SSB: West Day 2
July 12, 2005 SUMMARY
* Day 2 provided more confirmation that spending base remains generally firm (INTC, AMD, Samsung), but also CQ3:05 tool shipment/acceptance activity looks slower thus creating some revenue risk. CQ3:05 orders continue to look flattish Q/Q, but fewer large orders and more small orders vis-a-vis prior Qs.
* Memory remains strong w/KLAC noting DRAM customers appear to have more resolve than several months ago. Foundries still soft, but increasingly tighter capacity utilization fueling optimism (see our note dated 7/8/05) w/Tokyo Electron (#2 equipment vendor) suggesting recovery before YE:05.
* Outsourcing still big theme w/ checks suggesting AMAT may be linking divestiture of at least part of its Austin mfg facility w/future outsourcing deals.
* Tightening capacity utilization into mid 2006, bigger die sizes, and rising capital intensity should keep upward pressure on stocks as short lead times make orders big lagging indicator. Favor foundry leveraged names like AMAT.
OPINION
AMAT
* At the company's analyst meeting it commented that near-term business
trends remain mixed, with memory/microprocessor still strong, and
foundry still weak. While AMAT still sees foundry orders weak, it is
incrementally more optimistic given rising capacity utilization.
* AMAT expects the next phase of growth to be driven by emerging markets
and portability as compared to networking and computing that have driven
prior growth phases.
* As part of AMAT's continued push into services, the company notably has
signed an alliance with General Electric's (GE) equipment leasing arm to
offer preferred financing for used/refurbished tools. For example, in
2H:05 and 1H:06, we continue to see a host of 200mm opportunities --
particularly in China -- that will likely require used tools.
* AMAT provided more support for our view that rising die size should
provide additional upward pressure on spending.
* Most of the meeting was spent highlighting a number of new products
including: low-k (new Black Diamond II), etch (new AdvantEdge platform
for conductor etch together with Enabler and Producer - all new
platforms re-engineered in past 2yrs), and its new Uvision inspection
tool.
* Specific to etch, new AdvantEdge platform 1) improves yield around edge
of wafer, and 2) allows trimming of resist to complement lithography
upgrades thus extending the existing lithography installed base.
* Specific to inspection, checks suggest AMAT believes its new UVision
brightfield inspection tool may represent the best share gain
opportunity of any new tool in its lineup. While it is still being
evaluated by several customers, our checks suggest it may create a
credible option for customers like TSMC in the brighTfield space -- a
market in which KLAC has historically had dominant market share.
* AMAT continues to highlight its large opportunity in selling tools to
build flat panel displays. While it currently only serves the CVD and
inspection segments, we expect a new PVD tool toward year-end, with an
etch tool likely for C2006. AMAT, as a "films" company, has somewhat
unique market opportunity in flat-panel as the requirements are more
stringent when depositing a uniform layer of material over a wide area
like a flat panel relative to a smaller area like a 300mm diameter
wafer. Because the geometries of the structures being built on the glass
are not as small as what is built on a semiconductor wafer, the
opportunity is not as exciting for an optics company like KLAC.
* AMAT reiterated its financial model that drives 18, 22, and 23%
operating margin at $2B, $2.5B, and $3B respectively.
* Lastly, the company suggested it plans to continue aggressively buying
back stock at current prices. We note recent buy backs have amounted to
roughly one day of average trading volume per Q.
CMOS
* CMOS also hosted an analyst event. The event focused on four key
segments - debug and characterization, non-volatile (flash) memory,
analog/mixed signal, and system-on-chip.
* As we previewed, CMOS introduced a new product called D10 -- the first
in a series of a new family called Diamond -- which effectively
transfers the current ASL (analog/mixed signal) product line to the
Sapphire platform in a small form factor. While the ASP for this product
is ~$300k, we believe margins are higher than for most other Sapphire
products. While the margins are better, we see this as another example
of the rapid decline in ASP per function that is currently occurring in
the test business. CMOS indicated its main competitors in this sector
are Eagle and Yokogawa.
