Contract chip manufacturing giant Taiwan Semiconductor Manufacturing Company (TSM 4.37%) recently announced that for 2018, it expects to boost its capital expenditure budget to between $11.5 billion and $12 billion, up from a prior range of $10.5 billion to $11 billion.
Chip manufacturers' capital expenditures tend to consist largely of the very expensive tools required to develop and manufacture chips, and Taiwan Semiconductor (TSMC) is one of the world's largest logic-chip manufacturers.
An Apple A10 chip, manufactured by TSMC, inside of an iPhone 7. Image source: Apple.
While investors seem disappointed that TSMC is raising its spending, as evidenced by the large drop in the stock price following its earnings report, the company has two very good reasons to boost its capital expenditures for 2018:
1. Mask-making tools
A photomask is an "opaque plate with holes of transparencies that allow light to shine through in a defined pattern." Photomasks are used to, in effect, "print" chips on silicon wafers.
According to TSMC, the company is laying out an additional $500 million in capital expenditures to boost its mask-making capacity in a bid to "support [TSMC's] customers' higher tape-out activities."
In a nutshell, a mask set needs to be created for each chip that TSMC manufactures, and since TSMC is seeing a large increase in the number of chips that it's being tasked to produce, it needs to be able to make more masks.
It's a no-brainer for TSMC to lay out this additional capital to earn what is likely to be the billions in revenue that these additional chips will bring in.
2. More advanced tools
Developing chip manufacturing technology is expensive for two reasons: The brainy engineers who develop these technologies aren't cheap to employ, and -- perhaps more significantly -- the tools that those engineers use to develop these technologies are extremely expensive.
Companies like TSMC need to buy advanced chip manufacturing tools as soon as possible so that they can get to work developing manufacturing technologies that make good use of those tools.
That's what TSMC is doing this year. The company says that part of the reason that it revised its capital expenditure plans for the year is that it needed to make a pre-payment for a new type of chip manufacturing tool that will allow the company to get to work on developing the manufacturing technologies that it'll bring into high volume production sometime after 2022.
TSMC is smart to get such tools in-house as quickly as possible because developing new manufacturing technologies is a long, risky business and being able to get to work as early as possible gives the contract chip giant the best chance of continuing to deliver new manufacturing technologies on time, ultimately keeping its business humming.
Foolish takeaway
Ultimately, TSMC is making the right call in spending more to support its customers' needs and future manufacturing technologies. In the world of cutting-edge chip manufacturing, it costs a lot to stay on the cutting edge. But technology leadership is a key reason that TSMC is as successful as it is, so it's spending what it must to stay ahead.
