(Bloomberg) -- Taiwan Semiconductor Manufacturing Co. is locked in an investment duel with Samsung Electronics Co. to meet booming U.S. demand for Apple Inc.’s iPhone and other smartphones, benefiting electronics suppliers around the globe.
Taiwan Semiconductor, the world’s biggest custom-chipmaker, plans record spending on plants and equipment this year. It’s lavishing $12 billion on factories -- more than Intel Corp. has ever spent in a year -- to counter investments that Samsung is making to win chip orders from Apple, Qualcomm Inc. and its own handset division.
“The increase by TSMC is a response to Samsung,” said Samuel Tuan Wang, an analyst at Gartner Inc. in Santa Clara, California. While Suwon, South Korea-based Samsung is ahead for now in production technology, its Taiwanese rival “is moving aggressively.”
The spending is a boon for suppliers such as Applied Materials Inc. and Lam Research Corp. in the U.S. and ASML Holding NV in Europe, according to supply-chain data compiled by Bloomberg. Applied Materials, the largest maker of chip
equipment, gets a third of its revenue from TSMC and Samsung. Globally, suppliers’ sales rose 19 percent last year to $38 billion and may jump 15 percent this year, estimates from industry group SEMI show.
The rush for smartphones, and the tools to make parts for them, is one reflection of economic growth prospects in the U.S. -- forecast to lead the G7 countries for the next two years -- and in China, where even reduced estimates of 7 percent expansion is about five times that of the euro zone. For the quarter that ended in December, Apple reported iPhone sales rose 46 percent to 74.5 million units, putting it just behind Samsung’s phone businesses at 75.1 million, according to IDC.

Arms Race

“That’s the No. 1 thing that drives our business, and it’s the key competitive battleground for our customers,” Applied Materials Chief Executive Officer Gary Dickerson said in an interview. “That battle is still playing itself out.”
To keep enticing consumers, new phones need more powerful, and more power-efficient, brains. That’s where chipmakers come in, and why TSMC and Samsung are locked in an increasingly expensive battle to be first with new production technology.
By shrinking the circuit lines on semiconductors -- measured in nanometers -- manufacturers can improve chip capabilities or get more out of a production run. Modern plants cost more than $5 billion to build and equip and are obsolete in five years or less, so they need to operate 24 hours a day.
The tables can turn quickly. Samsung had been the supplier of the most important chip in Apple’s iPhone since its debut in 1997. That changed in the iPhone 6 with Apple’s A8 chips, which are manufactured by Hsinchu, Taiwan-based TSMC.

Samsung’s Bet

Now the South Korean chipmaker is trying to leapfrog TSMC in production technology to win the next round. UBS AG estimates Samsung made $3.7 billion in capital expenditures on its processor business alone in 2014 and may raise that to $4.9 billion this year. Samsung doesn’t disclose such numbers, but executives on a Jan. 29 conference call confirmed they will boost the spending this year.
“Samsung is in the lead because they’ve bet the farm on it,” said Len Jelinek, an analyst at IHS Corp. “They’ve had to.”
Founded in 1987, TSMC forged a business model that lets chipmakers like Qualcomm and Broadcom Corp. forgo expensive factories and outsource production of chips using their designs to facilities in Taiwan. Its annual revenue from the communications category more than doubled to $14 billion in five years, now accounting for more than half of sales.
For Taiwan’s biggest company, which gets an average of $8 in chip sales for every smartphone sold globally, keeping its factories equipped with the most advanced technology is important to compete with Samsung as well as other rivals including Globalfoundries Inc. and Intel, which recently entered the business of making chips for other companies.

Supply Chain

TSMC, Intel and Samsung’s processor businesses will account for around 60 percent of total spending on semiconductor equipment this year, according to Bloomberg calculations based on estimates from UBS and industry group SEMI.
Santa Clara, California-based Applied Materials gets about 21 percent of its revenue from TSMC and 12 percent from Samsung, according to the supply-chain data compiled by Bloomberg. Lam Research, based in Fremont, California, gets about 37 percent of its sales from the two Asian companies.
In 2014, share prices rose about 46 percent for Lam Research and 41 percent for Applied Materials, outpacing an 11 percent gain in the Standard & Poor’s 500 index.
Like Apple, other U.S. companies buy from, rather than sell to, TSMC. The Taiwanese company’s biggest customer is Qualcomm, a San Diego-based designer of mobile-phone processors and modems that accounts for about 22 percent of TSMC’s revenue. Apple makes up about 8.2 percent, the data show.
ASML Holding, based in the Netherlands, gets more than a third of its revenue from Samsung, with TSMC pitching in more than 8 percent.

Investment Risks

With Samsung and TSMC raising spending to add capacity, one of the two companies may be making bets that won’t pay off.
While TSMC is boosting spending by as much 25 percent this year from $9.5 billion last year, it’s forecasting only a 5 percent rise in chip-industry sales and 12 percent for the custom foundry business. That suggests it intends to win market share.
“We don’t build capacity on speculation,” Morris Chang, TSMC’s 83-year-old founder and chairman, told investors Jan. 15, predicting his company will outgrow the broader foundry sector by a few percentage points this year. “We build capacity when we know that it’s already sold.”

Expansion Plans

Samsung expressed similar confidence on a conference call with investors, saying its investment slated for the second half of 2015 “is already backed up by customers.” It dominates in memory chips, making it the world’s second-biggest semiconductor maker behind Intel. Because Samsung is also the biggest phonemaker -- therefore a direct rival to other potential customers -- it’s even more important for its production technology to be a must-have.
The big budget announcements by TSMC and Samsung haven’t yet translated into a flood of orders for chip equipment. Applied Materials said orders from foundries fell in the three months ended Jan. 25. The company expects that pattern to reverse in the second half of the year as the chipmakers work their way through the difficulties of shifting to more advanced production, Applied’s CEO said.
There’s another potential risk for chipmakers and, by extension, their suppliers. Apple wants to move production of chips for its phones to a so-called 14 nanometer process -- tighter circuitry than TSMC’s current 20 nanometers -- while other companies won’t need such advanced capabilities so quickly, according to Gartner’s Wang. With manufacturers building leading-edge capacity for so few clients, the result may be a glut of 14-nanometer capacity, leading to “fierce price competition,” he said.

Apple’s Chips

That would help boost profit at Apple, which spent $25.8 billion on chips last year, accounting for 7.6 percent of industrywide purchases, according to Gartner. The top two PC makers, Lenovo Group Ltd. and Hewlett-Packard Co., spent a combined $27.5 billion.
While Apple is the main prize, Samsung’s phone-making division, along with rivals like Lenovo and Xiaomi Corp., are looking for better-performing parts themselves as they try to take on the iPhone.
“All of these guys are racing to be on the leading edge of technology with their phones,” IHS’s Jelinek said. “TSMC are going to come forward and say we’re going to spend whatever it takes to win that next business. Right now they’re behind Samsung.”