Stick with the fundamental and use this weakness to
add more to your position. Fundamental with this
company is excellent.
--SUMMARY:--LAM Research Group--Semiconductor Equipment
*We are initiating coverage with a Buy (1H) rating and $69 price target.
*Participation in high growth markets (oxide etch, CMP) should afford
industry outperformance.
*Share gains via new tool acceptance amplifies growth.
*Large installed base creates follow-on order strength.
*Leveraged model supports strong earnings growth.
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 06/99 EPS $(0.23)A $(0.21)A $(0.13)A $0.09A $(0.48)A
Previous 06/00 EPS $0.19A $0.33A $0.37E $0.43E $1.32E
Current 06/00 EPS $0.19A $0.33A $0.37E $0.43E $1.32E
Previous 06/01 EPS $0.40E $0.43E $0.45E $0.52E $1.79E
Current 06/01 EPS $0.40E $0.43E $0.45E $0.52E $1.79E
Previous 06/02 EPS $N/A $N/A $N/A $N/A $N/A
Current 06/02 EPS $N/A $N/A $N/A $N/A $N/A
Footnotes:
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1H Prior: Price (04/10/00)....:$49.25
P/E Ratio 06/00.....:37.3x Target Price..:$69.00 Prior:No Change
P/E Ratio 06/01.....:27.5x Proj.5yr EPS Grth...:0.0%
Return on Eqty 99...:N/A% Book Value/Shr......:N/A
LT Debt-to-Capital(a)39.9% Dividend............:$N/A
Revenue (00)........:1230.20mil Yield...............:N/A%
Shares Outstanding..:N/Amil Convertible.........:No
Mkt. Capitalization.:N/Amil Hedge Clause(s).....:
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION:------------------------------------------------------------------
INVESTMENT THESIS
--We are initiating coverage of Lam Research with a Buy (1H) rating and a
price target of $69. Lam is a leading worldwide vendor of etch equipment
used in the manufacture of semiconductors and has a growing presence in
the CMP marketplace.
--Lam is one of our favorite names in the space as the combination of
industry outperformance and significant financial leverage should drive
above average earnings growth in 2000 and 2001 (+250% in 2000, +48% in
2001).
--Lam is participating 2 high growth segments of the semiconductor
capital equipment industry, oxide etch and CMP, creating the opportunity
for above-average revenue growth.
--Moreover, within these segments, the Company is gaining share. The
introduction of a new oxide etcher (in addition to increased business in
existing oxide etch tools) has resulted in significant penetration into
key accounts, particularly for copper and STI applications. Also
particularly for copper, the Company's unique approach to CMP has
resulted in meaningful account penetration.
--Lam is benefiting from its large installed base of tools. This
especially helps the Company in Korea and Europe. However, increased
penetration in the heretofore underserved Japanese market is also
significantly contributing to growth.
COMPANY DESCRIPTION:
Lam Research is a leading worldwide supplier of sophisticated equipment
used to manufacture semiconductors. The Company's core competency is in
the selective removal of materials from the wafer surface during the
manufacturing process. Lam currently focuses on two main process tools:
plasma etch equipment and chemical mechanical polishers.
Etch is a fundamental removal step in the fabrication of IC's and is
repeated several times throughout the process. Lam is a leading vendor of
etch equipment and manufactures tools that remove the metal, insulating
and polysilicon materials from the wafer surface. With the acquisition
of OnTrak, completed in August 1997, Lam has added both Chemical
Mechanical Planarization ("CMP") and CMP cleaning product lines. CMP is
the planarization technology of choice for manufacturing sub-0.35 micron
integrated circuits with multiple metal layers.
Lam is located in Fremont, California and operates throughout the United
States, Europe, Japan, and Asia/Pacific.
INVESTMENT HIGHLIGHTS:
Cyclical Industry Now in Growth Phase. The semiconductor capital
equipment industry is a growth cyclical industry, beholden to the under-
and over-investment patterns of semiconductor manufacturers. After a
difficult downturn in 1998, the semiconductor capital equipment industry
is now in the second year of what we expect to be a 3-4 year
growth-cycle. While 1999 was arguably a transition year, 2000 is poised
to be a significant expansion year that we expect will post double-digit
(>50%) year/year revenue growth. At this stage we further anticipate that
equipment revenues will continue to expand in 2001, also at double digit
rates, with potential for revenues to continue upwards into 2002.
