Brooks Automation (BRKS) Citigroup Investment Research
BRKS: Time to Cut Bait on Software Business
November 10, 2005
HOLD (2)
Speculative (S)
Mkt Cap: $982 mil.
Timothy Arcuri
1-415-951-1734
timothy.arcuri@citigroup.com
Daniel Berenbaum
+1-212-816-5848
daniel.berenbaum@citigroup.com
SUMMARY
* Breakeven operating EPS better than our ($0.02) model/($0.04) consensus. Guidance mixed w/revs light (software still issue 3 years later), but orders guided +15-20% on pro-forma basis - best of any equipment firm
for CQ4:05.
* Positives: core hardware biz picking up steam as OEM tool orders/shipments set to accelerate significantly, improving GM leverage despite lower sales.
* Negatives: BRKS continues to be mesmerized by high gross margins in software, yet this business has not grown for 3+ years and is arguably shrinking - it is time to cut bait; opex creeping up while revs keep disappointing.
* While we believe the timing is right in BRKS' tool hardware biz and valuation offers downside support, its efforts in software continue to be perplexing. Until company cuts bait on failed software effort, we simply can't recommend stock; this portion of revenue is not growing (Fig. 1) and in our view deserves nothing more than a big discount to market. Maintain Hold, target from $16 to $15.
FUNDAMENTALS
P/E (9/06E) 18.4x
P/E (9/07E) 13.9x
TEV/EBITDA (9/06E) 5.8x
TEV/EBITDA (9/07E) 4.5x
Book Value/Share (9/06E) $10.27
Price/Book Value 1.3x
Revenue (9/06E) $670.4 mil.
Proj. Long-Term EPS Growth NA
ROE (9/06E) 9.8%
Long-Term Debt to Capital(a) 19.5%
(a) Data as of most recent quarter
SHARE DATA .
Price (11/9/05) $13.20
Rating (Cur/Prev) 2S/2S
52-Week Range $18.73-$11.70
Target Price (Cur/Prev) $15.00/$16.00
Shares Outstanding(a) 74.4 mil.
Expected Share Price Return 13.6%
Div(E) (Cur/Prev) $0.00/$0.00
Expected Dividend Yield 0.0%
Expected Total Return 13.6%
OPINION
Given management guidance of $120-$125MM in revenue for FQ1:06, we are sizably
lowering our 1H:06 estimates to reflect BRKS' stagnant software business and
slowing FPD momentum. Accordingly, our EPS estimates are also falling and we
now expect FQ1:06 operating EPS ($0.03) versus our previous model of $0.11.
That being said, we remain bullish on BRKS' hardware business given its
exposure to what our checks suggest is increasing order momentum in front-end
equipment heading into C2006, and as such, we are leaving our 2H:06 revenue
estimates roughly unchanged. For F2006, our rev/EPS estimates are coming down
to $670MM/$0.72, while our F2007 numbers have been adjusted to $734MM/$0.95.
VALUATION
We rate BRKS Hold, Speculative Risk (2S) and reduce our price target from $16
to $15.
As the semiconductor cycle moderates, we believe investors should focus on a
metric that accurately captures cross-cycle earnings power. We generally focus
on "normalized," cross-cycle earnings on the notion that the downturn will be
more muted than any such downturn in recent memory. However, our model
suggests that full cost synergies from the recent HELX acquisition will not be
recognized on a quarterly basis until FQ4:06. We therefore look at the rolling
four-quarter period beginning with FQ4:06, and arrive at a fully-taxed earnings
power estimate of $0.65.
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 20x earnings.
As BRKS is 1) much smaller capitalization, and 2) focused in only the
automation segment of the larger capital equipment market, we choose a 10%
discount to the market multiple, arriving at 16.6x. During these 10-years,
during periods with earnings, BRKS has traded at 10-40x EPS.
Applying this 16.6x multiple to our $0.65 fully-taxed earnings estimate, we
arrive at a value of ~$11.00. We then add back the net present value per share
of the future cash flows resulting from BRKS' continued use of its large
deferred tax asset, which is currently not on the balance sheet. Accounting for
the uncertainty surrounding the exact timing of usage of the asset, we add back
$1.50 per share, bringing our price target from earnings to $12.30.
