TSMC at $0 Pre-Money?
[Edit 2021/9/22: I have left Taiwan for too long that I forgot that there’s another weird thing called “stock dividends” as opposed to “cash dividends”. This contributed to the growth of total outstanding shares similar to the US stock-splitting. I’ll update the paragraphs below to reflect this. Special thanks to my friend Stanley Lin in Taiwan, who shares the same interest as I in reading between the lines of financial reports]
Ben Gilbert and David Rosenthal did a very nice episode about TSMC at their Acquired Podcast a few weeks ago. I listened to the entire thing and really applauded their effort in researching and putting the pieces together. For anyone that’s interested in Morris Chang’s colorful story together with TSMC, I strongly recommend that you listen to it.
That said, neither Ben nor David was apparently a Taiwanese tech guy who had worked in Taiwan before. While the US part of Morris’ education & career (MIT, Texas Instrument, etc) were quite nicely covered, the Taiwan part — basically the whole TSMC thing— obviously had a few points that could have been better narrated had they had the chance to interview a few fellow Taiwanese.
As a ex-semi guy who had worked in HsinChu Science Park for almost a decade as an engineer and an entrepreneur, I’d like to clarify a few points that Ben and David made in their fabulous podcast about Morris and TSMC in this blogpost and maybe another to come later.
This one we’ll focus on in this blogpost will be the $0 Pre-Money valuation that Ben and David mentioned in the podcast.
$0 Pre-Money
Ben and David made a banter about the first round of financing of TSMC in 1987, which was provided by the Taiwanese government and Philips, of being made on a $0 Pre-Money valuation, i.e. Morris had not already owned founder’s shares prior to the financing.
While that is practically the case, it’s not technically correct.
Today in Silicon Valley a team of founders could register a company with $10k from their own savings and issue 1 million shares, each worth 1 cent. They can then go on to raise a $2M Seed Round at $8M pre-money and saw their own net worth jump from $10k to $8M. That’s the power of sweat equity.
Unfortunately that is not the case in general in Taiwan today given the constraint of the corporate laws, and definitely not the case back in 1987.
In 1987, all businesses in Taiwan were still very much driven by capital which was used to buy operating assets (machines, buildings, etc) to generate revenues. The idea of sweat equity did not exist. In other words, if you were Morris Chang in Taiwan in 1987 and you needed $50M to buy semiconductor equipments and buildings to host them before you hire any one to operate, either you had that $50M in your pocket and you threw them into the company as the initial capital, or you have to seek other financing options.
A traditional way was to borrow from the bank. This was how many of the billionaire families in Taiwan started back in the 70’s or 80’s, hitting the banters’ counters everyday. But to borrow from the bank you needed collaterals. For small businesses that needed little cash to get off the ground and had short working capital cycles such as retails or restaurants, one might be able to use one’s father-in-law’s house as collateral and got the loan. But borrowing $50M to build a risky semiconductor factory? You’d be lucky if the banker even gave you his office time.
The other way was to raise capital from equity investors. Note that TSMC was conceived by the government as a manufacturing company, with all the good old physical assets like plants and equipments, it was just natural that the capital was pumped in “upon” creation of the company, instead of allowing Morris to “found” the company with his own limited capital and then capital increase at a non-zero pre-money valuation.
In other words, while Morris was the unquestionable founder of TSMC and was the single most important driving force for its success over the next couple of decades, when TSMC was incorporated in 1987 with an initial capital of roughly TWD$1.378B (roughly $43M at the time), 100% of the shares were owned by the investors, which were the Taiwanese government and Philips. Morris owned 0 shares at the incorporation. By US standards he would be more like a hired CEO to run the new business, and he indeed was.
Did Morris really buy all his shares himself?
Ben and David then commented that the reason Morris is worth $3B today was that he bought TSMC shares afterward with his own money and rode the growth of the company share price to become a billionaire.
That’s also not correct.
