GS US SEMI EQUIP SEMICON WEST: NEWSFLOW DOESN`T MEET HEIGHTENED EXPECTATIONS
Summary: We attended the 1st day of SEMICON West on Mon. Key takeaways are: (1)
Most managements remained bullish, but we believe the overall tone of the show was less
bullish than expected driven by a combination of disappointing news upstream in the tech
chain, weaker Wall St. sentiment, and a less robust Q3 order growth outlook vs. recently
heightened expectations, (2) Managements focusing solely on the demand outlook and
ignoring the supply side of the equation, which we believe to be equally important, (3)
There was a surprising focus on operating models for the next downturn, (4) New product
introductions focused on 65-nm and below. New product introductions likely have
relatively positive implications for AMAT and NVLS with likely negative implications for
ACLS, and (5) Companies highlighting diversification strategies outside of the semi
business. The big event Tues. will be KLA's analyst meeting during which we expect the
company to provide an update to its Q2 orders and potentially provide Q3 order guidance.
SEMICON WEST NEWSFLOW NOT AS BULLISH AS HEIGHTENED STREET
EXPECTATIONS HAD CALLED FOR. We attended the first day of SEMICON West
(SW) in San Francisco, CA on Monday. Recall that SW is an industry trade show
sponsored by SEMI (an industry trade association). The front-end manufacturing portion
is being held through Wednesday in San Francisco and the back-end portion will be held
from Wednesday through Friday in San Jose. On Monday we met with Applied
Materials, Novellus Systems, Advanced Energy, MKS Instruments, and ASM
Lithography. While semi equipment management teams maintained their bullish tone, we
believe that the newsflow from the first day of the show did not meet heightened Street
expectations.
We provide our key takeaways from our first day of meetings below including: (1) While
most managements remained bullish, we believe the overall tone of the show was less
bullish than expected driven by a combination of disappointing news upstream in the tech
chain, weaker Wall St. sentiment, and a less robust Q3 order growth outlook vs. recently
heightened expectations, (2) Managements appear to be focusing solely on the demand
outlook and ignoring the supply side of the supply-demand equation, which we believe to
be equally important, (3) Companies spent a surprising amount of time talking about their
operating models for the next downturn, (4) New product introductions focused on 65-nm
and below. We believe new product introductions have relatively positive implications
for AMAT and NVLS with likely negative implications for ACLS, and (5) Companies
highlighting diversification strategies outside of the semi business.
FIVE KEY THEMES THAT EMERGED DURING DAY ONE OF SEMICON WEST:
(1) WHILE MOST SEMI EQUIPMENT MANAGEMENTS REMAINED BULLISH,
THE OVERALL TONE OF THE FIRST DAY OF THE SHOW WAS LESS BULLISH
THAN HEIGHTENED EXPECTATIONS HAD CALLED FOR. Semi equipment
managements remained bullish during formal presentations but we believe that the
overall tone of the first day of the trade show was less bullish than heightened Street
expectations had called for. We believe the less bullish tone at the show was driven by
some combination of the weaker than expected newsflow upstream in the technology chain (i.e.
recent negative preannouncements from software, hardware, and a few semiconductor device
companies), weaker Wall Street sentiment (companies seem to be significantly impacted by Wall
St. downgrades of the semi and semi equipment sectors and the ensuing sell- off in their stock
prices), and a less robust Q3 order growth outlook vs. recently heightened expectations. We believe
an issue that exacerbated the subdued tone was the fact that Novellus kicked off Semicon West and
earnings season with a less robust than expected outlook. Recall that Novellus reported earnings on
Monday morning (please see our full note for greater detail), indicating that Q3 orders (excluding
an acquisition) would be flat to up 5% sequentially, below heightened Street expectations that
called for at least 5% to 10% sequential order growth guidance.
(2) SEMI EQUIPMENT COMPANIES ARE FOCUSING SOLELY ON THE DEMAND
OUTLOOK AND IGNORING THE SUPPLY SIDE OF THE EQUATION. Probably our single
most important takeaway from the show on Monday was that many management teams appear to
be solely focused on the demand side of the supply-demand equation. Most semi equipment
companies are tracking closely how many fabs they expect to be built in 2004 and 2005 (with
Applied tracking a total of 48 300mm fabs with 32 expected to be built in 2004, 14 in 2005, and 2
after 2005 and Novellus tracking 34 300mm fabs that it expects will be built in 2004 and 2005).
