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TSMC Chairman Morris Chang

Why Are Taiwanese Companies Undervalued?

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The Price-Earnings Ratios of Taiwan's listed companies remain discounted internationally. A number of substantive steps can be taken to make the island?s corporations truly world-class, and raise the appraisal of Taiwan.

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Why Are Taiwanese Companies Undervalued?

By Sheree Chuang, Elaine Huang
From CommonWealth Magazine (vol. 379 )

Many different practices and ways of thinking are blocking Taiwanese companies from becoming true world-class enterprises, and thus they remain undervalued, says Morris Chang, who as chairman has dedicated his life to making Taiwan Semiconductor Manufacturing Co. (TSMC) into a global player.

Companies in the same industry with the same operating profits, but coming from different countries, find their share values appraised very differently by international analysts. Taiwanese shares, in particular, are often discounted when compared to North American and European shares.

Looking ahead, Taiwanese government and business could do more to eliminate the elements leading to the undervaluing of Taiwan, and transform the island’s corporations into truly world-class global enterprises. It is on that point that Chang shares some heartfelt insights.

On 17 July JP Morgan released its report on price-earnings (P/E) ratios for global semiconductor stocks. The report projects average P/E ratios for 2007 at 24 times earnings for North American companies, 20.4 times earnings for European companies, 19.3 times earnings for Japanese companies, and 14.2 times earnings for “Greater China” companies, a category combining China and Taiwan but primarily Taiwan, given China’s limited chip industry.

Furthermore, Taiwan’s projected ratio for 2008 remains unchanged at 14.2, still lower than the projected 2008 ratios for North America, 20; Europe, 16.1 and Japan, 17.4. Taiwan is undervalued. (See table)

P/E Ratios below Western and Japanese Counterparts

The table shows that P/E ratios for North American, European and Japanese semiconductor companies are all higher than those for Taiwan-dominated “Greater China” companies. For example, TSMC had earnings per share (EPS) last year of NT$5. Thus, with last year’s P/E ratio of 14, our share value is NT$70.

At the same time, however, an American company with a same EPS of NT$5 and a P/E ratio of 20 has a share value of NT$100. This is why P/E ratios are a benchmark for appraising share values.

If there are two similar companies with relatively similar profit margins, one located in the U.S., and investors show greater willingness to pay a higher price for shares in the U.S.-based company, that means the company has a higher appraised value. Is this a good thing or a bad thing?

I’ll give you an example. Suppose a Taiwanese company wants to buy an American company, or an American company wants to buy a Taiwanese company. The company with the higher P/E ratio obviously gets the better deal.

Taking the above example where the U.S. company has a share price of NT$100 and the Taiwanese company's share price is NT$70 because of different P/E ratios, say each company has issued 1 million shares. That means the U.S. company is worth NT$100 million, while the Taiwanese company is only worth NT$70 million.

Under that scenario, think about what it would take for the Taiwanese company to buy out its U.S. rival. It would have to issue another 1.41 million shares at NT$70 a share to buy out the U.S. firm, which would seriously dilute the Taiwanese firm's earnings per share (EPS) and likely anger its shareholders.

The U.S. company, on the other hand, would have a much easier time buying out the Taiwanese company.

When the company with the higher P/E ratio buys the company with the lower P/E ratio, earnings will be enhanced, shares in that company will rise further and investors will cheer and applaud. When the company with the lower P/E ratio buys the company with the higher ratio, earnings per share are diluted and investors will want to give the company a spanking. This is devaluation.

Globalization in Taiwan Still Lagging

Why are Taiwanese companies being undervalued? Why are their P/E ratios excessively low? There are many reasons for this, but it all boils down to Taiwan’s insufficient level of globalization.

Why is Taiwan still lagging in its level of globalization? The first element in so-called globalization is the globalization of the market. This Taiwan has accomplished relatively well. For example, as regards the manufacturing industry, market globalization means that the things you manufacture can be exported anywhere.

The second element is the ability to attract top-flight human resources from around the world. This is a relatively more troublesome element for developing markets than for fully globalized markets. A company that wants to develop on a global scale must tap into a globalized talent pool. There are virtually no countries boasting a completely globalized workforce entirely comprising individuals possessing expertise, be it technical expertise, management expertise or marketing expertise. The U.S. comes closest, but even they are not 100 percent.

Supposing a talented individual wants to go to the U.S. It is easier to accomplish than going to other countries. But amid the recent debate over immigration law in the U.S., there have been increasing calls for tougher restrictions and enforcement measures, an indicator that even in the U.S. the workforce is not completely globalized.

