it manufactures semiconductors designed by other companies. This is a departure from integrated device manufacturers (IDMs) that design and fabricate their own chips. TSEM focuses primarily on specialty analog semiconductors, which require a higher degree of design and process expertise than digital integrated circuits, and have longer life cycles. These products are typically used in power management, sensors, high-performance computing, and other applications requiring high-reliability, low-noise, high temperature, and/or high precision features.

The semiconductor industry overall is characterized by rapid technological changes and high capital expenditures. However, the foundry segment is less exposed to direct end-market volatility as they manufacture chips for diverse customers, in many end-use applications, allowing them to capture some overall market growth.

Revenue Streams: TSEM generates revenue by fabricating chips for its customers, which are mainly other semiconductor companies, original equipment manufacturers, fabless semiconductor companies, and companies producing products for communications, computer, consumer, industrial, automotive, and medical end markets. As of 2021, North America accounted for approximately 53.1%, the Asia Pacific region was about 24.3% and other areas the remaining 22.6% of revenues. The company operates primarily through three foundries located in Israel, Newport Beach California, and San Antonio Texas. This includes fabs for production and design and development purposes.

TSEM does not provide geographical revenue breakdown, however, notes that the bulk of its revenue is generated from its domestic customers and Japan.

  • Mobile: Sensors and analog semiconductors used in smartphones.
  • Industrial: Devices used in automation, power management, and various industrial control applications.
  • Automotive: Products that meet stringent quality and temperature requirements, such as those for automotive safety systems.
  • Medical: Components used in medical imaging, implantable devices, and other regulated applications.
  • Aerospace and Defense: High-reliability chips that withstand extreme conditions and are used in aerospace and defense applications.

Industry Trends: The semiconductor industry is growing due to increased demand for electronic devices and data processing, especially in the wake of increasing usage of advanced technologies such as IoT, AI and Machine Learning. The industry faces increasing consolidation, leading to greater pricing power for larger players. TSEM benefits from demand for specialized analog semiconductors and outsourced fabrication needs but still competes with some bigger and more established semiconductor companies. The company faces strong pricing pressure due to intense competition.

Competitive Landscape: TSEM operates in the foundry segment of the semiconductor industry, which is highly competitive. It faces competition from large, established foundries such as TSMC and GlobalFoundries, and from other specialty foundries. This industry is characterized by high capital requirements, technological innovation, and pricing pressure.

While TSEM is the largest pure play analog specialty foundry, there are numerous smaller niche competitors in the analog and mixed-signal markets, especially in the MEMS (Micro-Electro-Mechanical Systems) sector, that may possess certain technological advantages over TSEM.

  • TSMC (Taiwan Semiconductor Manufacturing Company): The dominant global foundry, primarily focused on digital ICs, but also with some analog capabilities.
  • GlobalFoundries: Another major player in the foundry industry, with a broader portfolio including digital, analog, and RF (radio frequency).
  • Samsung Foundry: The foundry division of Samsung, which is making big strides and has a significant capital base for further growth.
  • UMC (United Microelectronics Corporation): A Taiwanese foundry with a mix of digital and analog capabilities.
  • Specialty Foundries: A number of smaller players, including SkyWater Technology, X-Fab, and Jazz Semiconductor, which compete within specific analog niche applications.

What Makes TSEM Different? TSEM differentiates itself by specializing in analog semiconductors that require precise and custom processes. This focus enables them to develop strong ties with customers and retain their business long-term. Their specialty fabrication processes also lead to higher returns on capital than general foundries.

TSEM prides itself on being “technology focused”, and strives to be a leader in advanced technology solutions within its niche in a fast changing world.

Financials

TSEM’s financials exhibit characteristics of a capital-intensive industry, where revenue is dependent on the utilization rate of facilities.

Historical Revenue Growth: TSEM has shown modest revenue growth, but with some fluctuations primarily in line with industry trends and fluctuations in utilization rate. Note that due to the nature of its business as a pure-play foundry, its revenues are generally not directly tied to demand in end markets. In a volatile business, such as a semiconductor market, TSEM tries to increase revenues by bringing new customers through geographical expansions.

While TSEM’s business has been profitable with consistent revenues and earnings, its growth has not been robust. They continue to rely on R&D spending to innovate and enhance its fabrication process capabilities, but are limited by high amounts of long term debts, interest expense and capital expenditures, making it difficult to grow significantly faster.

Margins: As of 2021, TSEM’s average gross margin is 27.3% and has been improving steadily since 2019. While TSEM’s operating margin is 15.6%. There is a huge gap in margins which is eaten up by SG&A, R&D and other operating expenses, demonstrating the limitations to growth potential based on expense ratios.

Profitability: While TSEM’s profitability is somewhat stable, there are high fluctuations on per-quarter basis based on factors such as production volumes, facility maintenance and yield issues. These have a considerable impact on profitability on a quarterly basis. The high capital expenditures on the semiconductor industry affect these results as well.