* CMOS also is lowering its breakeven target to ~$110MM. At this revenue
level, it expects 47% GM, $23MM R&D, $26.5MM SG&A, 2% OM, and breakeven
net. This is largely consistent with the cost structure we have built
into our model.
* While in our view, Sapphire has yet to break from its microprocessor
legacy (INTC, AMD the main customers), checks do suggest it has
displaced LTXX at Mediatek for RF applications. We see the single
largest 2H opportunity for Sapphire at Samsung for logic applications.
We view TER and CMOS most likely to split the business.
ASYT
* Much like other companies we spoke to, ASYT has seen no change in tone
from key memory customers like Toshiba, Elpida, and Powerchip.
* ASYT noted that there are a number of 200mm AMHS opportunities including
three different China fabs. These will clearly be hotly contested, but
should generally be higher margin than recent 300mm deals.
* The biggest AMHS opportunity ASYT is tracking over the coming quarters
is TXN RFAB (2nd 300mm fab). BRKS is the incumbent, although checks
suggest it has already been eliminated from the selection at the
technical evaluation level.
* ASYT continues to do a solid job in improving margins with new financial
models suggesting there may be further upside to our gross margin
assumptions.
PLAB
* Recent issue of 8MM shares generating $170MM goes a long way towards
strengthening the balance sheet with a minimum of earnings dilution
(<10% dilutive to EPS) as it allows the re-purchase of remaining $100MM
of 4.75% notes outstanding, with enough leftover for additional
investment in partially owned subsidiaries PKL (Korea) and PSMC
(Taiwan), thus reducing minority interest. Our model now suggests that
free cash flow will be sufficient to repay the $150MM of the 2.25%
convertible note due in 2008.
* Management continues to see mid-teens revenue growth for the next
several years with a target of 50% incremental drop-through to the
operating line, driven by growth in core IC business (8-10%), market
share gains (~4%), and FPD outgrowth (~4%). PLAB expects growth in the
FPD segment, where it currently has less than 10% market share, to
outstrip core IC business growth by 3x. While we believe there is a
large market opportunity there, we believe PLAB's margin goals are still
too aggressive.
* PLAB suggesting the "sweet spot" for 130nm designs has still not
arrived, meaning that there is a lot of capacity on-line which should
become better utilized as 130nm design tapeouts increase, thus serving
as a tailwind to organically improve gross margins. While there should
be incremental 130nm business over the coming quarters, we continue to
be concerned that mask revenue has historically peaked ~6mos after
equipment revenue thus suggesting we may be close to the top of the mask
revenue cycle.
* Flat panel is clearly an opportunity here, but the magnitude, timing,
and effect on the bottom-line are all uncertain. At nearly 3x TTM sales
and 24x our CY2006 EPS estimate (at 20% tax rate given NOLs), valuation
still looks rich to us.
KLAC
* KLAC holds an analyst meeting tomorrow. Expect KLAC to comment on orders
and see FQ4:05 (Jun) orders down slightly Q/Q or on the lower half of
the --10%/+10% guidance range. If KLAC were to miss the mid-point of
order guidance, FQ4:05 would market the 3rd quarter in the past 4 that
this has occurred.
* In response to the excitement at AMAT surrounding its new UVision
brightfield inspection tool, KLAC has introduced a new broadband (DUV,
UV, and visible) brightfield inspection tool called the 2800 Series.
KLAC claims its broadband technology is truly differentiated due to
certain IP including supplier lockups surrounding lenses and lamps and
this technology allows for characterization of a broader range of
defects.
* KLAC seeing no signs of weakness in memory business -- in fact, tone
from DRAM customers in particular, has improved slightly versus 2-3
months ago.
* Though KLAC chooses to maintain ~6 months of backlog, actual
manufacturing cycle times are down to ~6 weeks for all but reticle
inspection tools where cycle times remain several months.
VECO
* Industry checks continue to support our bullish view on VECO's data
storage business as utilization is near 100% at thin film head fabs for
hard disk drives, but capacity addition continues to be relatively
measured. We expect order strength in the data storage segment will
continue through the end of the year.
