THE ROAD TO VALUATION: Part A
Group 7: TSMC & NVIDIA
AFFARA Ziad, DESPREAUX Antoine, ISLEK Dogukan, SHEN Sarah, Yashvardhan
IESEG School Of Management
FINANCIAL ACCOUNTING 0058
Dr. GOEL Pratik
October 10, 2023
INTRODUCTION
This report presents a comparative accounting analysis of two prominent technology
giants. The first company is NVIDIA, headquartered in California, USA, and publicly
listed on NASDAQ. Initially centered on Portable Computer (PC) graphics, NVIDIA has
diversified its interests into various domains, including artificial intelligence, data
science, autonomous vehicles, robotics, metaverse, and 3D internet applications. The
second company in focus is Taiwan Semiconductor Manufacturing Company (TSMC),
a global semiconductor foundry corporation headquartered in Hsinchu, Taiwan.
TSMC's operations mainly encompass technology and manufacturing. This company
achieved the distinction of being the first Taiwanese company to go public on the New
York Stock Exchange (NYSE).
NVIDIA is known for its investments in Research and Development (R&D), the
company has invested over US$37 billion in R&D over the last 30 years. As of 2022, it
addresses 4 large markets: Data Center (55%), Gaming (33%), Professional
Visualization (5%), Automotive (3%), Original Equipment Manufacturer (OEM) and
others (1.6%). In 2023, as of the end of the fiscal year (FY) which falls on the last
Sunday of January), NVIDIA had 26,196 employees in 35 countries. Around 75% of
the company’s manpower is engaged in R&D. Their total value of assets reached
US$41,182 million and total revenue stood at US$26,974 million, allocated mostly to
USA 30.7%, Taiwan 25.8%, China Including Hong Kong 21.4%, and other countries
21.9%.
TSMC, established in 1987, holds a prominent position in advanced, specialty, and
advanced packaging technologies, providing substantial capacity and cutting-edge
solutions for downstream innovations. By the end of 2022, TSMC and its subsidiaries
employed over 73,000 individuals worldwide. The company's major activities include
semiconductor manufacturing, advanced packaging technologies, and specialty
technologies. In terms of revenue, TSMC derived 68% from North America, 27% from
the Asia Pacific region and 5% from Europe and the Middle East. TSMC generates
41% of its revenue from high-performance computing and 39% from smartphones. The
remaining 20% is spread across other segments.
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NVIDIA: COVID & RELATED SUPPLY CHAIN ISSUES
COVID-19, alongside supply chain constraints, has cast a shadow over various
sectors, including the semiconductor industry. NVIDIA, grappling with chip shortages,
faced difficulties meeting surging customer demand, particularly in the gaming sector,
as people spent more time at home, leading to an entertainment shift toward gaming.
Consequently, NVIDIA's financials for the year ending in 2020 exhibited notable shifts:
NVIDIA's revenue witnessed a substantial rise, soaring from US$10,198 million to
US$16,675 million, propelled by heightened demand in the gaming market. Despite
the pandemic, the company opted to maintain its commitment to R&D increasing its
budget from US$2,829 million to US$3,924 million. Total liabilities surged from
US$5,111 million to US$11,898 million, partly due to prevailing low interest rates. To
mitigate supply chain uncertainties, NVIDIA nearly doubled its inventories. The
company proactively bolstered its inventory levels to avert shortages. Net income also
saw an uptick, climbing from US$2,796 million to US$4,332 million.
NVIDIA: ACQUISITION OF MELLANOX TECHNOLOGIES
On April 27th, 2020, NVIDIA's acquisition of Mellanox was completed, involving the
purchase of all outstanding shares for a total cash consideration of US$7.134 billion.
