I was thinking about "the lack of cash issue" today and how it relates to the many hurdles ahead for the semiconductor industry. Getting a bit more specific, I'm thinking about the capital required to develop 450mm and of all things, to fund an industry consolidation.
The 450mm question is easy and was answered several years ago. I say this even though several trade rags and one stock site have have found it necessary to publish comments from a new report saying the equipment industry is wary about 450mm development.
Duh.... Do you hear an echo?
Ron Leckie published a paper about the 450mm R&D spending gap almost four years ago. SEMI's EPWG (Equipment Productivity Working Group) released a paper in June of last year dissing the economics of 450mm - going as far to say:
"....work over the past two years has shown that 450 mm wafer scale-up represents a low-return, high-risk investment opportunity for the entire semiconductor ecosystem; 450mm should, therefore, be an extremely low priority area for industry investment."
They also said, "The equipment industry’s R&D resources have become limited due to slower end-user demand growth, consumer-era economics, and the impact of the 300mm transition."
Isn't it about time we put that one on the back burner? I mean, we're talking about survival right now.
What about that cash?
Unfortunately as this downturn plays out a tsunami of financial trouble is going to hit the industry. For the equipment folks and their supply chain I think we've just seen washout number one. The thing that is really bothersome is that one cannot necessarily attribute this financial trouble to failed investments in next generation tech. It's more a case of financial management. I find it simply mind-boggling to look back at how cash was squandered over the last few years.
The recent bankruptcy at Asyst fits this story along with actions pursued by many others in the semiconductor and semiconductor capital equipment space. Entegris, Electro Scientific and Brooks all spent cash in an effort to appease shareholders. Oops.
Today, cash is king and those without it have hell to pay. A comment from Mike Milken (of all folks) from today's WSJ is very much relevant:
"Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time."
Good ol' Mikey. I was at Merrill Lynch when he held the junk bond world by the short hair. Boy, those were the days. I have to admit, I was chuckling to myself this morning - the world's greatest financial alchemist jumps out of the woodwork to make a perfect call - in hindsight, of course. But hey, that's the way the world turns. We're a society that demands immediate gratification.
This letter that an ex-hedge fund manager jokingly put on his blog a few years ago is precious:
Wednesday, August 08, 2007
The Shareholder Letter You Should, But Won’t, Be Reading Next Spring
Well, it seemed like a good idea at the time.
I am referring to your board’s decision to approve a massive share buyback and huge special dividend last summer, when the buzzwords going around Wall Street were “returning value to shareholders.”
Why we did it was this: a smart banker from Goldman Lehman Lynch & Sachs came in, all gussied up and looking sharp, and made a terrific PowerPoint presentation to the board with multi-colored slides that showed how paying a special $10 a share dividend, plus buying back a bunch of our stock at the 52-week high, would “return value to our shareholders.”
We should have thrown the fellow out the window, along with his PowerPoint slides, but what happened was, my fellow board members and I were so busy deleting emails from our Blackberries that we just didn’t notice the last slide showing (in very tiny numbers) the “Trump-style” debt we would be incurring to do so.
We also missed the footnote showing the fees that would go to Goldman Lehman Lynch & Sachs for the courtesy of their showing us how to wreck our balance sheet.
Those fees, I am embarrassed to say, amounted to more money than we made the quarter before we “returned value to shareholders.”
But the fact is, we’d been getting so much pressure over the last few years from the hedge fund fellows who own our stock for ten minutes tops, not to mention the so-called “analysts” on Wall Street (around here we call them "Barking Seals"), to do something with the cash...well, the truth is we just couldn’t stand answering our phones any more.
So, in order to finally start getting things done instead of spending all day explaining to these hedge fund fellows and the Barking Seals on Wall Street why we weren’t “returning value to shareholders,” we decided to do the big buyback and the big dividend.
And for a few weeks there, it was pretty nice.
The stock jumped, the phones stopped ringing, and the Barking Seals started congratulating us on the conference calls instead of asking us when we were going to get rid of our cash.
Unfortunately, not only did getting rid of our cash and taking on a huge debt load NOT “return value” to you, our shareholders, it actually crippled the company for years to come.
For starters, as you know, the aftermath of last summer’s sub-prime debt crisis is forcing perfectly fine companies to liquidate businesses at fire-sale prices…but we can’t take advantage of those prices, because we have no cash. And thanks to the debt we incurred “returning value to shareholders,” the banks won’t loan us another dime.