* Atomic Force Microscope for semiconductor applications continues to
penetrate -- we now see an opportunity for five tools per fab at 65nm
with ASPs around $1.5MM.
* Still lots of opportunity for margin improvement from outsourcing. Our
analysis suggests that material cost on process tools in particular can
be reduced significantly, creating an additional tailwind for gross
margin improvement.
* With a technology refresh cycle in LED likely to happen in early 2006
(driven by new markets for higher brightness LEDs), data storage
strength continuing, and metrology and research/industrial sounding
solid, we remain positive on VECO's growth potential. Maintain Buy, $23
target.
VALUATION AND RISKS
Applied Materials, Inc. (AMAT--$17.20; 1H)
Valuation
We rate AMAT Buy, High Risk (1H) with a price target of $22.
With sharply reduced manufacturing cycle times at equipments OEMs allowing
swift corrective action by chipmakers in response to excess inventories, our
analysis suggests that the semiconductor equipment industry downturn will be
shorter and shallower than any in recent memory. As our analysis suggests that
most front-end equipment companies are thus unlikely to lose money at any point
in the downturn, we believe that investors should focus on a metric that
accurately captures cross-cycle earnings power. We thus focus on "normalized"
earnings on the notion that the downturn will be more muted than any such
downturn in recent memory. If we average peak rolling four quarter EPS of
$1.23 (FQ4:06) and trough (fully taxed) rolling four-quarter EPS of $0.64
(FQ4:05), we arrive at a normalized full year EPS estimate of $0.94.
We then note that the average 10-year historical S&P500 multiple (excluding the
1998-2000 Asian crisis/market bubble time period) is approximately 18.4x
earnings. As semiconductor equipment capital spending is likely to continue
growing in the high single digits % CAGR (or roughly 2x global GDP), we assign
a 10% premium to the market for bellwether AMAT, and arrive at a multiple of
about 20x earnings.
Applying this 20.2x multiple to roughly $1.00 in normalized earnings power, we
arrive at a value of approximately $20. As this is based on cross-cycle
normalized earnings, we consider this to be "fair value" for the stock.
On a book value basis, the ten-year historical average is 4.7x. Applying the
historical multiple to estimated book value per share at the end of CY2005 of
$5.32 yields a price target of roughly $25.
As our analysis of industry fundamentals lead us to believe that the downturn
will be short and shallow, we believe the most appropriate valuation metric is
one that takes into account this more muted cyclical downturn. However, as
many investors are still concerned about the more traditional price to book
method of valuing stocks, we do not wish to completely discount this. We thus
assign a weighting of 75% to our normalized earnings method and 25% to book
value. Therefore we arrive at a price target of roughly $22, and we maintain
our Buy, High Risk (1H) rating on the stock.
Because this methodology and result should be somewhat consistent regardless of
the point in the cycle, we would view this as a barometer of "fair value"
whereby meaningful deviations above or below should serve as stock triggers.
Risks
We rate AMAT High Risk, primarily due to stock price volatility as well as
earnings volatility. The following are key risk factors:
Our valuation methodology is based on the assumption that semiconductor capital
equipment cycle will exhibit a shallower downturn than previous cycles. As fab
utilization and capital equipment orders are closely linked to stock price, any
material differences to our supply/demand model (e.g., demand drops suddenly,
or supply increases more rapidly than we predict) may cause our valuation
methodology to be inaccurate.
Applied has recently undergone changes in their senior management structure,
installing a former Intel senior executive as CEO & President. While our
limited exposure to customer reaction suggests a positive view to this change,
we recognize the disruptions such changes in senior management can cause within
a firm and the potential impact to operations and/or order flow.
Applied is currently undergoing an extensive cost restructuring program in an
effort to align their infrastructure with their perception of future business
levels. Disruptions associated with this cost initiative or a mis-estimation
of potential future business levels could create difficulties in Applied's
ability to meet our forecasts.
As the market share leader in multiple sub-segments of semiconductor equipment,
Applied is uniquely positioned to capitalize on inflections in industry cycles.