Managements also continue to focus on demand for notebook PCs, feature rich cell phones, and
other consumer applications. While most companies are therefore closely tracking the demand
outlook, we believe that managements are paying little attention to the supply situation. For
example, Applied (among several other companies with which we met) was unable to provide an
estimate or a sense of how much capacity the industry has added thus far in 2004. As a matter of
fact, Applied management appeared rather put off when we asked them the question about whether
or not they measured the amount of capacity coming online in H2'04 and 2005. As we have
highlighted on numerous occasions, we believe that the industry is adding significantly more
supply than many are expecting as measured by the significant increase in worldwide semi
equipment shipments during the first quarter and the significant dollar amount spent on new fab
construction so far this cycle (please see our latest weekly for greater detail). Another management
with which we met highlighted that if semi units grew 20% in 2004 and then grew 15% in 2005,
they believe that the supply-demand situation would remain in balance. However, as we have
highlighted on previous occasions we believe that the semi industry is already in the fourth quarter
of above trendline unit growth in this upturn and to assume another five quarters of above trendline
unit growth (which would be necessary to achieve the 15% unit growth number this management
team cited for 2005), would result in units being above the trendline for 1.5x the length of time that
units stayed above the trendline in the 2000 cycle when end demand was significantly more robust.
(3) SURPRISING AMOUNT OF DISCUSSION ABOUT OPERATING MODELS DURING THE
NEXT DOWNTURN. We would note that there was a surprising amount of management focus on
how companies are positioned for the next industry downturn. We found the amount of discussion
about the next downturn interesting given how adamant so many managements are that we are in
the heart of the current upturn. Both Novellus and Applied discussed their operating models for the
next downturn with each company highlighting that they believe the next industry downturn will be
less severe than the most recent downturn. We strongly agree with this assertion, as our pure
cyclical thesis posits that upturns will be less robust and downturns will be less severe as the
consolidating chipmaker customer base adds capacity more rationally in an upturn and therefore
the industry does not wind up in as much of an excess capacity situation in a downturn.
(4) NEW PRODUCT INTRODUCTIONS FOCUSED ON 65-NANOMETERS AND BELOW -
WE BELIEVE NEW PRODUCT INTRODUCTIONS ARE RELATIVELY POSITIVE FOR
AMAT AND NVLS AND RELATIVLEY NEGATIVE FOR ACLS. SEMICON West has
typically been a forum to showcase new product introductions and this year was no exception to the
rule! We would note that new product introductions are now targeting 65- nanometer and below
device geometries. Applied Materials is focused on extending its technology platforms down to
65-nanometers and highlighted that there is a need for 65-nm devices across various market
segments including the consumer electronics, automotive, internet, gaming, broadband
communications, and computer segments. Applied highlighted three major new products during its
analyst meeting and booth tour including the Quantum X high current single wafer ion implanter,
the Reflexion LK Ecmp tool, and the Applied Endura 2 system.
The Quantum X is a single wafer (implanting one wafer at a time) high current implant tool
targeted at advanced logic applications for the 65-nm node. Applied's previous high current
implanter was a batch tool (implanting multiple wafers at a time) but given the more stringent
precision implanting requirements as device nodes continue to shrink it will be necessary for high
current implanters to move to a single wafer process. The existing high current market share leader,
Axcelis, had previously highlighted at its analyst meeting several months ago that single wafer
processing will indeed be necessary for an increasing number of applications at 65-nm, which was
an important admission given that Axcelis has historically only sold batch wafer tools. We learned at the
show that Applied has already begun to ship its Quantum X ion implanter to several customers and
we also learned from separate contacts that Axcelis' high current single wafer tool will not likely be
available before Q1'05, which is later than the company had indicated the tool would be available
at its analyst meeting.
In addition to the Quantum X implanter, Applied's other significant product introduction at the
show was the Reflexion Ecmp tool. This next generation Chemical Mechanical Planarization
(CMP) tool allows for three advancements over existing CMP tools. First, the tool offers lower
downforce pressure, which enables polishing of extremely delicate low-k materials. Second, the
slurry mixture used by the tool is less complex and therefore less expensive versus traditional slurry
used in Applied's previous tools (which allows for a 30% cost savings on slurry, the most
expensive consumable in the semi fab at an estimated $16 million per year per 300mm fab). Third,
the Reflexion Ecmp system has a vapor drying technology which allows for fewer defects during
the post-polishing drying process.
