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Apple's Next Chip Maker

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The ongoing feud between Apple (NASDAQ: AAPL) and competitor/partner Samsung has been all over the news in the last six months. The relationship between the two companies is tenuous as Apple currently sources its mobile processors from Samsung, while Samsung also manufactures some of Apples biggest competition in the smartphone and tablet arena. It’s an awkward situation that has led to lots of litigation, and will likely lead Apple to extract itself from its partnership with the chip manufacturer.

Apple took its first step to rid itself of Samsung earlier this year. In its most recent iterations of the iPhone and iPad, Apple implemented two new, in-house, chip designs – the A6 and the A6X. By contrast, the previous processor, the A5, included numerous patents from Samsung. Trying to change chip manufacturers earlier would have led to even more intellectual property lawsuits.

Who Gets Apple’s Business?

As Apple begins to shift its business away from Samsung, the company is likely to tap Taiwan Semiconductor (NYSE: TSM), one of the largest chip manufacturers in the world, to build its chips. Taiwan Semiconductor doesn’t design its own chips; it just makes other companies’ designs. This reduces the conflict of interest that has plagued the relationship Apple has with Samsung.

More importantly, however, the two companies already have an established relationship. Last year, Apple asked Taiwan Semiconductor to produce a trial run of the new A6 processors. The company is standing by waiting for Apple to make its order, making a switch from Samsung to Taiwan Semiconductor should be relatively seamless.

Not Just an Apple Derivative

In the past, with the success of smartphones and tablets, investors have had great success in investing in the companies Apple uses to source parts for its devices. The strategy works well, and ought to continue to work well as mobile computing grows. However, Taiwan Semiconductor could do just fine without a boost from Apple.

The company is well diversified amongst numerous contractors, and is unwilling to compromise its diversification for any one company. In fact, earlier this year both Apple and Qualcomm (NASDAQ: QCOM) placed bids to gain exclusive access to Taiwan Semiconductor’s fab capacity. Both were shot down. Instead, the company decided to maintain its flexibility with Qualcomm, Nvidia, Broadcom, and Apple, among the other smaller companies for whom it manufactures chips.

Taiwan Semiconductor estimates capital expenditures of nearly $9 billion this year, up 28% from the $7 billion the company spent last year. Operations are expanding quickly, as demand rises for mobile chip production. The increased production capacity will certainly help accommodate a shift by Apple from Samsung to Taiwan Semiconductor.

Over the last five years, earnings for Taiwan Semiconductor have grown at a rate of just over 16%. Analysts don’t see the company slowing down any time soon, and expect the next five years to return a similar 15% growth in earnings annually. Currently trading at just 15.9 times forward earnings, Taiwan Semiconductor presents a very good growth investment based on a valuation that’s below the industry average of 19.5 times earnings.

In its most recent quarter, Taiwan Semiconductor posted some very strong numbers. Revenue grew 65% year-over-year, leading to strong EPS of $0.32. Additionally, net income nearly doubled compared to the same period a year ago. More importantly, however, is that the market expects earnings to grow more than 20% next year, and a confirmed Apple contract will improve earnings even more.

Apple VS Samsung: Taiwan Semiconductor Wins

In the fallout between Apple and Samsung, Taiwan Semiconductor is poised to capitalize on Apple’s business. Yet, even in the unlikely worst-case scenario, where Apple takes its business elsewhere, Taiwan Semiconductor presents a good investing opportunity. The strength the company shows with its presence in the mobile chip manufacturing industry is not to be tested – not even by Apple or Qualcomm. The company prefers its flexibility, and to invest in its own growth potential. 2013 should be a good year for Taiwan Semiconductor.

adamlevy has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Qualcomm. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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