However, at their currently elevated share position, we believe incremental
share gains become increasingly difficult. While we believe share shifts are
largely stable at this stage, we recognize the competitive pressure Applied
faces from its smaller peers.
Additionally, although we view AMAT's efforts to expand their service business
positively, we believe that the expansion in core responsibilities risks
alienating some customers who may view AMAT as taking over too much of the
market.
If the impact on the company from any of these factors proves to be greater
than we anticipate, the stock will likely have difficulty achieving our target
price.
Asyst Technologies, Inc. (ASYT-- $4.93; 2S)
Valuation
We rate ASYT Hold, Speculative Risk (2S) with a $5 target. Our view of the
stock is based on a final "flush" of financial control issues at its ASI
(Asyst-Shinko, Inc.) joint venture, a clear runway for market share gains with
its Spartan wafer sorter product, improving margin profile as Spartan increases
within ASYT's product mix, and leverage to the percolating ramp in foundry
orders in 2H:05.
As the semiconductor cycle moderates, we believe investors should focus on a
metric that accurately captures cross-cycle earnings power. We thus focus on
"normalized" earnings on the notion that the downturn should be more muted than
any such downturn in recent memory. If we average peak rolling four quarter
EPS of $0.39 (forecasted to occur in FQ2:07) and trough rolling four-quarter
EPS of ($0.21) (forecasted to occur in FQ2:06), we arrive at a normalized full-
year EPS estimate of $0.09.
We then note that the average 10-year historical S&P500 multiple (excluding the
1998-2000 Asian crisis/market bubble time period) is approximately 18.4x
earnings. As semiconductor equipment capital spending is likely to continue
growing in the high single digits % CAGR (or roughly 2x global GDP), we assign
a 10% premium to the market for bellwether AMAT, and arrive at a multiple of
about 20x earnings. By contrast, given profitability issues and exposure to
arguably the most commoditized segment of the equipment market for ASYT, we
assign a 15% discount to the market and arrive at a multiple of 15.6x.
Applying this 15.6x multiple to our $0.09 normalized earnings estimate, we
derive a target price of about $1.41.
On a price to sales basis, we note that the historical multiple is 1.8x,
excluding the year 2000 period. Given ASYT's higher revenue levels at
materially lower margins (20%-range this cycle vs. 40%-range in C2000 on
$130MM/Q in sales) with the consolidation of the company's ASI (Asyst-Shinko,
Inc.) joint venture, price to sales valuation on this long-term historical
average does not make a compelling justification for upside to the stock, in
our view. To compensate for the risk associated with a non-linear (lumpy)
margin improvement in light of continued pricing pressure, we chose to be more
conservative and instead apply a more normalized cyclical trough multiple of
0.75x (historically, price to sales has troughed in the 0.5-1.0x range).
Applying this trough multiple to our normalized rolling forward four quarter
estimate of $562MM would derive a valuation of $8.75.
On a price/book value basis, the ten-year average multiple is 3.96. However,
with past execution problems and ($0.45) in tangible book value, we believe
that the average trough multiple of 1.5x is more appropriate. Applying this to
the YE2005 estimated book value of $3.02 (adjusted for deferred tax assets not
yet written back to the balance sheet), we arrive at an implied target of
$4.53.
Although we clearly prefer to use cross-cycle EPS, we expect ASYT to begin to
improve upon past operational performance and thus believe it is now
appropriate to swap our weighting of fair value based on price to book, used
previously, for price to sales instead (albeit at a "normalized" trough
multiple of 0.75x). Applying a 50% weighting to our cross-cycle earnings, and
50% to our price to sales methodology, we arrive at a blended fair value of
$5.08, rounding to our price target of $5.
Now with a late 10-K filing behind, and the replacement of accountable
management at ASI, we believe continued execution risk at ASI has been
mitigated. We also note that there are large deltas among the implied fair
value from price sales, $8.75, the result from price to book, $4.53, and result
from price to earnings, $1.41, and ascribe the discrepancy to the recovery post
restructuring and operational/financial snafus involving cost accounting of
certain FPD AMHS sales.
