Taiwan's TSMC has begun trial manufacturing of next generation chips for Apple Inc's mobile devices, a source with knowledge of the matter said on Friday, in a sign that the iPad maker is shifting from its traditional chip supplier, Samsung Electronics.

Samsung is the sole supplier of the A5 chips used in the iPad 2, but Apple has hinted it is keen to diversify away from the Korean company. The two are battling a legal dispute over patents, and Samsung has also emerged as Apple's toughest competitor in the smartphone and tablet market.

Apple faces several hurdles should it want to make a switch to TSMC, including patents and chip design issues as well as a push by Samsung to retain the business.

Apple is trying to diversify its orders but it will still maintain some kind of relationship with Samsung, said Fubon Securities analyst William Wang.

I think TSMC will get the new chip orders, the issue however is allocation. Apple won't give the whole 100 percent to TSMC. Maybe it'll allocate only 20-30 percent.

Analysts and other sources had previously said TSMC, the world's largest contract chip maker, was set to become a supplier of a next-generation processor chip to Apple, likely starting next year. However the chip may not be called the A6, as some reports have indicated, the sources said.

TSMC is an obvious candidate to win processor business from Apple as it has budgeted $7.8 billion this year to update technology and add capacity. It also has experience with the architecture of British chip designer ARM Holdings Plc, widely used by Apple to make power-efficient mobile chips.

TSMC spokeswoman Elizabeth Sun told Reuters she could not comment on this issue or on market rumors. Apple was not immediately available for comment and a Samsung spokesman declined to comment.

Shares of TSMC have slipped 1.5 percent so far this year, outperforming the broader market's 4.4 percent decline.

TSMC has got all the authorization and details ready. Whether Apple puts in a formal order will depend on the yield rate, said the source with knowledge of the matter, who requested anonymity on the grounds of not being authorized to speak to the media.

The source did not provide further details of the orders.

Whether TSMC would get actual orders for the chips would depend on its yield rate, or the amount of chips per batch that come out with no defects, the source said.

The global semiconductor industry is set to grow by 7.2 percent this year, boosted by soaring sales of tablets and smart phones, research firm His iSuppli says.

The market for tablets, created only last year with Apple's iPad, is expected to surge to 108 million devices next year from an estimated 70 million in 2011 and just 17.6 million in 2010, according to research firm Gartner.

Some analysts said any switch by Apple from Samsung could be tricky.

SAMSUNG AND APPLE TIES

It won't be easy for Apple to dramatically change its chip provider from Samsung, said Seo Won-seok, an analyst at NH Investment and Securities in Seoul.

It has to redesign the chipset, which Samsung has been deeply involved from the beginning and has some intellectual property. Apple could try various suppliers but they (Samsung and Apple) need each other and the relationship will continue.

The A5 chip is designed by the California company and analysts say it is based on British chip designer ARM Holdings technology. Details of Apple's technology are hard to come by though given its obsession with secrecy.

Andrew Lu, Hong Kong-based head of semiconductor research at Barclays Capital in Asia ex-Japan, also said he was doubtful that Apple would use TSMC to make the same chips as Samsung. It is more likely that TSMC will make what he calls A-X chips used for different products.

TSMC and Apple would have to come up with their own, and they cannot infringe Samsung's patent, which includes the system design and memory packaging, he said.

If TSMC manages to win all orders for the next generation chip, its earnings per share would be lifted by T$2 a year, Prudential Financial Securities Investment Trust's senior fund manager Bevan Yeh said. The T$2 would mean a one-third boost to TSMC's EPS based on the company's 2010 earnings.

Samsung will try everything it can and offer a very low price to save the orders, said Yeh, adding that Samsung, which had just built a new fab for Intel, might offer a price low enough just to cover the variable costs, or offer a bundled package that includes different components.

(Additional reporting by Miyoung Kim in SEOUL, Poornima Gupta and Noel Randewich in SAN FRANCISCO and Lee Chyen Yee in HONG KONG; Editing by Jonathan Standing and Anshuman Daga)

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