Debt: TSEM relies on large amounts of debts for capex and operations. For 2021 its long term debt is equal to $648.2 million. The debt has grown over time and TSEM is required to finance its capital expenditures with loans and equity. This has led to high interest expenses.

As of 2022, the company increased its debt liabilities to $1.3 Billion from $925 Million in 2021.

Capital Expenditures: TSEM invests heavily in research and development and manufacturing facilities to maintain technological edge. The capex requirements are relatively high. For 2021, its total capital expenditures stood at $220.4 million. The high capital expenses coupled with high debt can create a significant leverage risk.

Moat Assessment: 2/5

TSEM possesses a narrow economic moat based on specialized fabrication processes and customer relationships. However, the moat’s durability is questionable due to ongoing industry consolidation, technological advances, and competition.

Here’s why it gets a 2/5 rating:

  • Intangible Assets:
    • Patents: TSEM has patents in specialized process technology, but these are subject to legal challenges from competitors and limited lifespan.

  • Regulatory Approvals: TSEM is a pure play foundry and does not produce their own products for end markets. Instead it provides services and hence, regulatory approvals do not form a significant moat. * Brands: TSEM does not have major brand recognition among end consumers. However it has maintained customer loyalty through its reputation for delivering value added services. * Specialized Manufacturing: TSEM is a specialty manufacturing company, with strong technical capabilities, but its processes aren’t proprietary enough to ward off competition. However, some specific and highly niche facilities (like the X-FAB facility) and technology advantages provide a very small barrier.

  • Switching Costs: TSEM maintains a relatively tight relationship with most of its customers. Due to this, the cost of switching can become high (in terms of new validation protocols, time and resources), resulting in recurring sales.
    • TSEM’s customers usually develop strong ties with TSEM, because they work with the fab design for very specific semiconductors. This leads to high amounts of customer stickiness, as a customer that is familiar with the process and capabilities will most likely prefer working with TSEM.

  • Network Effects: No significant network effects exist in TSEM’s business model. Customers do not benefit from the size of the customer base.

  • Cost Advantages: TSEM does not have a clear advantage over peers in costs. Although their focus on smaller volume specialized products has led to less capex requirements, the need for frequent process upgrades requires very high capex.
    • Scale: The specialized technology and expertise needed limit the ability for TSEM to scale, making its manufacturing capabilities expensive and specialized, leading to lower margin output at higher capital expenditures than a general foundry.
    • Unique Assets TSEM has some unique capabilities and certain high-value assets in the form of unique processes.

Risks to the Moat and Business Resilience

  • Technological Obsolescence: The semiconductor industry is highly prone to rapid technological change, which could make TSEM’s expertise obsolete. New foundries may replicate or improve upon TSEM’s processes.
  • Competition: TSEM faces severe competition from larger and more diversified foundries, which could pressure pricing and reduce margins. The number of specialized foundries is also increasing.
  • Geopolitical Risks: Being geographically concentrated in volatile regions such as Israel exposes the company to considerable risks like armed conflict, which may disrupt operations.
  • Customer Concentration: TSEM is heavily reliant on a small number of customers for a large portion of its revenue. Loss of a major customer could affect its finances and profitability.
  • Capacity Utilization: TSEM needs very high utilization rates to meet its debt obligations. If production volumes decrease, or if market conditions force less production, then its financial outlook may turn negative.

Understandability Rating: 4/5

While the business model of a semiconductor foundry is easy to understand, a good understanding of its finances is fairly complex. The technology is difficult to fully understand (even by people with knowledge of the tech). Understanding the industry dynamics as a whole is difficult.

Balance Sheet Health: 3/5

TSEM’s balance sheet is reasonably healthy but has a lot of debt, which makes its finances dependent on maintaining positive operating performance.

  • Debt: TSEM’s long term debt is concerning and poses a significant financial risk
  • Cash: The company had cash and cash equivalents worth only approximately $478 million against 1.3 billion in long term debt as of Dec 2021.
  • Tangible Assets: Though the company possesses tangible assets, as a fabrication company, their value is tied to the ability of their assets to produce revenue, which means that they might not sell at the same price as is booked on the books.
  • Non Operating Assets: The company does not possess a lot of cash reserves that are not used for operating the business. This means they cannot weather an economic downturn and may face severe financial hardship if business performance dips.

Recent Concerns and Controversies

TSEM is in an active merger with Intel. They have been in talks for over a year now. The merger is expected to complete by 2023.

There is a significant risk regarding the merger. Intel might terminate the merger based on certain events outlined in the merger agreement, which would severely impact TSEM’s financial future.

A more recent event included “a potential cyber incident in its IT infrastructure” in Q4 2022, that impacted its normal functioning in production. This is expected to cause some material losses. While its impact was limited, this also demonstrates the company’s vulnerabilities in cybersecurity.

On the bright side, TSEM has been able to raise prices and reduce costs. These actions are expected to increase margins in the following periods, and may be a cause for upward re-rating by investors.