Risks
We rate Asyst Technologies a Speculative risk due primarily to low earnings
stability, high stock price volatility, and the lack of retained earnings. We
see the following as key risk factors:
1. ASYT derives the majority of its revenue from the highly cyclical
semiconductor industry, and has exposure to other volatile markets such as flat
panel display. Although revenues for the semiconductor industry are currently
relatively strong, indications are that fundamentals are weakening, and there
will likely be more bad news before there is good news.
2. Our valuation methodology is based on the assumption that semiconductor
capital equipment cycle will exhibit a shallower downturn than previous cycles.
As fab utilization and capital equipment orders are closely linked to stock
price, any material differences to our supply/demand model (e.g., demand drops
suddenly, or supply increases more rapidly than we predict) may cause our
valuation methodology to be inaccurate.
3. ASYT faces company-specific risks, namely:
a. ASYT is highly leveraged to the 200mm SMIF market and a higher industry
mix shift to 300mm vs. 200mm could negatively affect the company's order
patterns or margins.
b. Any slowdown of new fab construction could adversely impact the AMHS
market and thus ASYT revenue.
c. ASYT competes in a highly aggressive pricing environment especially in
AMHS, which could negatively affect earnings power.
If the impact on the company from any of these factors proves to be greater
than we anticipate, our target price may not prove to be conservative enough.
Additionally, in terms of potential upside to the stock:
4. We believe a significant increase in either 300mm fab construction or large
flat panel display projects could add to both revenue potential and gross
margin leverage, as increased demand could improve pricing power. Further,
unexpected market share gains, particularly in the fragmented Japanese
automation market, could provide upside to earnings.
5. Lastly, ASYT could also run the risk of exceeding our price target in the
event margin improvement progresses steadily without significant, negative
impacts from pricing. We do note that near term, major wafer sorter
competitors Recif (near bankruptcy) and Brooks Automation (in midst of
releasing a new product) are currently de-focused on the market, and could
provide near-term relief of past pricing pressure.
If the impact on the company from any of the above factors proves to be greater
than we anticipate, the stock could materially outperform our target price.
Photronics Inc. (PLAB--25.50; 2H)
Valuation
We rate PLAB Hold, High Risk (2H) with a $22 target price.
As semiconductor industry fundamentals move into what our analysis suggests
will be a relatively short downturn, we believe investors should focus on a
metric that accurately captures cross-cycle earnings power. We thus focus on
"normalized" earnings on the notion that the downturn will be more muted than
any such downturn in recent memory. We estimate that PLAB's normalized four-
quarter rolling average (fully-taxed) EPS across the cycle will be $0.90.
We then note that the average 10-year historical S&P500 multiple (excluding the
1998-2000 Asian crisis/market bubble time period) is approximately 18.4x
earnings. As semiconductor equipment capital spending is likely to continue
growing in the high single digits % CAGR (or roughly 2x global GDP), we assign
a 10% premium to the market for bellwether AMAT, and arrive at a multiple of
about 20x earnings. As PLAB has a much smaller market capitalization, and as
the merchant photomask industry faces significant structural headwinds, offset
by potential expansion into the flat panel arena, we conservatively assign a
market multiple to PLAB's earnings.
Applying this 18.4x multiple to our fully-taxed $0.90 cross-cycle EPS estimate,
and including an add-back for the present value of NOLs, we arrive at a value
of $17.
On a book-value basis, the 10-year average P/B is approximately 2.5x. As our
model suggests that PLAB will remain profitable throughout what is likely to be
a relatively short and shallow downturn, we apply the average multiple to
estimated book value at YE2006 (adjusted to include tax credits not yet written
back to the balance sheet) of $12.50 to arrive at target of $31.
On a sales basis, the 10-year average multiple is 2.3x. Applying this multiple
to our FY2006 revenue estimate of $464MM, we arrive at a target of $21.