This acquisition was subsequently integrated into NVIDIA's consolidated financial
statements for FY 2021. The acquisition of Mellanox Technologies expanded NVIDIA's
data center offerings, bolstering performance in data computation and networking. In
FY 2021, Mellanox contributed 10% of the overall company's revenue. Interest income
dipped from US$178 million to US$57 million, reflecting the cash payment for the
acquisition. Cash and cash equivalents also decreased, falling from US$10,896 million
to US$847 million. Consequently, Goodwill saw a notable increase, rising from US$618
million to US$4,193 million, with Mellanox's Purchase Price Allocation accounting for
US$3,431 million of this value.
TSMC: THE GLOBAL CHIP SHORTAGE
This is an ongoing crisis that has led to major price increases, long queues, and
reselling among consumers. The global chip crisis is due to a combination of different
events described as a perfect storm with the snowball effect of the COVID-19
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pandemic being the primary reason for accelerating shortages (Shein, 2023) causing
disruptions in global supply chains, including the semiconductor industry. Another
contributing factor is that demand is so great that existing production capacity is unable
to keep up (Vakil, 2021). The chip shortage has led to increased demand for chips,
resulting in higher prices and longer lead times. This has positively impacted TSMC's
financial performance, with a 42.6% increase in revenue compared to 2021.
Additionally, TSMC's gross profit margin increased by 8% in comparison to the
previous year, indicating the company's ability to maintain profitability despite the
heightened demand and higher prices. Moreover, TSMC's net income saw a growth of
70.4% from the 2021 level, reflecting the positive effects of these changes.
TSMC: EXPANSION IN US & ARIZONA PLANT INVESTMENT
TSMC announced the Arizona factory in May 2020, initially pledging a NT$12 billion
investment, which was later increased to a NT$40 billion commitment in December
2020 (Choudhury, 2023). These investments in the US were part of TSMC's strategic
efforts to address the growing demand for advanced chips and expand beyond Taiwan,
amidst political tensions with China. In terms of financial performance, TSMC reported
a 47% increase in net revenue from its US operations in 2022 compared to 2021, with
the US share of net revenue rising from 44.93% in 2021 to 66.1% in 2022. Additionally,
TSMC's property, plant, and equipment (PPE) grew by 28.7% between 2021 and 2022,
with a significant portion allocated to Equipment under Installation and Construction in
Progress, likely linked to its US market investment. Furthermore, TSMC increased its
investments in TSMC Arizona by NT$15,372,500 thousand and NT$20,787,702
thousand in 2022 and 2021, respectively.
INTANGIBLE ASSETS: IAS 38 (IFRS) & ASC 350 (U.S. GAAP)
NVIDIA follows U.S. GAAP standards, by which the company capitalizes and amortizes
intangible assets with finite lives from one to twenty years. This approach involves
systematically allocating the cost of these assets over their estimated useful lives,
reflecting the pattern in which they provide economic benefits. When that pattern
cannot be reliably determined, a straight-line amortization method is used. The explicit
mention of reclassifying In-Process R&D as an amortizable intangible asset upon
completion shows transparency in their accounting practices. In FY 2023, amortization
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expense reduced reported net income by US$699 million. TSMC follows IFRS (IAS
38), where intangible assets are recognized and measured at cost, with amortization
over their useful lives. TSMC amortizes its intangible assets using the straight-line
method over their estimated useful lives, which are determined based on factors such
as the technology's lifespan or contract period. Any changes in are accounted for
prospectively.
NVIDIA's recent accounting change in FY 2023 highlights a significant shift in the
treatment of R&D expenditures. Capitalizing and amortizing R&D expenses over five
years for domestic expenses and fifteen years for foreign expenses impacts both the
income statement and the balance sheet. This change caused NVIDIA’s capitalized
R&D expenditure to increase by more than 350% in FY 2023 compared to 2022. It also
helped in decreasing its R&D expenses and increasing its assets through capitalizing
and amortizing some of them over time. TSMC's disclosure does not provide specific
details about the capitalization and amortization of R&D expenditures. Therefore, the
impact on its financial statements is unclear. It is possible that TSMC follows IAS 38,
which allows for capitalization in specific circumstances, but the details are not
provided.
