ML:Order trending up Q-Q,Catalyst demand strong,connection system acq. adds upside
Excerpts fr Merrill Lynch 8/21/00
Investment Highlights:
• Teradyne is tracking well toward our third
quarter estimates. Bookings are on track for
Q/Q growth.
• Tight supply on certain semiconductor
components for the J973 high end product line
could cause a slight short fall on this one
product line’s shipments and orders.
However, other businesses, including Catalyst
are stronger than we expected easily offsetting
the constraints and allowing the company to
meet or slightly exceed our estimates.
• Teradyne announced the acquisition of two
California based printed circuit board
companies last week. These could provide
upside to our estimates with in 6 months.
• We reiterate our Buy Rating and $110 price
target.
Fundamental Highlights:
• Teradyne is the leading manufacturer of
automatic test equipment (ATE) serving the
electronics industry. The main product lines
include semiconductor, circuit board, and
telecom infrastructure test equipment, and
software testing. Teradyne is also a leading
Electronics Contract Manufacturer.
All cylinders are firing this quarter
Our checks indicate that Teradyne is seeing strength across
most of its product lines this quarter. Thus, at mid-quarter
we remain very comfortable with our $850 million revenue
estimate and $0.83 EPS estimate. These compare to $759
million in revenues last quarter and $497 million a year
ago. EPS is versus $0.76 last quarter and $0.35 a year ago.
Orders trending up versus last quarter
Typically, at only the mid point of the quarter, it is difficult
to judge if orders will be above the previous quarter for
Teradyne as the majority of the company’s orders are
usually closed in the last few weeks of the quarter.
However, our checks indicate that orders are tracking
above the second to all time record $826 million in orders
recorded last quarter. Thus, we are comfortable that orders
will be up quarter to quarter. Demand for Catalyst system-on-
a-chip testers and a pick-up from test houses are among
the positive factors providing visibility.
Supplier constraint could result in slightly different
product shipment mix this quarter
Teradyne’s High end J973 logic testers use a number of
custom, high performance chips. One supplier is having
problems obtaining the high performance packages
required to meet the record order levels the J973 is seeing.
Thus, there is the potential of about a $10 million revenue
and order shortfall on the J973 relative to plan. However,
the strength in the Catalyst, J750 low cost testers, software
test, connectors and backplanes and even solid board test
demand will easily offset any J973 shortfall. In fact, we
believe that an upside opportunity exists if the supplier can
resolve the packaging issue before the end of the quarter.
Recent Acquisitions fuel the torrid pace of growth for
Connection Systems
Teradyne’s Connection Systems division is an outsource
manufacturer focused on providing the high performance
connectors and backplanes critical to building high speed
electronic systems like communications switches, routers,
mass storage systems, servers etc. The company has been
growing this business internally at nearly a 60% CAGR
reaching the high teens percentage level. They achieve the
high margins due to proprietary connector technology and
backplane manufacturing expertise. Connection systems
grew 24% Q/Q last quarter, and is now approaching an $1
billion annualized run rate by our estimates.
Connection Systems growth has begun to strain capacity.
In order to add capacity quickly, Teradyne acquired 2
California companies last week. Herco Technologies (San
Diego) makes very large, multi-layer printed circuit boards
(PCBs) and Synthane Taylor supplies laminates for these
PCBs. Since backplanes are essentially huge, multi-layer
PCBs, the very modern Herco facilities can be quickly
converted to backplanes to complement Teradyne’s main
New Hampshire facilities.
We estimate that Herco was at a $70 million annualized
run rate. Synthane Taylor mainly services Herco. Teradyne
completed the deal as an all stock transaction for $100
million. We estimate that the acquisition will be neutral to
our EPS estimates for 1-2 quarters and then begin to add a
several cents per quarter.
Investment Opinion
Reiterate BUY and price target of $110.
We believe the stock should regain a valuation in-line with
Applied Materials and KLA-Tencor as the leaders in their
respective segments at 25-30x 2001 EPS estimates. Thus,
our price target is $110, based on our 2001 EPS estimate
of $4.00. We have not adjusted our estimate for the
acquisitions discussed above yet. We note that our
valuation analysis is very conservative. We estimate that
20% of our $4.00 EPS will come from contract
manufacturing (Connection Systems) were the closest
comparable is Sanmina. If we value this portion of the EPS
at 50x like Sanmina, that yields a $40 price. The remaining
$3.20 even at only 20x 2001, yields $64. Thus, the sum of
the parts valuation is $104. This is nearly our price target
even with a very low P/E multiple on the semiconductor
equipment portion. Another way to look at it is that
investors are buying the Connection Systems business at a
70% discount at the current price level. |
