Last August, the world was hurtling toward what many were calling the fourth Taiwan Strait crisis. During this crisis, tensions between China and Taiwan (along with the United States) were the highest they’ve been since 1996. While international instability and potential trade disruptions are generally topics of interest to investors, this incident was particularly salient in the financial world due to Taiwan’s role in the critical semiconductor industry.
So, what should investors actually be concerned about regarding a potential China-Taiwan conflict and risks to the island’s semiconductor sector? (Spoiler: A Chinese invasion is low on the list.)
Taiwan’s Digital Economy
Semiconductors are Taiwan’s most well-known export, and the country’s digital economy is a cornerstone of the world’s technology economy. As the Financial Times points out:
“…its companies also turn out other crucial components from printed circuit boards to advanced camera lenses and they run huge device assembly operations in China.”
Of Taiwan’s top 10 largest companies by market capitalization, seven are directly connected to the technology sector. The largest on the list, however, stands above all others with a market cap of more than double the other nine combined: Taiwan Semiconductor Manufacturing Company (NASDAQ:TSM), or just TSMC for short. And despite the various risks, TSM stock is still worth backing for the long run.
TSMC’s $476 billion market cap makes it the 12th-largest company in the world. According to the International Data Corporation (IDC), as of 2022, TSMC holds a dominating share of about 55.5% of the semiconductor foundry market. Over half of its top 10 customers by revenue are American companies.
To understand the geopolitical risks that TSMC faces, investors should understand one key term: “foundry.” Foundries are physical production facilities or fabricators (“fabs”). This contrasts with “fabless” semiconductor companies like Nvidia (NASDAQ:NVDA) that do not physically construct the chips they “produce.” And so, due to their large resource, infrastructure, and skilled personnel requirements, semiconductor fabs are large, static locations.
This makes TSMC one big target (in more ways than one).
Where Things Stand Between China, Taiwan (And the United States)
To understand why Chinese and Taiwanese relations are so tense, one needs a brief history lesson. The 1949 Chinese Civil War ended disastrously for the Nationalists. The Communists took control of the entire Chinese mainland, and the Nationalists retreated to the island of Formosa, also known as Taiwan.
The Communists had planned on capturing the island in 1950. It was supposed to be the grand conclusion of the civil war. However, those plans were derailed by the surprise outbreak of the Korean War. The war resulted in increased U.S. engagement with the region that persisted well after the armistice was signed. This made things particularly difficult in the long run for China’s invasion plans as the United States adopted a foreign policy supportive of Taiwan. Backing this pledge of support was the U.S. Navy, which was prepared to disrupt any invasion attempts of Taiwan.
Fast forward to Jan. 1, 1979. In a surprise shift in Chinese-U.S. relations, the United States switched its recognition of the “sole legitimate government” of China from the Republic of China (Taiwan) to the People’s Republic of China (the mainland Communist government).
Yet, the U.S. pledged to support Taiwan’s de facto independence and security remained. And it has been renewed, to various degrees, by U.S. presidents and politicians over the decades.
To this day, this “strategic ambiguity” has been the cornerstone of the U.S.’s China-Taiwan foreign policy.
Is Taiwan a part of China? No.
Is Taiwan officially recognized as an independent country by the U.S.? Also no.
But does the U.S. still have diplomatic and military relations with Taiwan? Yes.
So, does the U.S. have any security obligations (like an alliance) to defend Taiwan? Yes, well… it’s complicated.
The Two Chinas’ Economic Conundrum
Forty-four years later, both still exist. And both have thriving economies.
Both countries’ economies are vitally important to the world. China is the world’s manufacturer of essentially everything, and Taiwan is the world’s semiconductor foundry.
Considering their hostile history, they are, ironically, thoroughly economically intertwined. As pointed out earlier, some Taiwanese companies own and operate factories in China.
The most well-known in the U.S. is Hon Hai Precision Industry Co, Ltd (OTCMKTS:HNHPF), or as it is known internationally: Foxconn. The Taiwanese manufacturer is best known for building Apple’s (NASDAQ:AAPL) iPhone. It does this predominantly in factories in mainland China but sources chips from TSMC’s Taiwan-based semiconductor foundries. Reportedly, about a quarter of TSMC’s sales come from Apple.
With designs and specs from the United States, chips from Taiwan, and assembly in China, an iPhone gets made. At this point, investors might be asking themselves: Why might China upset this Apple cart? And how?
Nationalism and the Overhyped Threat of Invasion
The answer to the “why” question is relatively simple: nationalism. Taiwan, from China’s point of view, is still Chinese soil. It is part of the Chinese national identity. The argument goes that if, say, Texas was to secede (again) from the United States, then it would only make sense that the U.S. would try and retake it, right?