First, TSMC went public in 1994 on Taiwan Stock Exchange. The first day of trading there were only 4,000 shares that changed hands. (In Taiwan 1,000 shares are grouped to be “1 bill” of shares. Only 4 bills of TSMC shares were transacted on the first day). The closing price was TWD$96, about $3.
The simple question is then: if you own 1 share of TSMC on the IPO day in 1994, how much is that worth today?
First we have to find out how many shares that 1 share in 1994 will have become as of today. Note that there’s no stock splitting in Taiwanese stock market, but there is this thing called “stock dividend” (as opposed to “cash dividend”). By giving shareholders extra stocks in lieu of cash, this contributed to the growth of outstanding shares in a similar way to stock splitting.
My friend Stanley provided the table above regarding the capital stock history of TSMC. In 1994 when TSMC went IPO, the total outstanding shares were only 780 million shares. By 2020, it has ballooned to almost 26 billion shares, almost 33x.
During this time TSMC resorted to capital increase for financing only 2 times: 1999 and 2000. Beyond 2000, TSMC has not conducted any capital increase. There were even 3 capital decreases (to return cash to the shareholders), in 2004, 2008 and 2011. The capital stock more or less stabilized since 2006. We’ll talk about this timing at the end of this article.
As one can see since 1996 most of the capital stock increase came from “issuing new shares based on annual profit” (盈餘轉增資). This is a very weird thing to the American investors but it was the growth engine of the tech industry in Taiwan before 2006. Again, I’ll explain this part of the history at the end of this article.
Since most of the capital stock increases after 1994 came from “issuing new shares based on annual profit”, we can (overly) simplify the calculation and simply state that if you own 1 share of TSMC in 1994, you’ll be owning 33 shares today. (Again, not the case but it’s in the right direction for my argument below).
Today TSMC’s share price is TWD$600, about $20. For a $3B personal net worth, Morris would have to hold 150 million shares. Assuming theses 150 million shares grew from the shares Morris purchased with his own money in the year of IPO and assuming the 33x multiple as stated above, Morris would have had bought 4.5 million shares in 1994 on IPO day. At $3/share, that would require him to doll out $13.6 million out of pocket.
As successful as his previous career at TI was, I’m pretty sure that he did not have that amount of cash at hand in 1994.
In fact, in the first Annual Report of TSMC as a public company (1994), Morris was listed as owning 6,512,777 shares, more than the 4.5M shares we estimated above.
These shares were worth $19.5M on the day of IPO. Now, it could be that Morris did pay out of pocket and participate in the several capital increases over the years before the 1994 IPO to acquire some shares. However, most of his TSMC shares probably came in the form of a special Taiwanese version of RSU (restrict stock units).
Employee stock bonuses (before 2006)
For example, in the fiscal year of 2000 (when I started my semiconductor career in HsinChu Science Park at an office that’s just 5mins away from TSMC’s original headquarter), TSMC reported to issue 110,457,000 shares for employee bonuses. These shares, when taken at the face value of TWD$10/share would be valued at TWD$1.1B. The pre-tax profit of TSMC in the same year was TWD$63.8B. So the bonus seemed to be only 1.7% of the pre-tax profit.
But obviously a successful company like TSMC was not transacted at face value, not even in the aftermath of the bursted dot-com bubble. In fact, in February 2001 when the TSMC employees received these 110,457,000 shares (including a few classmates of mine), the average TSMC share price in that month was about TWD$95 (~$3.2), so 9.5x the face value. In other words, these employee bonus shares were worth $350M on the market back then.
That’s the mainstream way for tech firms in Taiwan to compensate the employees at that time. Though I did not benefit too much from it personally, several of my classmates and close friends got reasonably well off in the first few years of their career thanks to this good old system. (The government would later change the regulations and effectively killed this system. I’ll talk about that at the end of this article).
And yes, even though Morris’ title was Founder/CEO, he was entitled to this employee bonus program every year as well. In other words, during those years, many “founder/CEO”’s of Taiwanese tech firms actually gained their wealth this way, instead of the sweat equity.