Secondly, as you also know, we’ve had to lay off hundreds of loyal, hard working employees to pay the interest expense and principal on all that debt, because unlike Donald Trump, we actually repay our debts.
Furthermore, as you probably don’t know, we’ve also scaled back some interesting research projects that had great long-term potential for the company, but were deemed too expensive to continue in light of the fact that we have no cash.
Now, I’d feel a heck of a lot worse about all this if we were the only company suckered into buying our stock at a record high price and paying a big fat dividend on top of it.
But I’m happy to report there were others who also did the same stupid thing.
For example, Cracker Barrel, the restaurant chain that depends on people having enough money for gas to get to its stores along Interstates across America, spent 46 bucks a share for 5.4 million shares of its stock early last year to “return value to shareholders.”Cracker Barrel’s stock now trades at $39.
And Scott’s Miracle-Gro, whose business is so seasonal it loses money two quarters out of four, put over a billion dollars of debt on its books with the kind of special dividend and share buyback we did.
Health Management Associates—a healthcare chain that can’t collect money from about a quarter of the patients it handles—paid shareholders ten bucks a share in a special dividend to “return value to shareholders” and then missed its very next earnings report because of all those unpaid bills and all that new interest expense it was paying.
Oh, and Dean Foods, a commodity dairy processor with 2% profit margins, returned all sorts of value to shareholders early last year—almost $2 billion worth—just before its business went to hell in a hand basket when raw milk prices soared.
So, you see, everybody was doing it.
And boy, do I wish we hadn’t.
Barking seals.... Ya gotta love it.....
Mid-day I received a question from an industry associate about this piece:
There are some mixed messages from the Street this morning on Lam Research (LRCX) ahead of the company’s results for its fiscal third quarter ended March, which are due after the close on Wednesday.
* Barclays Capital analyst C.J. Muse cut his rating on the stock to Equal Weight, from Overweight, trimming his price target to $28, from $30. The call is partly based on valuation. But he also notes that losses are likely through 2010, and he writes that “the DRAM semtiment trade with memory making tentative appearance in orders books is now nearly fully discounted,” adding that a sharp uplift in fundamentals is unlikely. He now sees a 2009 loss of $1.02 a share, versus $1 previously; for 2010 he now sees a loss of $1.07, compared to his previous forecast for a loss of 42 cents.
* Stifel Nicolaus analyst Patrick Ho, by contrast, maintains his Buy rating, while upping his target to $34, from $28. His view is that the semi equipment industry over the next few months will “return to some level of normalcy,” though “still in a downturn scenario.”
* Wunderlich Securities analyst Timothy Summers today repeated his Hold rating on the stock, but upped his target to $27, from $20. He writes that “conditions in the semiconductor equipment industry have stabilized and business in the back half of the calendar year will more likely improve than remain flat or decline.”
Here is my response:
If you are asking about the stock I would suggest taking profits here because the valuation is very, very extended. That is the case for most of the semi-related issues.
More likely you are asking about business conditions. I think we limp off the bottom for the rest of the summer. We're probably not going much lower but I seriously doubt if we scream higher. I say that because there is a lot of refurbishing taking place - that along with a ton of stuff sitting on used lots that will be cannibalized before folks start buying brand new stuff in bulk.
Notice how vague the comments are from the two that are bullish. As I have mentioned in some of my notes, it is relatively easy to call a bottom here. The guy from Stifel speaks with forked tongue - the industry will "return to some level of normalcy" but is "still in a downturn scenario". It's as if he is saying, "The normal trend is down but over the next few months the industry will not be going down as fast as it has been over the last nine months. With that in mind we feel as though we should raise our price target."
Ya gotta love it....
Spending on new tools is centered on Intel, Samsung and TSM. A bit will take place at the Foundry Co. but that is going to take a while to get rolling. Earlier today I mailed some friends in the south some comments from the Texas Instruments report that highlight the state of end demand. Let's just say there are question marks on that front. The weakness in end demand has implications for capital equipment sales. It's as plain as the nose on your face.
There's some real action taking place in the refurb/spares and materials supply chain ranks. Attrition and consolidation have the OEMs and the fabs scrambling. I'd love to read an earnings call transcript that contained some biting questions about the health of the supply chain. For example, Lam Research reports tomorrow, what would they say if asked about Air Products leaving the equipment refurb business?
After finishing that note a discussion came up about the health of the supply chain (again). My industry cohorts tell me that there will be a program focused on these supply chain concerns during Semicon West so I thought I would add $0.02 to the jar.