Moving to goodwill, NVIDIA follows U.S. GAAP for the accounting and impairment
testing. They perform annual impairment tests based on qualitative and quantitative
factors. The explicit breakdown of goodwill allocated to different reporting units and the
absence of impairment in recent years indicate the stability and health of these units.
In 2021, NVIDIA’s acquisition of Mellanox resulted in increasing its goodwill by
US$3,431 million. On the other hand, TSMC's approach to goodwill aligns with IAS 36
under IFRS. The company also conducts annual impairment tests, with disclosed
discount rates, and mentions the absence of goodwill impairment in 2022 and 2021.
INVENTORY: IAS 2 (IFRS) & ASC 330 (U.S. GAAP)
Under U.S. GAAP, NVIDIA adopts a First-In, First-Out (FIFO) basis for inventory
costing. They employ an adjusted standard basis, factoring in actual costs. When
inventory needs to be written down due to obsolescence, falling below cost, or net
realizable value, these adjustments are recorded in their cost of sales. NVIDIA relies
on forecasts and third-party manufacturers for inventory procurement. Due to this, their
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2023 earnings decreased by 7.5%. As a fabless1 semiconductor company, NVIDIA’s
purchasing process of inventory relies on the forecasts and the third-party
manufacturers in consideration of market and macroeconomic environment. As of
January 31, 2021, their total inventory amounted to US$5,159 million, distributed
across Raw Materials (46.98%), Work in Process (9.02%), and Finished Goods
(43.99%). TSMC, on the other hand, adheres to IFRS, which doesn't permit the use of
the Last-In, First-Out (LIFO) method. Their inventory is adjusted from standard cost to
a weighted-average cost at the reporting period's end. The net realizable value is
determined by subtracting anticipated completion and sale-related costs from the
expected selling price. TSMC evaluates inventory for waste, obsolescence, and
unmarketable items, writing down inventory to net realizable value. TSMC records write
down as “Inventory losses” which stated at NT$ 4,689,112 for FY 2022. Future demand
projections significantly influence the net realizable value. The cost of revenue
accounts for inventory write-downs and reversals due to value increases. As of
December 31, 2022, TSMC reported total inventories of NT$221,149,148 thousand,
including Raw Materials (9.22%), Work in Process (56.89%), Finished Goods
(24.77%), and Supplies and Spare Parts (9.12%).
PROPERTY, PLANT, AND EQUIPMENT: IAS 16 (IFRS) & ASC 360 (U.S. GAAP)
TSMC follows IFRS standards (IAS 16). As seen during the course, PPE acquisitions
are used in the operations of the business and are not intended for sale to customers.
They are expected to provide a service for the company for a set number of years.
Their cost has to be measured reliably and has to be free of error, unbiased and
neutral. Unlike U.S. GAAP standards on PPE, IFRS may use a revaluation model to
measure the property owned by the company at its fair value. However, U.S. GAAP
cannot reevaluate PPE assets. For instance, TSMC made a transaction on February
15, 2022, for real estate properties, totaling at an amount of NT$213,300,000
thousand. They measured it at cost less accumulated depreciation and accumulated
impairment. TSMC either has the choice to apply the cost model, as explained
previously, or the revaluation model, where assets can be assessed to their fair value
1
The term "fabless" means that the company designs and sells the hardware and semiconductor chips but does
not manufacture the silicon wafers, or chips, used in its products; instead, it outsources the fabrication to a
manufacturing plant or foundry.
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less subsequent accumulated depreciation and impairment losses, resulting in a
fluctuation of the carrying amount of PPE. NVIDIA, on the other hand, under U.S.
GAAP obligations, states that it can only apply the cost model to its cost of acquisition
of a new investment.
