Bargain-Hunting in Chip-Making Stocks, Disaster Strikes BT Group; Value on the Internet?
By Eric J. Savitz
The news from the semiconductor equipment sector remains as bleak as ever. There's little hope that demand for chipmaking gear will turn around before the middle of next year, and perhaps not until 2000. Shipments remain weak, orders weaker, and stock prices weaker still. So imagine our surprise to hear that Mark Fitzgerald, who tracks the industry at Merrill Lynch, of all places, sees in this mess a real investment opportunity.
Now, make no mistake: Fitzgerald wholeheartedly accepts Merrill's party line on the chip industry. Like his colleague Tom Kurlak, the bearish Merrill semiconductor analyst, Fitzgerald expects tough times to continue. Fitzgerald expects spending on semiconductor manufacturing gear to be down 25%-30% this year, and flat in 1999. He thinks shares of the industry leaders, including Applied Materials, remain vulnerable. Applied, he says, could yet report some money-losing quarters. At the same time, Fitzgerald says the time has come to hunt for bargains among the sector's lesser lights.
Small-cap equipment stocks, Fitzgerald says, have suffered considerably more than the industry's leaders. Fitzgerald has compiled a long list of companies that trade at a discount to book value. At least a dozen small-equipment stocks, he says, have cash positions equal to 50% or more of their market capitalization. Valuations, he declares, have reached extreme levels. His forecast: a wave of consolidation, as larger companies use their relatively higher-valued stock as currency to buy smaller rivals. Most interestingly, Fitzgerald has some specific matchmaking ideas.
For instance, he expects to see consolidation in semiconductor production automation, systems for moving silicon wafers around a factory floor. It's an area, Fitzgerald says, that isn't addressed by market leaders like Applied Materials and KLA Tencor. There's room, he adds, for at least one big player. And he thinks one could be created via acquisition. In particular, Fitzgerald contends there's real logic in PRI Automation acquiring rival Brooks Automation.
Applied Materials, says Fitzgerald, could be shopping for a company that has specialized systems for wafer "track" tools. He notes that it's a large marketabout $1.25 billion -- and Applied has phased out an internal development effort in the area. The segment is dominated by Tokyo Electron. Applied, he says, could make a move on Dainippon Screen, the No. 2 player in the market. It would be a bold move; it's not often a U.S. company buys a Japanese manufacturer. But Applied, he notes, has always had a strong presence in Japan, and Dainippon's stock has been sliding. Fitzgerald also thinks it's possible Applied could buy a lithography business -- ASM Lithography, or Silicon Valley Group.
Novellus, Fitzgerald says, lacks technology in chemical mechanical planarization, a method for polishing silicon wafers. The most likely target, he believes, would be Integrated Process Equipment. But Novellus may have a rival suitor -- Fitzgerald says Integrated Process apparently has been holding talks with a German equipment company called Steag. "I have high confidence they've sat down and had conversations," he says.
Fitzgerald sees the potential for a bold stroke by KLA Tencor, which dominates the market for the process control segment of the business. "The gutsy move would be for them to go into the process tool business, and buy Lam Research or Novellus. They could really be a counterbalance to Applied. In this business, size really matters."
He sees a range of other possible targets, including ADE, in process controls; ATMI, which sells materials used to replace certain toxic gases used in chip production; and CFM Technologies, which makes wafer-cleaning products. He says Credence Systems, which makes wafer-testing gear, could be targeted by Teraydne, or by Advantest of Japan. Also vulnerable, he says, are Applied Science & Technology, which sells power supplies to the equipment business; Helix Technology, a specialist in cryogenic and vacuum technology, and IBIS Technology, which makes oxygen implanters. "We're looking at 2000 before the industry can get back to 18%-20% growth," Fitzgerald says. "Some of these smaller companies were able to come public in an era when the industry was showing 40%, 50%, even 60% growth. It's going to be a difficult environment for niche companies." Unless, of course, they get acquired.
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