Your mileage will definitely vary with this ramble....
We all have some sort of map in our heads but perhaps putting something in a visible form to clarify who is on and who is off the bubble would be helpful. You know, we're at that point where it is really a case of focusing and supporting the "last man standing". No doubt many will fall off the map this summer. This is particularly true where business is driven by the construction of new fabs. The fall of Asyst is a case in point. Some might disagree but I would even go as far to say that Brooks might be in a similar position very soon.
Now, the *last man standing* theme could encompass several arenas - for one, how about, rather simply, the support and development of semi-mfg and tech development in the US. They are doing it in Europe - with a spokesperson, Malcolm Penn - of all people! And don't forget about the bailouts in Taiwan.
Given the new world order it seems clear that the OEMs must develop a business model that is much more balanced. Although I have not spent time thinking about this recently I've taken the liberty of pasting a small excerpt from a piece published way back in '05. Hopefully it helps describe what I am thinking. Obviously this is dated material and much has changed. The review does bring about a few ideas. Maybe it will do the same for you.
Best Regards (excerpt below),
--- Many firms have turned to services as the key vehicle for growth ---
As customer markets mature, value migrates from the initial purchase of product to services provided later in the lifecycle (e.g., financing, parts, and maintenance). In many industries, (elevators, compressors, aircraft engines, semiconductor equipment), product margins are minimal relative to the potential profits available across the entire lifecycle of product use.
The idea of finding new sources of value is not new. What is new is how information technology is allowing firms to track customers across the use cycle, and in some cases, as in the semiconductor industry, connect with the product in use. Firms such as GE Aircraft Engines dominate their industries using this approach; GEAE is not only after the engine margin but the entire profit of the engine usage cycle (except for fuel). This is possible because GE uses a few dozen sensors in each engine, connected to a satellite to track real time behavior of the fleet. This improved control enables lower cost to GE (through better asset utilization and preventative maintenance) and more importantly, it gives GE the power to price service and parts contracts with much more specificity and longevity. This enables GE to lock up the most important profit pool in the entire engine industry before the competition even gets a bite at the apple.
The most important part of the GE innovation was not the technology, it was the way they created the organizational capacity to analyze the data at their applied statistics lab, and then create management incentives to capture the downstream service revenue – enabling aggressive pricing of engines to capture the service revenue. Despite much rhetoric about being customer focused, most Fortune 500 organizations are “product-based silos” that drive toward market share targets based mainly on product/margin volume. This approach will never realize the full potential of what can be captured by measuring and managing for “share of wallet” – e.g. calculating the entire potential profit across the entire product life cycle and aiming for the sweetest profit pools. When this is done, all the attendant services, parts, etc. become visible as sources of value and growth.
To maximize the complete service relationship, organizations must change their way of thinking from market share to share of wallet. This seemingly simple change is profound and requires a fundamental change in how the company performs market analysis, management control, and information sharing. This shift from share of market to share of wallet also creates a change in the power of the company and its channel partners because he who touches the customer has power.
--- The Otis Example ---
Otis is an example of a company that simultaneously grabbed control of the relationship with the end customer without driving out its channel partners. In the late 1980's a large portion of the services market (where the entire margin is to be found) was controlled by independent service companies (many small) who were often Otis repair personnel who struck out on their own. Then President George David created a centralized call handing and dispatch system called Otisline. By centralizing this dispatch and problem-reporting, Otis was able to capture the customer need, and then direct it into their own service channel, or through the independent service channel. This approach created incremental service for the independent service technicians – and thereby creating support for the system. At the same time the Otisline system gave the manufacturer a closed loop system that allowed Otis management to sort the good service companies from the bad. When desired, Otis could also decide to take the service call themselves.
As the corporation collected the specific service data on each elevator, they acquired better knowledge about the different products that were in service out in the field, and could then arrange to have salespeople approach building owners who had dilapidated elevators, and sell them lucrative replacement elevators.
The next step was for Otis to instrument the elevator itself with a system called Remote Elevator Monitoring (REM). This allowed Otis, like GE, to monitor the fleet of elevators in use. Doing so enabled preventative maintenance, as well as prompt service dispatch with superior knowledge of the correct part and service protocol. Again, the technology was an enabler, but the real change was the management analysis and will to change the culture and the means of measurement. In this way, Otis simultaneously got closer to its customers, controlled more of the service revenue, and built up their channel partners. This model of shared information and monitoring is one that will be copied by many industrial firms who are after share of wallet not just share of market.
That's all for tonight.