New U.S. Restrictions on Chip-Related Exports to China Spook Traders; Foundries Remain Undervalued

We retain our fair value estimates for TSMC at TWD 990 (USD 166 per ADR), UMC at TWD 62, and SMIC at HKD 21 per share respectively after the U.S. Department of Commerce introduced new rules to restrict semiconductor-related exports to China on Oct. 7. We intend to update our forecasts for both companies once they announce financials later this month. We believe short-term uncertainties over foundry demand will increase, as China is the world’s second-largest cloud computing market, and local cloud service providers may struggle to secure chips for their expansion initiatives. The new shock may further dampen sentiment in a sector that is already ravaged by weak consumer electronics demand. However, our long-term outlook remains positive, since export licenses are still possible under the new rules, and unfulfilled demand can be met by overseas peers. Although we believe TSMC is undervalued as an outsize beneficiary in cloud services over the long term, its near-term share performance may be weaker than UMC and SMIC given its exposure in cutting-edge nodes.

The DOC issued new rules, which aim to restrict China’s ability to acquire or manufacture advanced computing chips and supercomputers. These rules, together with potential CHIPS and Science Act-related stipulations, are likely to prompt TSMC to scrap or downsize 16nm expansion in Nanjing, China that was announced in mid-2021. The new rules appear broader than we would have imagined, as these cover direct and indirect exports, and can be interpreted to include lenses, lasers, and other peripheral components that have uses outside semiconductors. More importantly, it blocks U.S. people (and companies) supporting development and production at China-based plants without a license, which we believe may lead to revocation of electronic design automation software licenses, and new sites in China.