As a cross check, we also investigated the notion of fair value starting from
book value. Looking at price to book, we note that although the stock has
troughed below 1.0x reported book, the longer-term average has been roughly
2.0x (unadjusted for off-balance sheet NOLs). We estimate BRKS' C2005 year-end
tangible book value will be $5.38 per share and if we were to add in 50% of the
deferred tax asset that is currently off balance sheet, we arrive at an
adjusted book value of $8.31 per share. Applying the historical, average
multiple of 2.0x to this implies a $16.50 valuation through the cycle. As
semiconductor cycles appear to be more muted than in the past, we choose the
average multiple as representing the most likely valuation moving forward.
We note that, examining price to sales, BRKS has traded at a 10-year historical
price to trailing sales multiple of approximately 2.0x. Accounting for full
effects of the HELX acquisition, we model a cross-cycle revenue power of $734MM
($9.15 per share) for BRKS. Applying a 2.0x historical multiple to this, we
estimate a fair-value of ~$18.30. As semiconductor cycles appear to be more
muted than in the past, we choose the average multiple as representing the most
likely valuation moving forward.
As the semiconductor cycle moderates, we believe the most appropriate metric is
one based more on earnings than on book value. However, we believe that it is
also appropriate to take into account a valuation based on price to sales,
particularly as the cyclical recovery plays out in C2H:05. We therefore have
chosen to weight our target price 50% on earnings and 50% on price to sales. We
thus lower our price target from $16 to $15 and maintain our Hold, Speculative
(2S) rating.
Our previous price target of $16 was based on a 50/50 blend of our earnings and
sale methodologies, and used a cross-cycle EPS estimate of $0.70 and a cross-
cycle sales estimate of $9.50 per share.
RISKS
We rate Brooks Automation Speculative risk due primarily to low earnings
stability, high stock price volatility, and the company's acquisition strategy
in the last several years. The following are among the key risk factors:
BRKS 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 the semiconductor industry currently appears to be in the
early stages of a cyclical recovery, any unexpected drop in semiconductor
demand or delays/cancellations in new fab projects or expansions could
significantly lower demand for BRKS' products
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.
BRKS now faces integration risks due to the recent HELX acquisition. We model
the acquisition to be accretive to EPS -- any missteps could cause our model to
be too generous. Conversely, accelerated realization of merger synergies or
unexpected cross-marketing opportunities could cause our estimates to be too
low.
Brooks faces company-specific risks, namely:
o Brooks is well leveraged to the 300mm market and a higher industry mix
shift to 200mm vs. 300mm could negatively affect the company's order
patterns or margins.
o Any slowdown of the trend for equipment OEMs to outsource tool
hardware could negatively affect BRKS' potential earnings growth.
o Brooks 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, the stock could fall below our target price.
In terms of potential upside to the stock, we believe a significant increase in
tool hardware outsourcing from equipment OEMs could provide revenue upside for
BRKS as the company is well leveraged to the tool automation market. Also,
increased market share and an acceleration of software revenue could also
provide upside to earnings. These factors could cause the shares to rise above
our target price.
INVESTMENT THESIS
We rate BRKS 2S (Hold, Speculative risk). As the semiconductor cycle forms a
rolling top, 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 thus average peak and trough rolling four quarter EPS to
arrive at a cross-cycle earnings power of $0.52. While we believe BRKS is well
positioned at its customers, particularly in tool automation, we do not believe
that this earnings power will drive upside to the stock from here. In fact,
our analysis suggests that risk/reward is not attractive at these levels.
Although the transition to 300mm (which requires more automation per tool and
per fab) puts the wind at BRKS back, we remain concerned as software revenue
has remained essentially flat for the past nine quarters, and we continue to
see factory automation as an anchor to margins as the company attempts to
expand its footprint.
COMPANY DESCRIPTION
Brooks Automation is a leading supplier of automation solutions to the global
semiconductor industry and other related industries including flat panel
display manufacturing and data storage. The company was founded in 1978 and
became publicly traded in 1995. Partly through acquisitions such as PRI-
Automation in May 2002, BRKS has transformed itself from a niche player in the
tool automation market to the largest automation player in the semiconductor
industry. BRKS serves all three main segments of the semiconductor automation
market, being the share leader in tool hardware, #2 in software and #3 in
factory hardware. BRKS includes nearly every major chipmaker and equipment OEM
in its customer list, with no single customer accounting for greater than 10%
of revenue in FY2004. The company continues to be well leveraged to the
industry transition to 300mm, and after a series of substantial cost
reductions, the company is finally starting to see some meaningful operating
leverage.
ANALYST CERTIFICATION APPENDIX A-1
I, Timothy Arcuri, research analyst and the author of this report, hereby
certify that all of the views expressed in this research report accurately
reflect my personal views |
