Hiraman
Are we in a brand new demand cycle for tech {hardware} because the COVID-era PC- and smartphone-purchase growth hits the primary leg of its substitute cycle? And can AI-enabling units act as a tailwind? In that case, how can buyers profit?
These are the questions we sought to reply earlier this 12 months when 5 of our international fairness portfolio managers and analysts visited Taiwan, which is hard to high from an effectivity perspective: dozens of tech firms are clustered in a handful of science parks.
We met with 25 firms in various tech industries throughout the market-cap spectrum and got here away with the next key insights.
A Alternative Cycle Features Traction
Our investable universe in Taiwan successfully consists of know-how {hardware} (33.5%) and semiconductors (66.1%), with just a few software program or IT providers firms.
Inside tech {hardware} and semis, smartphones and PCs are nonetheless the biggest end-markets, regardless of sooner development in areas resembling automotive and industrials. Smartphones and PCs have been additionally two of the most important subjects of dialog on our journey.
Each of those end-markets noticed double-digit unit cargo declines in 2022 and 2023, however their outlook is bettering. A destocking course of led to decrease inventories, however demand is popping constructive, so we may see extra manufacturing in 2024. With the supply-demand imbalance beginning to transfer again within the firms’ favor, they’ve extra pricing energy.
The smartphone business, for instance, had exceptionally excessive stock ranges within the first and second quarters of 2023, however there was a noticeable lower within the fourth quarter of 2023. This led to a surge in rush orders for tech {hardware} and semis, and subsequently element restocking and important stock changes. These changes recommend an enchancment in development throughout the sector. Furthermore, we anticipate a rebound in smartphone unit development, maybe a 5% enhance in 2024-2025, following a ten% decline in 2022-2023.
Within the PC sector, our funding targets have persistently elevated their market share. Every time a brand new PC mannequin is launched, business requirements evolve, usually resulting in a rise within the common promoting worth and subsequent development for these firms’ merchandise.
It is very important emphasize that, in our view, the present pattern is just not merely a short-term cyclical upswing or a brief restocking section, as might need been the case with related industries in Taiwan a decade in the past. As a substitute, we consider we’re observing a sustainable, long-term tailwind that may doubtlessly profit the businesses in our portfolio.
One in all our largest holdings—a Taiwanese multinational semiconductor contract manufacturing and design firm—has a core enterprise centered on PCs and smartphones. However smaller firms are additionally benefiting from this substitute cycle.
For instance, a design providers agency in our portfolio makes use of superior packaging capability on the foundry (the semiconductor manufacturing and design firm talked about above) on behalf of end-clients resembling Intel (INTC) and Amazon (AMZN). This design providers agency is a broad AI enabler within the {hardware} provide chain.
One other smaller firm manufactures hybrid bonding gear that’s essential for superior packaging. It isn’t primarily based in Taiwan however illustrates that the availability chain is bigger than the island.
As we transfer right into a dialogue of synthetic intelligence (AI), it’s value noting that we’re in a standard substitute cycle for each smartphones and PCs. However what if these units grow to be AI-oriented?
Whenever you add AI to the standard {hardware} upcycle, you’ll doubtless see elevated demand. Whether or not which means we’ll get large content material upgrades on our current smartphones or we’ll all have two units is but to be seen; however both approach, it’s the spending we care about, and other people will certainly spend extra for the productiveness acquire provided by the brand new system or the killer app. There’s an pleasure there.
One other Tailwind: AI
AI presents a second avenue of development for a lot of of those Taiwanese firms, particularly these which can be aligned with the AI server.
For instance, 6% of 2023 income for the aforementioned Taiwanese multinational semiconductor firm was AI-related. Definitely, that’s a small portion, however we consider it has the potential to double or triple over the subsequent few years.
For this firm and others prefer it, key AI choices can be semiconductors which can be particularly designed for the tech stack that’s enabling the AI cloud—suppose Google (GOOG)(GOOGL), OpenAI, Meta (META), and all the opposite firms which can be constructing out their very own proprietary AI companies. These firms want extra superior semiconductors; they want {hardware} (servers); they want the reminiscence that goes into these servers.
Over the long run, we consider the software program mannequin is poised to seize important AI-related earnings, as a result of a considerable portion of every sale interprets into further income and margin.
Microsoft (MSFT) is maybe the perfect instance. It fees customers $10 a month for Outlook 365. However Outlook with Copilot—the AI-enabled model—prices $30 a month. That’s $20 extra per person with AI added.
Take into consideration how many individuals use Microsoft, and the way rather more environment friendly they could possibly be with AI. So, we consider there shall be excessive adoption, and thus a major enhance in income and margin for these software program firms.
In fact, that gained’t occur till acceptance units in, and we’re nonetheless within the early levels—our workforce refers to this as constructing the inspiration. However firms are constructing the {hardware} to allow that development now, and that’s why we’re so bullish on the {hardware} provide chain.
Contemplate AI servers. Particularly designed for AI workloads, together with machine studying and deep studying duties, these servers are optimized to deal with complicated computations, large knowledge units, and complicated algorithms, which require intensive processing energy and quick knowledge throughput. That requires specialised {hardware}. Among the many folks we spoke with on our journey, there was continued optimism round unit development for AI servers, and everybody expects non-AI server unit development to be near flat this 12 months.
Progress can be anticipated in superior packaging, which refers to a set of refined semiconductor packaging strategies that transcend conventional strategies to enhance efficiency, cut back dimension, and improve performance of semiconductor chips. Not like standard packaging, which primarily serves to guard and supply connections for a single chip, superior packaging integrates a number of chips right into a single package deal, enabling larger efficiency and performance whereas lowering area and energy consumption.
There’s a important constraint within the availability of superior packaging capability, which is important for the manufacturing of AI chips. This shortage impacts the power of firms to package deal their AI chips successfully.
In different phrases, the demand for superior packaging providers, that are important for assembling and finalizing AI chips, outstrips the out there provide, resulting in challenges in assembly manufacturing wants for these high-tech elements. This bottleneck can impression the well timed supply and scaling of AI applied sciences available in the market.
Within the close to time period, volumes will doubtless be restricted, so the income alternative is unlikely to begin in 2024; it’s extra of a longer-term alternative.
Portfolio Implications
Reflecting on our funding technique, which emphasizes understanding market cycles, the previous 12 months’s beneficial properties in Taiwan tech have been primarily pushed by will increase in inventory valuations. In 2024, we anticipate the main target to shift towards earnings. In essence, we’re concentrating our investments on superior drivers—the applied sciences and corporations on the forefront of their fields—and corporations exhibiting indicators of elementary enchancment and anticipated demand resurgence of their respective markets.
Editor’s Word: The abstract bullets for this text have been chosen by In search of Alpha editors.
