Article from Fortune mag:
October 27, 1997
The No-Name High-Tech Star
Alan Farnham
What's the hottest tech company you've likely never heard of? Applied
Materials of Santa Clara, Cal., whose stock has quadrupled over the
last 12 months. A 30-year-old company with 1996 sales of $4.1 billion
and profits of $600 million, Applied seems a slightly more reliable bet
than, say, a search engine with a few months of revenues and
minuscule profits. Among all FORTUNE 500 companies, Applied
ranks No. 1 in earnings-per-share growth over the past decade and
ninth in total return to investors. So why isn't it a household name?
While Applied's lock on its corner of computerdom is nearly as tight as
Microsoft's and Intel's on theirs, Applied makes a profoundly unsexy
product: semiconductor capital equip-ment, the machines that
transform raw wafers of silicon into finished chips. Not surprisingly,
Applied lacks a catchy slogan. In a more equitable world, chips would
carry a little decal saying "Applied Inside."
Applied equipment
dominates nearly every
step in chip manufacturing.
Its market share ranges
from a high of 62% of the
industry's PVD equipment
("physical vapor
deposition," in which
molecules of conductive
material are deposited in
layers on the surface of a
wafer) to 29% of all
plasma etching machines
(in which ionized gases eat away portions of those layers, leaving
behind circuit lines as thin as 0.25 microns. The thinnest human hair is
50 microns wide).
Intel, Fujitsu, Motorola, Micron Technology, and other top chipmakers
keep Applied's phone number on hand, since Applied not only builds
their machines but fixes them when they break. The owner of an
etcher costing somewhere from $1.5 million to $3.5 million kind of
hates to see it sit idle. Worse, one machine going down can
compromise the output of an entire "fab," the chip-fabrication plants
that can cost $1 billion or more to build. CEO James Morgan, a man
not given to effete understatement, puts it this way: "Our customers
trust us with the family jewels."
Despite operating in a famously cyclical industry, Applied has managed
to turn a profit even during troughs and has now piled up $1 billion in
cash. In fact, it's been consistently profitable every year since 1983. (It
took a while to get in the black, however: The company was founded
in 1967 and was nearly bankrupt by the time Morgan arrived as
president in 1976. He refocused the company on making
semiconductor equipment exclusively, but it wasn't until 1981 that
Applied had its first monster hit: an etching machine.) One thing that
helps smooth the cycles is the company's strength overseas: 70% of
sales are generated outside the U.S.; more than 50% come from Asia.
Since not all semiconductor markets around the world move in sync,
Applied's diversification insulates it from the wild swings of the U.S.
market.
Applied's size also gives it an edge. The company is far and away the
biggest player in the business, with sales more than three times greater
than those of its primary U.S. competitors: Lam Research of Fremont,
Cal., Teradyne of Boston, and Novellus of San Jose. No competitor
offers so wide a range of chip-making products. Applied has
consistently been "firstest with the mostest," getting 42 new products to
market in the past ten years, some in as little as nine months. "Next
year 85% of our revenues will come from products we didn't have 18
months ago," says Joseph Bronson, president of Applied's etch
products group. Such product innovation requires robust expenditures
on research and development, to say the least. Last year Applied spent
$481 million on R&D--$20 million more than Novellus' 1996 revenues.
Finding securities analysts
not in love with Applied
isn't easy. One of the few
skeptics--Eliot Glazer of
broker-dealer du Pasquier
& Co. of
Manhattan--considers
Applied's stock fully
valued now and cites
misgivings about the
company's exposure in
Thailand, Indonesia,
Singapore, and other
markets he considers wobbly. Indeed, a Thai customer recently
canceled a $16 million order. Morgan dismisses the cancellation as
insignificant, since Applied managed to resell the equipment elsewhere.
Applied's stock, which as of late September was trading about ten
points below its 52-week high of 108, packs a plump price/earnings
ratio of 46. Asked if his company's stock isn't maybe fully valued,
Morgan betrays mild annoyance: He is building for the ages, it seems,
not the moment. He later sends FORTUNE a fax that reads, "You
asked about the valuation of Applied Materials. The real question is,
What will a very unique corporation that has the real potential to
become one of the great global corporations of the 21st century be
worth?"
The answer is "more"--unless the whole chip industry tanks. At the
moment, chip sales (which lead equipment sales by about three
months) are rising. Sales this year should hit $138 billion, up modestly
from 1996. Sue Billat, who follows Applied for investment banker
Robertson Stephens, notes that some equipment makers, in expectation
of stronger demand (and seeking greater manufacturing efficiencies),
have begun ordering new equipment already. This spring Applied
received the largest single order ever reported in the industry, from a
Taiwanese chipmaker that wanted $182 million worth of equipment.
Since the final quarter of 1996, Applied's book-to-bill ratio (new orders
vs. current billings) has firmed from 0.79 to 1.17.
More auspicious for Applied is a huge pending change in
manufacturing technology. Currently chips are cut from silicon wafers
that are 200 millimeters (eight inches) in diameter. Seeking better
yields, chipmakers are graduating to larger, 300-millimeter (12-inch)
wafers, from which they will be able to harvest 2.25 times as many
chips. This is no minor engineering tweak: Existing 200-millimeter
machines can't be modified to handle the larger wafers, so new
equipment must be bought, to the tune of tens of billions of dollars.
How much of this melody will waft Applied's way? Says Morgan: "Of
$18 billion to $37 billion in initial spending, we'd be happy to get 30% to
35%." (Who wouldn't?) Applied is touting itself as the only provider of
a complete, soup-to-nuts 300-millimeter system. Much of Applied's
R&D budget has been devoted to developing a new line of equipment
that can accommodate the larger wafers, and the company is
converting a 60,000-square-foot building at its Santa Clara
headquarters into a model 300-millimeter fab. When it's finished,
customers will be able not only to kick the tires of individual machines
but also to see how the entire line works in concert. |