While equipment cycles are an inevitability, several factors lead us to
believe that the current cycle has several quarters of growth left.
These include:
1. multiple chip drivers (PC, communications, consumer) causing
under-supply in several device types elevating overall equipment demand
and reducing concentration risk for equipment vendors
2. rational DRAM spending mitigating over-expansion; looming under-supply
to drive additional growth
3. new materials and new wafer sizes creating strong technology driver;
to create pockets of strength as rates of adoption accelerates
Participating in High Growth Segments. While the industry overall is in
expansion mode, certain equipment sub-segments are growing at
greater-than-industry average growth rates. Lam is participating in two
of these segments: oxide etch and CMP. Whereas we expect the overall
semiconductor equipment industry to grow at ~52% in 2000, we expect the
oxide etch market to grow 58% and the CMP market to grow at 57%. Longer
term, the overall industry CAGR 1999-2002, according to Dataquest, is
expected to be 22%. The 1999-2002 CAGR for oxide etch is expected to be
24-25% and 23% for CMP.
The oxide etch market's outperformance is linked to the advent of copper
interconnect technology. Copper's unique manufacturing process (called
dual damascene) emphasizes oxide etch versus metal etch in the overall
manufacturing process. As a result, because the copper interconnect rate
of adoption exceeds industry growth, the oxide etch market stands to
outperform.
Copper is the next generation material that will be used to interconnect
circuits on a semiconductor. With a resistivity almost half that of
aluminum, copper enables: 1) increased chip speed; 2) reduced metal
layers; 3) reduced processing costs; and 4) reduced power consumption.
These traits are in fact accelerating the adoption of copper by logic
chipmakers and are consequently increasing the growth of copper related
equipment.
While copper is also a driver for CMP (particularly metal CMP), CMP's
rate of adoption is driven by a more basic trend. As the device designs
become more complex and material layers increase, the need for
topographical integrity on the wafer increases. This is particularly
true as device geometries shrink and tolerances become tighter. As the
method of choice for surface planarization, CMP's growth is consequently
accelerated.
Gaining Share in Oxide Etch... While Lam's share in oxide etch has
historically been relatively low (~25% Lam,~30% Applied, ~45% Tokyo
Electron), the recent introduction of a new oxide etcher (the Exelan) has
helped Lam gain share in the oxide etch market. The Exelan is a
streamlined oxide etcher (high throughout and low cost of ownership),
that utilizes a plasma confinement ring to mitigate wafer damage. Our
checks indicate that the Exelan has performed well against older
technologies from its nearest competitors.
The Company believes it can gain 3-4% market share over the course of
FY00(Jun). Important wins at US, Taiwanese, and Korean customers have
significantly solidified their position. Furthermore, we expect Lam's
oxide etch business in Japan (an area where it has traditionally not
fared well against domestic provider TEL), to improve by as much as 5x in
2000, as concerted marketing efforts therein show results.
...And in CMP. After much delay, Lam has also recently entered the CMP
market with a new tool called the Teres. Unlike current offerings (that
work much like a floor polisher), Lam's tool works like a belt-sander.
The Company believes this unique technology offers better tool uptime and
superior process results and will allow the Company to achieve 20% of
total CMP bookings by 4Q00(Dec). The Company is well on its way to
meeting this goal. To date, Lam is tool of record for copper processes
at both TSMC and AMD. We believe further penetration in US, Taiwanese
and Japanese accounts is likely.
Benefiting from Large Installed Base. Although manufacturing
inefficiencies caused Lam to lose share (particularly in the US) over the
last downturn, the Company has historically been the number 2 or 3 etch
vendor in the world. In today's equipment market, where the urgent need
for capacity is resulting in chipmakers replicating their existing
installed base (to steepen yield curves), Lam is seeing significant
follow-on business from existing customers. This is particularly true in
Europe and Korea, areas of strength for the Company.
New Penetration into Japan. We expect Japan revenues for Lam to more
than double in 2000, based on the Company's focused efforts on multiple
Japanese accounts. In particular, we anticipate significant growth in
oxide etch penetration (incurring on domestic vendor Tokyo Electron) with
Lam's older oxide etch products. The introduction of the Exelan into
Japan could further improve the Company's prospects. We also believe
the construction of new fabs in Japan will significantly help Lam's
efforts.