As an example, in the case of my first company, which was also a publicly traded company in Taiwan, the CEO back then was rumored to be taking 50% of all employee bonus shares — every year.
TSMC being a very US-style corporate, with lots of employees (to compensate) and foreign institutional investors and has long had its ADR traded on NYSE, what Morris got were more normal (or down-to-earth if you would).
In 2003, for example, he was reported in the news to have received 3,385,000 shares as a bonus, worth about TWD$200M at the time (roughly $6.5M), making him the highest paid “employee” (quoted directly from the title of this news article) of the year in Taiwan. It was also mentioned in this article that in 2001 he received 9,024,000 shares for FY2000 (the fiscal year we talked about above), which was worth about $17M back then.
While $6.5M or $17M might sound like peanuts compared to his $3B net worth today, but those years TSMC share prices were in general stable in the range of TWD$60–100. If Morris had kept all those shares without selling, factoring in the share multiplication due to the aforementioned stock dividends, today they’d be worth 10~20x today. And consider that Morris was getting this type of shares every year — also don’t forget that he already owned 6.5M shares in 1994 when the company went public — you can see how a $3B net worth today with TSMC share price hitting TWD$600 is not all that crazy without founders shares. (Note that both Tim Cook and Sundar Pinchai became billionaires as non-founding CEOs).
Also one has to know that unlike modern tech giants that do not issue dividends (but instead do share buybacks), TSMC has issued stable dividends over the decades. In fact those dividends have been so stable that many institutional asset managers counted them as “fixed-income” cash flows, to the point that in the wake of Lehman shock when TSMC did not have enough accounting profit to pay the same dividend rate as before, the board authorized to use the retained earnings to keep paying the dividends, so that the institutional asset managers did not get a cash flow shock — at least not from their end.
And owning meaningful amount of shares, Morris might have used those dividends to buy more shares automatically, which given his US citizen status probably benefited from tax deferral. That surely added up to his ownership as well.
Bottom line: the story of Morris and TSMC is as much a success as a fascinating story, which Ben and David did a wonderful job of presenting. On the other hand, the $0 Pre-Money and the Morris buying his own shares narratives could have used a bit more research — I wouldn’t mind being a sounding board for my silicon valley friends who no longer have direct semiconductor connections in Asia, for example.
In the next blogpost, I’ll write about the $30B capex plan and how TSMC can finance it with “only” $20B operating profit.
Postscript: gone were the good old days
Now back to the employee stock bonus program in those good old days that made Morris a billionaire “employee” (and several of my friends multi-millionaires.)
If you’re a US investor, at this point of reading this article you are probably wondering what the fuss is about this face value of TWD$10/share.
It’s one of those very old things that somehow never got updated in Taiwan. Basically in the pre-computer days, shares were printed on papers. The government regulated that each share would have a TWD$10 face value and each paper “bill” contains 1,000 shares, so the face value of this bill would be TWD$10,000, roughly $300.
When you set up a company, you put in initial capital and issue these shares in paper bills. If your initial capital is TWD$1M, you will have 100,000 shares in the form of 100 bills.
That practice carried over to electronics stock exchange. Even as today, at Taiwan Stock Exchange the shares are by default in the unit of bill, i.e. 1,000 shares. It means you buy or sell at the units of 1,000 shares. Also since there’s fundamentally no stock split or merge like in US, the face value remain TWD$10/share throughout the life of the company’s history.
Now obviously stocks rarely trade at face values. That created, initially a challenge for the Taiwanese government on how to regulate employee stock bonuses.
In US if you receive a RSU on a certain day, you are taxed at the full market price of that RSU share on that day. (Or was it 30-day average? I forgot).
In Taiwan back at that time most people hated volatility. Also the high-tech industry was just getting started and the government really wanted talents to come in, so they did something quite unusual by US standards that would have profound impact in the industry for the years to come.
Basically a company could issue new shares based on a percentage of their annual net profit and give these new shares to the employees as bonuses. There’s a cap of the percentage but usually it’s around 20%.