Taiwan is in even more of a bind, with environmental factors making it difficult to attract top-flight global personnel, particularly those from advanced nations, to come live and work in Taiwan.

Foreign Investors Lack Faith in Taiwanese Companies

The third element is the globalization of investment capital. Global development requires a handle on global investment capital. Any company seeking to realize global development must secure an infusion of foreign investment capital. You need foreign investment capital in addition to that from shareholders from the company headquarters’ locality. And if you want foreign investment capital, you must win the confidence of foreign investors before they will be willing to invest. Similarly, global development also requires bank financing from investment banks around the world, which also requires winning the confidence of global banks before they will be willing to lend. This is relatively difficult for the average company to achieve.

Many Taiwanese companies have a fairly high ratio of foreign investment capital but this is a separate issue from devaluation. Taiwan’s undervalued companies have attracted foreign capital, but the level is insufficient. If everyone is interested, then your stock price will be high, and you won’t be undervalued.

The fourth element is the globalization of production. Global development necessitates borderless production capability. The actual meaning of borderless production is: production that is carried out wherever it can be of greatest advantage to the company, regardless of national borders. Borderless production also includes so-called “outsourcing.”

Taiwanese companies are currently subject to government regulation. The information industry is subject to partial regulation. In IC manufacturing and the semiconductor industry, the chip-packaging sector has been partially deregulated subject to technology restrictions, so production cannot be globalized.

We have opened to the world, with restrictions remaining in place solely as regards China. But China is a major playing field.

In the information industry, you can market yourself anywhere and everywhere, but to sell your product in some places, you have to go there, you have to have factories there, because you need to be nearby to provide service. Then a client can at least come see exactly how the thing he is purchasing is being made.

This was the reason that Intel went to China and set up a plant in Dalian, in Shandong Province. It was not because of low costs. To be honest, taking into account all the factors, the manpower costs in mainland China are not much different from Taiwan right now.

We have a global market share of around 50 percent, but in China we are far below 50 percent. For our clients this is a liability.

Taiwan Lacks Independent Boards of Directors

Additionally, globalization will require that Taiwan’s system and legal structure be brought in line with the world’s economic powerhouses. This includes the following items:

First, for example, independent, professional executives are needed. This kind of system has never taken root in Taiwan.

The definition of an independent, professional executive is one that has been appointed by an independent board of directors. An independent board of directors is one that is independent of the major shareholders and independent of management. Thus, company interests are not suborned to those of the major shareholders nor are they suborned to those of management, since company interests are those of the entirety of shareholders.

In developed countries virtually all [listed] companies have an independent board of directors. This is quite rare in Taiwan and is actually a reason behind the discounting. During the reconstruction of Japan following World War II, the old system was completely reformed, and Hong Kong is now also pretty good. But in Taiwan there are still far too many companies that have quite a ways to go before realizing a system of independent professional executives within their business groupings.

Second, the government has now decided to require that employee bonuses be booked as an operating expense. I believe this represents progress. Employee bonuses reflect an actual operating expense. Although cost will appear to be higher than before, the discount ratio applied in share price appraisal will perhaps fall slightly. If P/E ratios rise slightly, share prices will remain roughly the same. The end result will be the same.

Not All the Government’s Fault

The discounting is not entirely the result of government policy. It is also a result of the administrative practices of some companies.

The objective of corporate administration is clear – to balance relations among several major interested parties. Among a company’s major interested parties are, first, the shareholders; second, management; third, the workforce and fourth, society.

Stable corporate development is contingent upon corporate administration striking a harmonious balance between the interested parties rather than a confrontational balance. Conflict among the shareholders, employees, management or society must be avoided, as long-term corporate development will be affected.

Politically speaking, Taiwan’s level of democratization is quite high. On the other hand, a country’s level of democratization is ordinarily not overly relevant to its level of economic development. From a legal perspective, however, a nation’s application of the rule of law is highly relevant to its level of economic development. Rule of law includes both the writing and the enforcement of legislation: fairly, honorably and clearly written and strictly, impartially and effectively enforced. In terms of the rule of law, Taiwan still has a lot more work to do to attain an environment suitable for global development.

Deficiencies in the rule of law, insufficient economic openness and a variety of backward or otherwise dysfunctional systemic deficiencies have resulted in the so-called “Taiwan discount.” Removing those elements that lead to the Taiwan discount is the best way to resolve the problem and put Taiwan on a footing with the economic powers, and thus assist in the development of Taiwanese companies in the global market.

Translated from the Chinese by Brian Kennedy

Keywords:

好友人數