Apple (AAPL 1.45%) unveiled its new artificial intelligence features dubbed "Apple Intelligence" at its Worldwide Developers Conference a few weeks ago. The highlights include text generation and summarization across apps, advanced AI-assisted photo editing capabilities, and a much smarter and more powerful Siri. It also integrates third-party services like ChatGPT for more advanced prompts.
What makes Apple Intelligence so compelling is the amount of AI processing it does on the device. Instead of taking your query, sending it to a server along with any relevant data, waiting for the server to process your request, and then downloading the results to your device, the entire process happens on your iPhone, Mac, or iPad. For more advanced queries requiring a larger foundation model, Apple uses its own servers and system called Private Cloud Compute, which protects users' privacy.
Both of those developments could be a major win for one of Apple's biggest suppliers. Since all of these new features run on Apple-designed silicon, chip foundry Taiwan Semiconductor Manufacturing Co. (TSM +0.40%) could see an increase in orders due to Apple Intelligence. What's more, as Apple leads the way in on-device AI processing, it could push other device makers to buy more advanced chips from TSMC as well.
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Pushing artificial intelligence to the edge
With Apple Intelligence, Apple is ushering in the next phase of artificial intelligence known as edge AI (when data and algorithms are processed directly on the end device, in this case a smartphone, tablet, or personal computer).
In order to process AI queries on device, though, the devices need to be capable. That means hardware that's even just a few years old might not be able to handle AI requests as well as newer devices can, if they can even handle them at all. Apple, for example, is limiting Apple Intelligence features to the iPhone 15 Pro, iPhone 15 Pro Max, and the forthcoming iPhone 16 devices. (Note the limiting factor here is the amount of short-term memory, or RAM, on the device, not the processors themselves.)
NYSE: TSM
Key Data Points
As a result, Apple could see strong demand from users eager to upgrade their phones over the next few years as Apple Intelligence features roll out around the world. And more iPhone sales means more demand for TSMC's chips.
But TSMC doesn't just supply chips for Apple. It manufactures the majority of chips in the world, accounting for over 60% of the market. That scale gives it a massive competitive advantage over smaller foundries, as it can invest more money in R&D to develop more advanced processes to print more powerful and energy-efficient chips. That ensures it keeps existing customers like Apple that are looking for leading-edge chips, and it attracts more of their business. It also helps TSMC draw in new customers as innovations like edge AI push companies to adopt new chip designs.
The Apple cloud is just getting started
In order to support third-party large language models (LLMs) and its own more advanced LLM, Apple created Private Cloud Compute (PCC). The system uses Apple servers that also deploy the tech titan's own chip designs.
It's worth noting that Apple isn't using the platform to train AI models. It's using PCC to process data and algorithms that would require more compute power than what's available on consumer devices. The first implementation is sending prompts to ChatGPT.
There's a lot of potential for Apple to grow its data center capacity as it partners with more businesses and developers looking to integrate their AI services with Apple's platform. When the company announced its partnership with OpenAI's ChatGPT, it said it's working to bring more partners to the platform later this year. If Apple pushes developers to use PCC, it could further increase Apple's demand for TSMC's services. It also offers another way for Apple to generate income from developers.
There's a long runway for Apple to grow AI features through third-party integrations. Just consider the phenomenal growth of the App Store over the past 15 years. Similar growth would be a boon for both Apple and TSMC.
Making a $1 trillion semiconductor company
TSMC already has a market cap of around $900 billion. Even so, shares look undervalued at today's price given the growth potential spurred by continued demand for AI chips.
The stock trades for about 27x forward earnings estimates, which is a more than fair price to pay. It should be able to grow its earnings fast enough to justify that price as demand for more advanced chips supports its top-line growth and improves its operating margins. Analysts expect earnings will increase over 25% next year.
A strong iPhone upgrade cycle over the next few years, incremental demand from Apple's new data centers, and the overall push toward edge computing all favor TSMC's continued growth. Its competitive advantage in creating the most advanced, powerful, and energy-efficient chips will serve it well over the next few years. It's only a matter of time before the company tops a $1 trillion market cap.