Giving 20% of your annual profit to the employees as bonuses doesn’t sound too bad for the investors, right? Wall Street investment banks, for example, routinely and (in)famously set aside 50% of the profit as employee bonuses.
But, there’s a catch here.
The number of the shares that will be issued is based on taking the TWD$ amount, e.g. 20% of profit in TWD$ — and then divide it by the share face value, TWD$10/share.
In other words, if the stock trades at 10x the face value, then the bonus pool is all of a sudden amplified by 10x. In dollar-term, this means that if your annual profit is TWD$100M, and you’re actually giving employees TWD$200M worth of bonus!
What’s even crazier, at the time the employees were taxed at the face value of the stocks that received. So those TWD$200M worth of stocks would only be taxed at a value of TWD$20M.
And did I mention that there was no vesting at the time? You could receive the shares and dump them all the next day. Keeping your life an equity-free cash-flow-driven one.
This extremely employee-friendly system plus the early traction of the new tech firms in Taiwan created huge momentum for the industry to take off in the late 90's. We’re not just talking about semiconductor, there were also the EMS firms, datacom companies, electronics component distributors — one of them at its peak was trading at 100x the face value —all kinds of design service firms, etc. Many engineers started to make annual incomes that surpassed medical doctors and lawyers (while paying much lower tax), which until that point were the highest-paid jobs one could find in Taiwan.
But these money did not fall from the sky. You couldn’t have a TWD$100M profit and be paying the employees TWD$200M for bonus afterward. Obviously it came from someone else’s pocket.
You got it. It’s the shareholders that foot the bill, albeit indirectly.
When a company issued employee bonus shares this way and it was trading at a high multiple, it was diluting the existing shareholders. This was evident in that usually after the company announced the employee bonus program, their stocks always started trading at a lower price the next day.
In the go-go years as share prices kept climbing, shareholders did not mind that much. But after the dot-com bubble bursted in 2000 and as an integral part of the internet industry, share prices of most Taiwanese tech firms also dropped, it became a thornier issue for shareholders.
As the pressure from shareholders climbed, another pressure from the society was also mounting.
It’s simply unfair how those employees stocks were taxed at the face value. It made no sense at all for anyone that could do basic reasoning. It was initially created as an incentive to draw talents into the tech industry but by early 2000 that goal was already achieved. Did Taiwan still need such a highly distorting system that benefited only a small percentage of the population?
After years of debate in the congress. in 2006 the government passed new regulations that mandate that corporates expense the stock bonus at the market prices. In other words, that company that made $100M but then gave out $200M worth of employee bonus would now be in a loss of $100M by this change in accounting.
Now as a finance guy, these accounting rule changes don’t affect how I value a company as all info are already public with or without them. But it does have an impact on how the executives plan stock bonuses.
This is because usually the personal bonuses of high-level executives were also partly tied to the profitability of the company. If by paying out $200M employee bonuses in the form of stocks it would, accounting-wise, sink the company into a loss of $100M accounting-wise, leading to part of the exec’s personal bonus going away, of course they would not be giving out shares that easily.
Not in the same bill but on the personal income tax part, the government also tightened the loop hole by starting to tax those stock bonuses based on market prices, just like in US.
Long story short, with the two sea changes, what the industry eventually settled down on was:
(1) Increasing employee salaries to higher levels (If you have to expense the stocks anyway why not pay in cash?)
(2) Reduce the RSU or completely remove it and replace with options
(3) Also have all these non-cash incentives vest over 4 years
The overall effect on employees was that you no longer hear those crazy stories of a college roommate making 5x what you were making in a certain year simply because the share price went up by 10x. Or that someone got headhunted by a rival and received a ridiculous amount (in dollar term) of stocks just because the high trading multiple.
As a side note, Morris quit his position as the CEO of TSMC in 2005 before returning in 2009. Reasonably probably most of the stocks he owns now came before 2005.