Going further into depreciation of assets, TSMC and NVIDIA are semiconductor
producers and leaders in the market. These electronics are assets that are rather quick
to become obsolete due to rapid technological advances. However, TSMC states that
it is using the straight-line depreciation method from the beginning of their acquisition
up until the earliest date of end of useful life. TSMC fluctuations of depreciation
balances from 2021 to 2022 went from NT$3,088,445,841 to NT$3,469,341,554, an
increase of approximately 12% over the years. This can be determined by the ongoing
deprecation of TSMC buildings, machinery, and equipment, but can also be explained
by the newly acquired equipment under installation and construction in 2022, at a total
cost of NT$790,740. In the depreciation of assets, TSMC recognizes the transfers to
assets subject to operating leases in sub parts of the accumulated depreciation of PPE,
whereas NVIDIA does not. NVIDIA recognizes the accumulated depreciation and
amortization without much detail. It is just stated under the table amounts of leasehold
improvements and finance leases per year. The main difference between the use of
U.S. GAAP and IRFS for PPE lies in the revaluation option of the PPE at its fair value
under IFRS standards, which cannot be applied by NVIDIA under U.S. GAAP,
restricting companies to use the cost model.
STATEMENT OF CASH FLOWS: IAS 7 (IFRS) & ASC 230 (U.S. GAAP)
Depreciation expenses NT$428,498,179 thousand contributed to a substantial cash
inflow. In investing activities, TSMC's investment in PPE NT$(1,082,672,130) thousand
amounted to a significant cash outflow, indicating expansion plans. Despite receiving
government grants NT$7,046,136 thousand for PPE, the net cash used in investing
activities still increased substantiallyInterest paid NT$(12,218,659) thousand and cash
dividends NT$(285,234,185) thousand were categorized as financial activities,
although they could have been recognized as operating activities under IFRS.
Proceeds from the issuance of bonds NT$198,293,561 thousand contributed to cash
inflows. TSMC ended 2022 with cash and cash equivalents of NT$1,342,814,083
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thousand showing a 26% increase compared to 2021. In NVIDIA's operating activities
for 2023, stock-based compensation US$2,709 million, depreciation US$1,544 million
and accounts receivable US$822 million led to significant cash inflows. Accounts
receivable shifted from US$(2,215) million (2022) to US$822 million (2023), indicating
more credit transactions and a decline in free cash flow. In investing activities,
proceeds from maturities of marketable securities increased by 27.8% compared to
2022, signifying long-term revenue generation. In financing activities, payments related
to stock repurchases US$(10,039) million and dividends US$(398) million resulted in
significant cash outflows, indicating. NVIDIA's statements of cash flows revealed a
significant increase in cash and cash equivalents, rising by 70% US$1,990 million
2023.
CONCLUSION
The disparities in accounting standards for intangible assets, inventory, PPE and
statement of cash flows between IFRS and GAAP could introduce variations in
reported financial metrics during the comparative financial analysis. Addressing and
reconciling these differences is essential for ensuring accurate and meaningful
assessments of the selected companies' performance. For instance, the Mellanox
acquisition significantly impacted NVIDIA's PPE accounts, as they focused on
investing in new equipment for productivity gains. This increased capital spending may
affect financial statements, leading to higher revenue, increased depreciation, elevated
operating costs, and potential tax implications. NVIDIA also faced inventory challenges
due to its fabless nature, resulting in missed write-down forecasts as they sought to
maintain adequate inventory levels for sales opportunities. To enhance financial
performance, NVIDIA should explore more accurate inventory forecasting methods to
reduce future write-down risks. According to IFRS, TSMC has used cash for Financing
activities resulting in cash outflow that acted as a slight increase in Cash and Cash
equivalents compared to NVIDIA where significant increases in Financing activities are
noticed. All in all, the importance of these accounting policies will ultimately have an
impact on the financial statements of both companies, depending on their specificities
and way of recording.
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