TSMC’s legal meeting will be held today. TSM has a premium of nearly 30% compared to 2330. Is there any arbitrage opportunity?

TSMC's earnings call will be held today at 2:00 PM Taipei time. Its ADR (ticker TSM) in the US surged 2.66% yesterday, trading at a 28% premium over the Taiwan stock 2330. Is this one of the most profitable arbitrage trades in the financial world?

What is TSMC ADR and how is it different from 2330?

ADR stands for American Depositary Receipts, which refers to the stock certificates of a non-US company that are traded in the US market. Companies like TSMC issue ADRs to allow US investors to more easily buy their stocks and to raise capital in the US market.

TSMC issued ADRs in the US in 1997, with the ticker symbol TSM. The exchange ratio between TSM and the Taiwan-listed 2330 is 1:5. Since the ADRs are directly derived from the shares issued in Taiwan, the stock prices should be close.

In theory, this is one of the most profitable arbitrage trades in the financial world - the stock price of TSMC in New York is much higher than the price in Taipei. Short the TSMC ADR (TSM) and buy the Taiwan stock (2330), can one easily profit?

According to Bloomberg, the price gap between TSM and 2330 has not only not narrowed, but the average price difference in January expanded to 25%, the highest level since 2009, exceeding the 10-year average of 6.4%.

As the frenzy for AI shows no signs of abating, TSMC has become a favorite of US investors, who cannot easily buy the cheaper Taiwan-listed stocks of this chipmaker. For hedge funds trying to bet on the gap narrowing, their concern is that even as the premium soars to eye-watering levels, investors will continue to bid up the US stock.

Riding the AI wave, TSMC continues to surge

TSMC is the preferred chipmaker for Nvidia and Apple, and has been a top AI stock held by global equity investors, thanks to its leading technology and reasonable valuation compared to US tech giants. Since the release of ChatGPT in 2022, as of Tuesday, TSM has surged over 150%, while 2330 has risen 124%.

TSM not only attracts active investors, but is also included in indexes like the Philadelphia Semiconductor Index and ETFs, meaning funds tracking them must buy the US version, causing it to outperform the Taiwan-listed stock. Bloomberg data shows that while TSM accounts for only a fifth of the company's total listed shares, its average daily trading volume over the past three months is double that of 2330.

Furthermore, according to a June study by Goldman Sachs, the time it takes for the TSM premium to expand is usually longer than the time it takes to narrow, and this trend is unlikely to reverse until after 2023.

TSMC earnings call is imminent, over 90% of analysts still recommend buy

TSMC's earnings call will be held today at 2:00 PM Taipei time, giving global investors a chance to assess AI demand, as the chip giant will release quarterly sales outlook and this year's capital expenditure guidance. According to Bloomberg-compiled data, the company is expected to post a gross margin of around 58% for the three months ending December, with profits growing 55%.

S&P Global data shows that as of Monday, the short interest in TSM as a percentage of shares outstanding was 0.4%, down from 3.1% in June, indicating investors remain bullish, and according to Bloomberg-compiled data, over 90% of analysts recommend buying the stock.