Taiwan, of course, argues that it has been a sovereign nation-state since 1912 and predates the People‘s Republic of China. And it is thus a separate and distinct political entity. (Just don’t call it “independent.”)
Regardless, China has repeatedly threatened, almost nonstop since 1949, to retake the “rogue province” through force. Naturally, such an invasion would immediately obliterate these trade links and upend Taiwan’s semiconductor industry.
But can China do that any time soon?
To quote Secretary of Defense Lloyd Austin, I “seriously doubt” it.
Why a Chinese Invasion of Taiwan Is Unlikely Anytime Soon
When Russian forces stormed over neighboring Ukraine’s border last year in their 10-day-turned-500-plus day “special military operation,” a lot of commentators immediately (and haphazardly) started drawing parallels to China and Taiwan.
Ideologically, it is a fair comparison as both Ukraine and Taiwan’s situations can be framed as a “struggle between authoritarianism and democracy,” as The New York Times put it. But economically and militarily, an invasion of Taiwan by China would be on an entirely different level.
The biggest hurdle for a potential invasion by China is also the most obvious one: geography. Taiwan is a very mountainous and urbanized island. It has a population of about 24 million and could counter a Chinese invasion with anywhere from 450,000 troops to 2 million if every reservist was successfully called up.
It is hard to understate how difficult a contested amphibious invasion across the Taiwan Strait would be. The short way to explain it is that it would look nothing like D-Day. It would be unprecedented and would require massive Chinese military mobilization. An invasion would require anywhere from 300,000 troops in a Chinese “best-case” scenario to 2 million in a “worst-case” scenario.
The fate of TSMC’s chip foundries has also been of interest to policymakers, with a “scorched earth” contingency in response to a Chinese invasion a strong possibility. Preemptively destroying TSMC’s facilities would rob China of any significant economic gains from an invasion. Destroying, or even threatening to destroy TSMC’s foundries would be “unnecessary and counterproductive,” as David Sacks of the Council of Foreign Relations puts it.
Willing But Not Able
China’s military is more modern, better equipped, and significantly larger than Taiwan’s, but that’s what everyone said about Russia compared to Ukraine, too. China’s military advantage also means little when stacked up against the three most difficult environments to fight in: water, urban and mountains. Taiwan has all three strongly working in its favor.
China’s armed forces are almost entirely untested. Most of the fighting they’ve been involved in has been in small border skirmishes between Indian and Soviet border guards. The only actual significant war China has fought in the past 43 years was the Sino-Vietnamese War in 1979. This war lasted about four weeks and essentially ended in a stalemate.
In other words, China simply does not have the experience or capability to invade any time soon. It might be willing but not able.
Now, nothing rules out China resorting to other military alternatives short of an invasion, like a blockade. Or a bombardment of the island from China’s ever-growing missile force. Undoubtedly though, either of these hostile actions would result in the same harsh diplomatic and economic backlash from the U.S. and the international community.
The Actual Threat(s) From China to Taiwan’s Semiconductor Industry
Let’s table a potential Chinese invasion of Taiwan and look at some more present and active threats to Taiwan and the country’s semiconductor industry.
At the top of the list of threats is espionage. China’s involvement in state-backed corporate espionage is not exactly a secret. In 2021, the U.S. Department of Justice linked about 60% of trade secret thefts to China. Last year, Taiwan, concerned about this very same threat, amended its laws to crack down on Chinese “economic espionage.” This crackdown comes after the uncovering of an extensive espionage campaign by Chinese spies. A thumb drive of corporate secrets there, a hacked server there… taken altogether, these actions could give a Chinese state-backed semiconductor competitor quite the leg up.
That said, however, all the stolen schematics, production plans and data in the world won’t get China anywhere if it doesn’t have the skilled personnel to utilize that information. Unsurprisingly then, China has been extremely active in trying to poach Taiwanese engineers.
China’s Chips
With these somewhat underhanded methods, one might imagine that China’s semiconductor industry is a serious threat to TSMC’s chipmaking dominance. And while that is indeed a potential threat in the long run, as of now, that just does not seem to be the case.
China’s semiconductor industry has received a lot of state support and is set to grow from about 9% to around 23% of the world’s chip design industry. Yet China’s semiconductor industry is simply not very competitive with the likes of Nvidia and TSMC.
Investors might recognize the country’s largest and best-known chipmaker Semiconductor Manufacturing International Corporation (SMIC). It traded on the Nasdaq until it voluntarily delisted in 2019 due to low trading volumes (and was likely caught in the blast of Huawei’s “blacklisting”). SMIC primarily makes lower-tech logic chips (as opposed to memory chips). The firm had, until recently, been making strides in smaller, more advanced chips. New U.S. export controls will make SMIC’s life much more difficult as it tries to compete in the high-tech chip market without access to U.S. technology.
