Chips Off the AI Block

I’ve been thinking a lot about chips lately, and not only because, according to The New York Times, chocolate chip ice cream has fallen out of favor.  As dismayed as I was about that, I was even more surprised to learn that, as of last Wednesday, computer chip maker Nvidia now is the 3^rd largest U.S. company – and 4^th largest worldwide – by market capitalization. Bigger than Amazon, Alphabet, or Meta, not to mention Tesla.

Credit: Bing Image Creator

If you’re a stock maven, or are deeply interested in A.I., you might have been following Nvidia. The company specializes in designing chips that powers A.I. applications. It has also has long been a presence in advanced chips for, among other things, gaming, cloud computing, and image computing. But Nvidia is hardly a top-of-mind company for consumers, unlike Microsoft or Apple (both of whom it trails in market cap) or the other Big Tech companies.

You may want to start paying more attention to it.

The A.I. revolution of the last two years has been very good for Nvidia; its stock is up over 200% in the last 12 months alone. Charlie Blaine of The Street noted: “Let's say you bought 100 Nvidia shares at the end of 2018. Adjusting for the split later on, the price would be $33. Today, your stake would be worth $726,700, up 2,100%.”

Nvidia first hit $1 trillion in market capitalization last May, some 24 years after going public. It is now worth around $1.8 trillion, and analysts are eagerly awaiting Wednesday’s earnings call. "It could be the most important earnings in all tech year to date, and possibly the entire stock market," Jordan Klein, managing director for tech, media and telecom sector trading at Mizuho Securities, said in a client note. "Nvidia is not up 47% year to date to $1.8 trillion market cap because nobody cares, right?"

By contrast, Intel – which many consumers might be able to name – has a market cap about one tenth of Nvidia’s, although Nvidia trailed Intel as recently as 2020.

To call Nvidia a chip maker or chip manufacturer is somewhat misleading, though. What it does uniquely well is chip design. TMSC (Taiwan Semiconductor Manufacturing Company) does most of its actual production, as it does for many chip companies. Oh, sure, there are other chip manufacturers, including AMD, Intel and Samsung, but TMSC produces about 90% of the world’s high performance chips. You want AI? You want quantum computing? You want the future?  Then you need Nvidia.

Given the decades-long tensions between China and Taiwan, not to mention increasing tensions between China and America, including US restrictions on advanced technology to China, it should give pause to think that a Chinese invasion of, or a missile strike on, Taiwan could severely hamper development of AI and other advanced technologies.

That’s one reason TMSC is diversifying the locations of its fabrication plants, with two planned in the US, two in Japan, and “possibly” one in Germany.  Its first planned Arizona plant was scheduled to start production by the end of 2024, but that has slipped into the first half of 2025, a delay attributed in part to lack of skilled employees. Its second Arizona plant now won’t be in production until 2027 or 2028, instead of 2026. The progress is somewhat dependent on “how much incentives that the U.S. government can provide,” Mark Liu, TSMC’s chairman, said in an investor call. The Wall Street Journal reports: “negotiations between the Biden administration and TSMC over subsidies have proven challenging, say people on both sides.”

Those incentives were supposed to come from the 2022 Chips and Science Act, which was to invest some $50b to boost US chip manufacturing. But progress has been slower than expected. Similar to TMSC’s issues in Arizona, Intel’s much publicized Ohio expansion now isn’t expected to even be completed until late 2026, instead of beginning production in 2025 as originally planned.

Just last week the Biden administration released its first major award, some $1.5b to New York-based GlobalFoundaries, with another $1.6b in loans. That’s a long way from $50b and not much visible progress for 18 months since passage. “Nothing has failed yet,” Emily Kilcrease, a senior fellow and the director of the energy, economics and security program at the Center for a New American Security, told NYT. “But we’re going to have to see some progress and those factories actually coming online in the next few years for the program to be considered a success.”

And, in any event, TSMC may be planning to keep its most advanced processes at home, not in its overseas plants. So much for reducing dependency.

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If you think the world’s dependence on a single manufacturing company for our most advanced chips is scary, it’s worse than that. TSMC and other chip manufacturers rely on EUV lithography, which is used to engrave the chips. And there’s only one company -- Advanced Semiconductor Materials Lithography – that produces the machines to do that.

If you hadn’t heard of Nvidia, and perhaps even if you had, you almost certainly hadn’t heard of ASML, or understood its importance. “ASML has a monopoly on the fabrication of EUV lithography machines, the most advanced type of lithography equipment that’s needed to make every single advanced processor chip that we use today,” Chris Miller, assistant professor at the Fletcher School at Tufts University, explained to CNBC. “The machines that they produce, each one of them is among the most complicated devices ever made.” TMSC, Intel, and Samsung – all of whom are major investors -- account for over 80% of its sales.

ASML is located in the Netherlands, so is just one hypersonic missile away from Russia destroying the chip market.

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I’ll be watching Nvidia’s earning report with some interest. Its stock might be in a bubble, but AI is only going to get bigger, which is good for Nvidia. It’d be cool to see if it can top $2 trillion in market cap, especially if it vaults Saudi Aramco into 3^rd overall spot. Its success is a classic capitalism success story; it built a better mousetrap, and the world beat a path to it.

But reliance on two companies – TMSC and ASML – for some of our most advanced technologies is the opposite of capitalism, especially when they are so geographically constrained. If we want to play hardball with our geopolitical rivals about advanced technologies, just remember that they can do some brush back of their own.

The Chips Act was a widely supported effort at industrial policy, but, so far, it has been too little, too slow.