DigiTimes asserts in a recent article that Samsung (NASDAQOTH:SSNLF) and Taiwan Semiconductor (NYSE:TSM) are locked in a battle for Apple's (NASDAQ:AAPL) A9 chip orders. According to the article, citing "industry sources," Apple is "expected to confirm the chip supplier or suppliers by the end of 2014."
What I found particularly interesting in the article, though, is that Samsung is reportedly "offered lower quotes" than Taiwan Semiconductor has in order to grab this business. DigiTimes also points out that Samsung is able to supply additional chips and services, such as flash memory and "backend services" (i.e., packaging and test), as well.
Given that Samsung's mobile device business is now seeing relatively weak operating profit, it seems that the company might be shifting its focus on its semiconductor business. This, in my view, is probably the correct strategy for the company to pursue; here's why.
Semiconductors have a much higher barrier to entry than do mobile devices
The market for mobile devices has a very low barrier to entry: just about any company can decide to pour the money into building an Android smartphone. While many continue to point the finger at Apple for Samsung's mobile weakness, I would venture a guess that Samsung's profit squeeze is caused at least as much by the competition at the low end and the midrange (where Apple does not play) as it is by the high-end competition from Apple.
It's very hard to command gargantuan profits on what are essentially commodity Android devices.
However, semiconductors are difficult. The research and development required to develop and deploy a world-class, high-yielding, leading-edge semiconductor logic process is huge. Further, even with the right investment level, developing semiconductor manufacturing technology is fundamentally hard and getting harder.
That's good news for Samsung ...
The good news is that with so few companies able to actually build leading-edge process technologies, Samsung could build itself a very profitable business as Taiwan Semiconductor has. Indeed, with a proven track record of developing viable manufacturing processes, coupled with significant financial might, it wouldn't be a shocker to see Samsung thrive as a general purpose chip foundry over the long haul.
However, there's one snag that could serve as potential headwinds to Samsung's foundry ambitions.
Samsung is in direct competition with most, if not all, leading-edge customers
In the foundry market, the two fabless customers that seem to require the most leading-edge technology volume are Qualcomm (NASDAQ:QCOM) and Apple. The problem here is that Samsung's internal chip teams compete directly with Qualcomm for spots in Samsung Mobile's devices, and Apple obviously competes directly with Samsung mobile.
Now, this didn't stop Apple from using Samsung for the vast majority of the iPhones sold to date, and it didn't stop Qualcomm from having Samsung build some of its stand-alone baseband chips. However, I would imagine that the fact that Samsung is a direct competitor to both of these companies in their respective core businesses could lead to some hesitation among Samsung's potential foundry customers.
That said, if Samsung has the best technology available at the best prices available, it's hard to see the fabless companies thumbing their noses at Samsung's offer, potential conflicts of interests notwithstanding.
What does this mean for TSMC?
If the DigiTimes story is correct and Samsung is offering very aggressive pricing to bring over Apple, then this could potentially be a problem for Taiwan Semiconductor. Given the position Samsung is in, Apple probably isn't the only company that Samsung is offering aggressive pricing to.
Indeed, DigiTimes reported back in July that the "Samsung/Globalfoundries team" landed 14-nanometer orders from Qualcomm and Apple. In fact, a quick search on LinkedIn reveals the profile of a Qualcomm engineer who claims to be designing next-generation Qualcomm chips on Samsung's 14-nanometer process:
It seems likely that Taiwan Semiconductor is going to have quite the battle on its hands to maintain its substantial customer base for leading-edge foundry technology.
Foolish bottom line
In light of the weak performance from Samsung's mobile division, which I believe to be largely out of Samsung's control, it seems smart for the company to build out its semiconductor business even further. The barriers to entry for leading-edge foundry are quite high, and although the total profit to be had here isn't as high as what Samsung saw from the mobile business at its peak, it's likely a more sustainable business over the long run.
Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.