Novellus also introduced two new significant products during the show. First, Novellus introduced
its own re-engineered CMP tool called the Xceda. With Applied Materials currently garnering at
least 70% market share in the CMP segment, Novellus believes (and our channel checks support)
that customers are anxious to find a second-source CMP supplier. Novellus believes the key
advantage to its new CMP tool is that slurry is deposited through the pad as opposed to directly
onto the wafer as in traditional CMP tools, thus allowing for an estimated 40% reduction in the
aforementioned slurry. Further, Novellus believes that its new tool offers increased throughput (at
approximately 35 to 40 wafers per hour versus approximately 28 wafers per hour on a competitor
tool). We believe that the CMP market will be one of the most hotly contested segments within
semi equipment going forward, as Applied, the existing market share leader seems to have
introduced a compelling new technology with Novellus perhaps finally offering customers a viable
second source alternative in CMP. Given that copper CMP is one of the fastest growing segments
in the semi equipment space, which tool appears to be gaining traction will be critical to watch
over the next 12 months.
Novellus' second major new product introduction at the show was its revised Gamma dry strip tool.
Recall that Novellus is the market share leader in dry strip. However, its existing dry strip tool
focuses only on the Front- End-Of-Line (FEOL) (i.e. transistor formation) and Novellus has not
historically addressed the faster-growing Back-End-Of-Line (BEOL) (i.e. interconnect) dry strip
segment. Novellus' re-engineered Gamma dry strip tool seems well-positioned to gain share in the
BEOL segment, likely at the expense of Axcelis and Mattson.
(5) COMPANIES CONTINUE TO HIGHLIGHT DIVERSIFICATION STRATEGIES OUTSIDE
OF THE SEMICONDUCTOR BUSINESS. Another common theme that emerged during
meetings at the trade show was that managements remain focused on diversifying into less volatile
businesses outside of the semiconductor market thereby reducing the inherent cyclicality in their
business models. Applied highlighted at its analyst meeting its increasing focus on the services
market, which the company hopes will allow it to capture not only customer capex dollars but
customer opex dollars as well, thus increasing its served available market. Applied highlighted
three agreements it has entered into on the services side, including an agreement with Praxair to
provide commodity consumables management services to fab customers, another agreement with
Brooks Automation under which Applied will provide on-sight service and spare parts for Brooks'
factory automation equipment, and a final agreement with Phoenix Silicon whereby Applied will
provide 300mm test wafer reclaim services. Novellus continued the discussion of diversification
away from the semi equipment business by highlighting its recent acquisition of Peter Wolters AG,
an industrial polishing company. Novellus intends to combine Peter Wolters AG with its previously
acquired industrial applications business from Speedfam-IPEC to provide the company with a
positive cash flow non-semi cycle driven diversification strategy. MKS and AE also both reiterated
their previous strategy of diversifying into the thin-film, medical, government, and environmental
segments.
EXPECT TUESDAY AT SEMICON WEST TO BE HIGHLIGHTED BY KLA'S ANALYST
MEETING DURING WHICH THE COMPANY IS LIKELY TO REPORT CQ2 ORDER
GROWTH OF 5-10% (HIGH END OF GUIDANCE RANGE) AND PERHAPS PROVIDE CQ3
ORDER GUIDANCE FOR 5% SEQUENTIAL GROWTH. KLA will be hosting an analyst
meeting in conjunction with SEMICON West on Tuesday morning. Traditionally, KLA has kicked
off its analyst meeting by "preannouncing" its CQ2 orders and then offering guidance for CQ3
order growth. We believe that if KLA were to continue this tradition it will report CQ2 orders of
+5% to +10% sequential growth, at the high end of its previous guidance range of -15% to +10%
sequential growth, based on order activity driven by Samsung and TSMC during the quarter. We
also believe that it is possible/likely that KLA will provide CQ3 order guidance, which we would
expect to call for +5% sequential growth, consistent with Novellus' order guidance on Monday.
While bulls will highlight that 5% sequential order growth in September is encouraging as it is
traditionally a seasonally slower quarter for KLA's orders, bears will likely highlight that, even at
the high end of its CQ2 range of orders, the June-quarter was relatively disappointing as it is
traditionally the company's seasonally strongest quarter for orders.
I, Jim Covello, hereby certify that all of |