As most semiconductor equipment and related companies will likely not lose
money during what our analysis suggests will be a relatively short and shallow
downturn, we believe the most appropriate valuation metric is one that focuses
on normalized, cross-cycle earnings. However, as many investors are still
concerned about the more traditional price-to-book method of valuing stocks, we
do not wish to completely discount this. Further, as steady revenue growth
through the cycle is an important part of the PLAB story, we wish to include
sales in our valuation. We thus assign a weighting of 50% to our earnings
method, 25% to book value, and 25% to sales, arriving at a target price of $22.
Near-term market volatility and short-term trading patterns may cause the
Expected Total Return to become temporarily misaligned relative to the hurdle
for this stock's fundamental rating, as defined under our current system.
Risks
We rate PLAB High Risk due to a highly leveraged balance sheet, stock
volatility, relatively stable revenue potential, and small market
capitalization. The following are key risk factors:
* PLAB's revenue stream is based entirely on the highly cyclical
semiconductor industry. Although the current industry downturn is
expected to be short and shallow, any disappointment in the timing or
magnitude of the recovery could adversely affect PLAB's revenue and
earnings potential, and any unexpected drop in end-user demand could
potentially lower IC demand and thus photomask demand.
* Specific to the photomask segment, there is a risk that higher mask
design and manufacturing costs will drive a shift toward programmable
logic devices (PLDs) as opposed to application specific integrated
circuits (ASICs), which will in turn drive fewer overall IC designs and
therefore lower volumes at merchant mask shops. Further, there is the
possibility that more stringent technology requirements related to
device geometry shrinks will drive chipmakers to use maskless
lithography, which will also lower volumes at merchant mask shops.
* PLAB's balance sheet is relatively highly leveraged, with debt/equity
currently at 77%. PLAB generated $46MM in free cash flow in FY2004, and
although we now estimate that they will essentially be free cash flow
neutral in FY2005, this is due to the repurchase of some outstanding
convertible debt and an arguably aggressive capex plan. Thus, while the
significant amount of debt due from C2006-C2008 does narrow the margin
for error, we believe internal sources of cash flow will be sufficient.
* On the upside, PLAB has recently entered the market for Large Area Masks
for the Flat Panel Display industry. We estimate that it currently
holds <10% share in this market, and revenue from this segment will grow
slowly over the next several years. If revenue from FPD grows more
quickly than anticipated the stock could exceed our price target,
* Finally, the photomask industry is capital intensive and service
focused, and there is always a risk that missteps in customer management
and satisfaction could drive loss of market share and revenue.
If the impact on the company from any of these factors proves to be less than
we anticipate, the stock could move above our target price for an extended
period. Similarly, if the impact on the company from any of these factors
proves to be greater than we anticipate, the stock will likely have difficulty
achieving our target price
Veeco Instruments (VECO--16.72; 1S)
Valuation
We rate VECO Buy, Speculative Risk (1S) with a $23 price target, ~30% upside
from current levels.
As the semiconductor/technology cycle moderates into what we view as a
relatively muted downturn, our analysis suggests that most companies in the
sector are unlikely to lose money for an extended period as they have in
previous cycles. We thus believe that investors should focus on a metric that
accurately captures cross-cycle earnings power. If we take the average (fully
taxed) TTM EPS estimates across the remainder of 2005 and 2006, we arrive at a
normalized full year EPS estimate of $0.59.
We apply an 18.4x multiple to earnings, a 15% premium to the S&P500 16x 2006
multiple, based on the expectation that VECO's earnings will outgrow the ~7%
anticipated earnings growth for the S&P500, to arrive at a target of $10.88.
We note that this is based on fully-taxed EPS estimates. However, VECO will
likely not pay taxes through the period of our estimates due to accumulated Net
Operating Losses (NOL). We thus add $1.15 per share present value of the
$136MM NOL to our $10.88 from above to arrive at a $12 target.
Excluding the abnormal CY2000 timeframe, the ten-year historical price to TTM
sales is in the range of 1.0x to 3.0x, with the average being 2.0x. Although
VECO top-line is likely to outgrow historical average moving forward (1998-2003
CAGR of 0% vs. 2003-2008 estimated CAGR of 12%, excluding potential
acquisition), we conservatively apply this multiple to our cross-cycle rolling
four-quarter sales estimate of $440MM and arrive at a price target of $29.