Leverage Left in the Model. Lam continues to have significant leverage
in its model. We are currently modeling 68% revenue growth in CY00,
followed by a very conservative 25% growth in CY01. We note there is
upside potential to our conservative CY01 estimates. With gross margin cur
rently at 43%, we believe there is significant room for margin
improvement. We are modeling a 50 basis point sequential margin gain for
each of the next 5 quarters. Operationally, we expect Lam to ramp R&D
spending as rapidly as possible. Even so, we are modeling R&D as a
percentage of revenues to decline from the 14% level to 12% by the end of
FY01(Jun). At the same time, we anticipate SG&A to decline from 13% to
11.5% over that same period as business ramps in excess of overhead
expenditures. This results in an over 250% increase in fully-taxed
earnings CY00/CY99 and a conservative 32% increase in earnings CY01/CY00.
INVESTMENT RISKS
ERP Could Impact 3Q00(Mar) Results. Lam's implementation of an ERP
system at the end of 3Q00(Mar) could impact 3Q00(Mar) results. While our
estimates reflect our belief that there will be negligible impact, we
note the risk that such an implementation could have reduced Lam's
revenues in the quarter below our current expectations.
A Cyclical Business. The semiconductor capital equipment industry is a
growth cyclical industry, beholden to the under- and over-investment
patterns of semiconductor manufacturers. Cyclicality is a function of the
long lead times to build a fab (18 to 24 months) and the commodity nature
of certain devices. Fab projects are often begun without a clear picture
of future profitability due to device price fluctuations. As a result,
periods of high investment are often followed by periods of extremely low
investment as chipmakers are forced to reassess spending patterns against
changes in expected profitability. While the industry is currently in a
period of upturn, cycles are inevitable.
Steep Competition. Lam faces significant competition from Applied
Materials and Tokyo Electron, both large multi-product line companies.
While we believe the Company's tools are competitively positioned, the
prospect of competitive incursions should not be overlooked.
US Market Penetration. While we believe there are near-term
opportunities in the US market for Lam, the Company faces barriers to
entry, as Applied Materials holds a strong position with US customers.
We continue to believe prospects in the US market are positive for Lam,
but simply note the difficult competitive landscape therein.
Rate of Adoption. Particularly as we believe Lam's industry
outperformance is partially attributable to share gains, there is a risk
that customers do not adopt Lam's technology at current rates. We note,
however, that Lam's products are currently being well accepted by the
market.
VALUATION
As is historically the case, equipment stocks have reacted quickly to
improving fundamentals. Since September of 1998, Lam's stock price has
increased over 1400%. While clearly the "easy money" associated with
the early stages of the upturn has been made, we continue to believe
significant stock appreciation is possible.
Our confidence in stock price appreciation is supported by our belief
that 2000 industry growth will be significant and that sequential
bookings growth will continue throughout the year (albeit at naturally
lower levels than current double digit rates). Bookings growth has been
a historical driver of stock price.
At various points in cycles, different valuation metrics apply to
semiconductor capital equipment stocks. While during down-cycles, more
static measures such as price-to-book and price-to-trailing sales are
relevant, in upturns, forward looking measures are more important.
Accordingly, we base our belief in additional appreciation on forward p/e.
The mean CY00 p/e for the public US semiconductor capital equipment
companies is 39x (as of 4/7/00). Lam, however, is recently trading at 34x
CY00 estimates, below the industry p/e and well below the mean for large
cap ($>3B) equipment stocks of 43x.
Based on our analysis of historical forward-calendar year p/e's and
actual one-year growth rates, we believe a multiple equivalent to 1-year
forward growth rates, or a 55x CY00 p/e multiple, is appropriate. While
we have significant confidence in Lam's ability to gain market share, we
afford the Company a multiple discount, reflecting the tougher
competitive environment relative to larger equipment companies. We are
establishing a $69 price target for Lam research based on 50x our
fully-taxed CY00 EPS estimate of $1.37.
As visibility into 2001 growth rates improve, we will apply similar
reasoning. At this point, we note that Lam is trading at 24x 2001
earnings, still below expected growth rates for 2001. |
