Thursday, August 25, 2011

Applied Materials and the Semi-Equips

I suppose I could comment on HP and the news from Apple but there’s plenty of fodder for that on the worldwide InterTubes. Instead, I thought I would wordsmith a few comments about yesterday’s report from Applied Materials.

I’ve said it and heard it from others in the industry: “The Achilles heel for most capital equipment companies, and for that matter, semiconductor companies, is the inability to see changes in end demand.” Jim Bagley made this clear a few years ago at SEMI's Industry Strategy Symposium when he pretty much said he really didn’t care what was happening in the end markets because their job (at that time he was with Lam) was to stay in step with Moore’s Law.

You have to admit, they are focused.

To AMAT's credit, they have been pretty open about the weakness they were seeing in the PC markets. That really makes you wonder when Intel is going to say something negative.

On the AMAT call and the report…

I doubt that there was an investor out there that didn't expect bookings to be down and the outlook to be weak. I won't bore you with those details. I did find it interesting to hear management talk about foundries moving equipment from under-utilized trailing edge nodes, 65nm, to 28nm production lines. I’ve pinged folks in the industry to learn more about migrating old equipment to advanced lines. I know it has been going on for years but now we're talking about some serious reuse. If you have any insights please feel free to chime in.

From what I hear yields at 32nm and below are very low – some suggesting that good yields are below 20% (yes, there are some exceptions - Intel and a few of the bleeding edge memory companies but generally advanced yields are not good). I also hear from my moles that getting yields up is going to take longer than expected. KLA’s management team made this very clear on their earnings conference call. If anyone knows, they should. I posted some of KLA's comments here:

More Capital Spending Revisions - Tokyo Electron

As for next year, AMAT’s management talks about spending for 20nm and 14nm device production. Well, there are issues here – particularly with inspection and measurement – not to mention the cost of the lithography bay. A few folks in the inspection and measurement business have suggested that when the industry reaches 22nm inspection will hit the wall. We’ll likely hear more about this but I’ll say it now, “You can’t measure and you can't fix what you can’t see.”

For posterity let’s assume the up cycle kicks in again and AMAT does get orders for 20nm and below – call it a couple of years worth. After that we head to bigger, 450mm, silicon wafers. Uh, Oh! Remember this one?

When Getting Bigger Makes You Smaller

If only a few chipmakers are able to buy the 450mm tools, then the R&D costs must be passed on to that small universe. The tool vendors are bound to be impacted financially, perhaps severely. Either way, a small number of buyers means more development costs have to be absorbed by the tool vendors. Said another way - the tools are more expensive in smaller volumes.

What I am trying to get my arms around is exactly who is paying for 450mm development?

And if all the big semi-equip vendors develop 450mm tools, except for just one in the critical chain of manufacturing, then the fab can’t operate. So lithography, etch, CVD, PVD, clean, robotics must all commit to develop in parallel. And to do so they must be motivated that the timing is right and the returns are there. Further they must have sufficient balance sheet to support a long time line effort where the returns are years out.

Yes, this could go on for hours…..

Moving along, I’ve got a lot of doubts about the solar business and a big recovery. AMAT is very optimistic about solar and they believe projects will get funded. They might…. I'll admit that I am a skeptic. I hate to say it but I suspect that in just a few short years we are going to see much higher efficiencies and we will regret funding a lot of these projects. Then again, maybe they are right and the money spigots will remain open…. Regardless of the economic considerations and our fiscal issues.

Messy, messy.

Last but not least, some thoughts on the stock…. I’m not a fan. There are companies out there in chipland that are growing faster and, of all things, yielding more than AMAT so I think it is best to look at them first. Where does the stock get appealing to me? I’d like to see a 4% dividend yield – at least.

The major semi-equip investment attraction is, and has always been, the volatility and calling the turn. That’s what keeps the hedge funds engaged with the group. Without the hedgies p/e’s for the group would likely fall further. Using some of the newly revised Wall Street estimates, say $1.10 for CY11, and less than that for CY12, I believe the share price of AMAT, which is currently trading at ~9.9x that number, does not reflect larger earnings cuts ahead.

We will know when we have arrived, as the volatility will discount the p/e rather than be a premium. Semiconductor capital equipment companies are cash rich, mature and will either institute a dividend or up their dividend. As all mature companies do. Notable is the fact that 3M and CAT have higher p/e’s.

Go figure.

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