We further note that price to sales has historically troughed in the 1.0x
range, around where the stock is currently trading, suggesting there may be
downside support at these levels.
Due to acquisitions in the FY2001 timeframe, intangibles became a much larger
percentage of reported book value (30-40% vs. historical 5%), and the book
multiple dropped accordingly. We see that the average book value prior to
Q3:01, (excluding the abnormal FY2000 timeframe) was approximately 4.0.
Applying this multiple to our YE2006 tangible book value of $5.16 (including
value of off-balance sheet NOLs) we arrive at a price target of $21.
Although in general we prefer to focus on cross-cycle earnings, our analysis
suggests that any investment thesis on VECO should be based primarily on top-
line growth potential as primary end markets such as LED and data storage are
at an early stage in their development, and margins are in some cases being
sacrificed to establish the market. However, given recent cost accounting
difficulties and margin structure issues, we do not wish to discount earnings
completely. We thus assign a 65% weighting to price to sales, and 35%
weighting to cross-cycle earnings. Using this methodology we arrive at a price
target of $23.
We note the disparity in the valuation between sales and earnings
methodologies. As relatively low gross margins have been the price of
admission into several key process equipment segments in both the LED and data
storage markets, our analysis suggests that near-term earnings are not fully
indicative of the longer-term growth potential of the company.
Risks
We rate VECO Speculative Risk. Previously, we argued that while earnings and
stock volatility would tend to suggest that a Speculative Risk rating would be
appropriate, these factors were offset by a broad customer base (only one
customer >10% of revenue) spread across multiple end markets (four markets at
roughly 25% of revenue apiece) and a broad product portfolio (a dozen major
product lines in both process and inspection). However, given last quarter's
delay in reporting full FQ4:04 (Dec) results, we believe execution risks
associated with VECO's active strategy of growth by acquisitions (three in 2003
alone) still deserves highlighting, outweighing breadth of its
products/customers, especially as VECO implements new SAP business management
software in C2005 across all divisions.
The following are key risk factors:
1. Accounting issues in the TurboDisc division (acquired in Nov 2003 from
Emcore) caused a delay in reporting FQ4:04 (Dec) results. Although
issues were isolated to this division and we are encouraged by the fact
that VECO discovered these issues during an internal audit, there is
some risk that accounting issues will be discovered in other divisions.
2. Our "cross-cycle" valuation methodology is based on the assumption that
semiconductor cycle (and therefore related industry cycles) will be
shorter and shallower than the historical norm. Should the
semiconductor industry downturn be deeper or lengthier than our model
anticipates, our valuation methodology may prove inaccurate.
3. VECO competes in several highly fragmented markets. Underperformance in
any one sector due to unexpected market share losses could cause the
company to miss guidance, which would likely cause the stock to
decrease.
4. VECO is primarily exposed to the relatively immature data storage and
compound semiconductor industries. VECO's customers in these industries
do not have solid track records of profitability, thus making it
difficult for a supplier such as VECO to be certain of future revenue
streams.
5. Roughly one third of VECO's revenue is derived from data storage, a
market in which four companies hold 82% market share. Should one of
these main customers decide to exit the disk drive business, the impact
to VECO revenues could be severe.
6. A weak net cash position relative to semiconductor equipment peers may
become more of an issue if the cyclical downturn lasts longer than we
currently expect.
7. VECO has historically been very acquisitive, and will likely continue to
be so. Although future acquisitions are likely to be small technology
purchases, there is some risk involved in the integration of any future
activities.
8. Although VECO is well-positioned in the relatively immature LED market,
explosive growth in that market could draw in larger, better funded
competitors. We judge this risk to be low, as many of VECO's products
are targeted at very specific technologies, where large competitors like
AMAT or NVLS do not have offerings.
If the impact on the company from any of these factors proves to be greater
than we anticipate, the stock will likely have difficulty achieving our target
price.
ANALYST CERTIFICATION APPENDIX A-1
I, Timothy Arcuri, the author of |
