United Microelectronics (UMC -1.27%), Taiwan's second-largest contract chipmaker and the world's third-largest foundry, doesn't attract nearly as much attention as the market leader Taiwan Semiconductor Manufacturing (TSM 0.15%). TSMC and UMC are both based in Hsinchu, Taiwan, but the former generated more than seven times as much revenue as the latter last year.

Many conversations regarding the Taiwanese semiconductor market gloss over UMC and focus on TSMC's development of the world's most advanced chips for fabless chipmakers like Apple, Advanced Micro Devices, and Qualcomm instead. But could UMC expand significantly over the next few years and become the next TSMC?

Two silicon wafers.

Image source: Getty Images.

The key differences between UMC and TSMC

Back in 1980, Taiwan's government-backed Industrial Technology Research Institute (ITRI) spun out UMC as the country's first semiconductor company. Morris Chang, the chairman of ITRI at the time, founded TSMC in 1987.

UMC was initially an integrated device manufacturer like Texas Instruments that produced first-party chips through its own foundry. TSMC, however, was established as a dedicated foundry that only manufactured chips for other fabless chipmakers. In 1995, UMC downsized its IDM business and transitioned to a contract chipmaking model like TSMC. The following year, UMC spun off its IC design divisions as several smaller chipmakers (which included Mediatek).

UMC and TSMC remained fierce competitors in the "process race" to manufacture smaller and denser chips (as measured in nanometers) for years. But in 2018, UMC suspended its development of smaller chips beyond the 14nm node and surrendered that higher-end market to TSMC, Samsung, and Intel.

Meanwhile, TSMC -- which adopted ASML's extreme ultraviolet (EUV) systems to manufacture more advanced chips -- continued to produce even smaller 7nm and 5nm chips. It's currently rolling out its 4nm and 3nm chips.

In its latest quarter, UMC generated a quarter of its revenue from 22/28 nm chips. The rest came from even larger and older nodes. TSMC generated more than half of its revenue from 5nm and 7nm chips in its latest quarter.

Therefore, UMC is generally considered a contract chipmaker for lower-end chips -- especially for cheaper mobile devices, connected cars, industrial machines, and Internet of Things (IoT) gadgets -- while TSMC is the preferred manufacturer of top-tier chips in premium phones, high-performance computers, and other demanding markets.

Which company has been growing faster?

Between 2016 and 2021, UMC's annual revenue increased at a compound annual growth rate (CAGR) of 7.6% as its net income -- which was driven by its aforementioned retreat from pricier chip nodes -- rose at a CAGR of 46.3%. During those five years, TSMC's annual revenue grew at a CAGR of 10.5%, while its net income increased at a CAGR of 12.5%.

TSMC generated stronger sales growth than UMC, driven by the market's robust demand for smaller and denser chips, but its net income rose at a slower rate because it needed to aggressively ramp up its R&D expenses to stay ahead of Samsung, Intel, and other foundries in the process race. 

Analysts expected UMC's revenue to rise 31% in 2022, and expect it to decline 13% in 2023 as the semiconductor market cools off. They expected TSMC's revenue to increase 43% in 2022, but predict it will grow just 4% in 2023 as it faces the same macro headwinds. But over the long term, both chipmakers should continue to grow as the broader semiconductor sector bounces back.

Why UMC won't become the next TSMC

Before UMC dropped out of the nanometer race in 2018, it might have had a shot (albeit a long one) at becoming the next TSMC. But over the past four years, UMC made it abundantly clear that it wasn't its ultimate goal.

Instead of pouring tens of billions of dollars into the latest chip designs and EUV systems every year, UMC seems content to manufacture cheaper (but just as important) chips for a wide range of customers. That strategy exposes it to more direct competition from other underdog foundries like GlobalFoundries and the Chinese chipmaking giant SMIC, but dealing with those smaller rivals would arguably be a lot less expensive than chasing TSMC.

In short, I don't believe UMC will ever become the next TSMC. But that doesn't necessarily make it a bad investment -- it's another bellwether of the semiconductor sector which should have plenty of room to run when a new bull market starts.