A potential unintended consequence of these new technological hurdles facing Chinese semiconductor companies like SMIC is that they might be pressured to engage in even more corporate espionage against neighboring Taiwan’s semiconductor industry.
Simply put, China’s semiconductor industry might be incentivized to lash out at the likes of TSMC and Nvidia. However, while this might win Chinese companies a few corporate battles, it won’t win the semiconductor war.
If investors are looking to avoid the geopolitical risks associated with Taiwan by betting on China’s semiconductor industry, don’t bother. The Chinese semiconductor market just isn’t worth investors’ time. China’s semiconductor sector will remain uncompetitive and unappealing to outside investment. Especially if U.S. export controls stay this strict and access to China’s capital markets remains so unreliable.
TSM Stock and Its Geopolitical Woes
Geopolitical competition has made China’s semiconductor industry inaccessible to investors. This puts semiconductor stocks like TSM and NVDA in the same geopolitical risk category as a lot of oil stocks. When tensions rise between the United States and China over Taiwan, TSM stock suffers.
During last year’s crisis, which started roughly around Aug. 3, TSM stock started a painful slide down the price charts. Between Aug. 3, 2022, and Nov. 3, 2022, TSM stock fell about 32%.
Another crisis or attempt by China to put pressure on Taiwan would likely put a similar months-long dent in the price of TSM stock.
The thing is, though, this August-to-November slump in the price of TSM stock was reversed halfway through November. By Nov. 15, 2022, TSM stock was back up 32%. About six months later, on May 26, 2023, TSM had added another 41% on top of those November gains.
Expansion Plans and Those Risks
Relying on the unsteady trade winds of geopolitics isn’t exactly a dream situation for investors. However, the future of TSM stock and TSMC may not even be on the island but overseas. TSMC’s $12 billion Arizona plant was, until recently, set to go online next year. TSMC has delayed its opening due to a lack of skilled personnel available. Taiwan Semiconductor is planning on opening another chip plant in Japan. And it’s considering building a fab in Germany too.
A more spread-out production chain is a double-edged sword. It can protect Taiwan’s semiconductor industry from China’s “local” military threats. However, it also magnifies two already present risks that the industry faces: labor supply and nationalist sentiment.
These global expansion plans compound TSMC’s difficulties with recruiting and maintaining skilled personnel. TSMC claims the Arizona plant will create 1,600 new high-tech jobs in the state. Yet the company has had such a hard time recruiting skilled workers that it will send a “task force” of about 500 skilled workers from Taiwan to keep the project afloat. This has upset a local union, which claims “that TSMC has deliberately misrepresented the skillset of Arizona’s workforce.”
The chipmaker needs to do everything in its power to resolve these labor issues. TSMC and TSM stock will suffer the longer they go on and the more negative headlines build up. The last thing TSMC needs right now is political backlash from its foreign partners.
Additionally, TSMC’s competition isn’t only Chinese. Nationalism is the name of the game right now in international trade. Therefore, TSMC and its Taiwanese cohorts must make clear that they’re on “Team America” (or at least not “Team China”), or they could lose out to other U.S.-backed companies. The company’s current international expansions into Arizona, Japan and Germany are all good starts. These expansions deserve all the time and money TSMC is putting into them.
TSM Stock and Taiwan Semiconductor Is Still a Good Bet
So, while investors should not be overly concerned about a Chinese invasion any time soon, they should be worried about TSMC failing to keep a step ahead of its competition. Chinese bombs and missiles may always be a looming (and headline-grabbing) threat, but investors are better off worrying about the industry’s more immediate problems.
All said, TSM stock, and by extension, Taiwan’s digital economy, is still worth betting on.
However, investors will need to see further innovation, an unwavering focus on expansion (while avoiding populist and nationalist pitfalls), and further efforts to counter China’s espionage activities. And, perhaps most importantly, an emphasis on the industry’s very distinctive labor market issues.
The “reunification” that China seeks could someday come, whether militarily or through some other peaceful means. However, the good news for Taiwan’s chip industry and TSM stock is that it has quite a lot of time before either is anywhere near a high possibility.
Taiwan and its chip industry’s future is ultimately a political one. But what is clear is that a Chinese invasion, or any attempt to fully disrupt Taiwan’s semiconductor industry, would be an incredibly costly gamble. As Hsieh Yong-fen, founder of MA-tek, put it: “If anyone hits Taiwan, or there is a serious disruption … the tech and electronics industry worldwide is basically screwed.”
On the date of publication, Andrew Bush held a LONG position in TSM, NVDA and AAPL. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
