Sorry to waste your time on the MTSN report. I meant pp. 24-25 of Legg Mason's April Monthly report, the NVLS report, which corresponds to pp. 26-27 of the pdf file. I am referring in particular to doubts the analyst has about NVLS' competitive position and ability to reach its margin goals as I have emphasised in bold.
Here I will cut & paste:---->snip
We are initiating coverage of Novellus Systems with
a Hold rating on the shares with a fair value stock
price of $29, based on 20x our CY06 EPS estimate of
$1.45. Although we are quite bullish on the outlook
for the industry over the next several quarters and
expect a rally from the stocks in the group, we
believe that Novellus-specific issues will outweigh
the benefits from a rising industry tide. In particular,
we believe the company’s operating leverage
continues to trail many of its peers and we also
believe the competitive threat is increasing, where
Novellus could experience market share losses
across several areas.
We believe that the fundamental issues surrounding
the company will cause the stock to
underperform relative to its peers in a potential
upturn scenario. We continue to have concerns over
the company’s ability to deliver consistent financial
performance on the cost and expense fronts, as well
as its market share position in several key areas. In
particular, we believe Applied Materials’ recent
product introductions will heighten the competitive
pressures on Novellus, and market share shifts
could occur.
At the same time, we believe that these hurdles can
be overcome. The company possesses a solid balance
sheet and its operating model has significant
leverage, in our view. The most significant issue
that we see has been execution to drive the leverage
built into its model.
Risks
Inconsistent Financial Performance Suppressing
Operating Leverage
One of our metrics in evaluating our group is operating
leverage. In this area, we believe that
Novellus has underperformed its peers. In past presentations
and conference calls, the company has
targeted 52%-54% gross margin for quarterly revenues
in the $350 million-$400 million range. We do
not believe the company can reach this level when it
hits these revenue points. At this point, we expect
that margins will continue to experience near-term
pressures. While underutilization of capacity is
clearly a major driver for lower margins, we believe
that internal inefficiencies, the pressures from its
underperforming CMP business, as well as some
aggressive pricing tactics, are also impacting
Novellus. From our standpoint, this is not something
new as the company has struggled over the
past two years internally on the execution front. In
particular, the company has underperformed its
peers (namely, Applied Materials and Lam
Research) in terms of its margins and operating
leverage. Going forward, we do not believe the current
situation will change dramatically.
Increasing Competitive Pressures in Novellus’
Market Share Leadership
Although Novellus remains the market share leader
in both the electrofill and dry strip markets, we
believe that the company is experiencing heightened
competitive pressures in both markets. In the
dry strip marketplace, we believe both Mattson
Technology and Axcelis Technologies are garnering
market share at the expense of Novellus. In particular,
some of our checks indicate that Mattson’s
Aspen ICP product line has been receiving excellent
feedback. In terms of the electrofill market, we
expect Novellus to remain the market share leader
in the near term, but it is facing a formidable push
from Applied Materials’ new SlimCell product.
After several misses in the past, we believe that
Applied has finally delivered a competitive product
to Novellus’ SABRE offering. We anticipate more
competitive supplier bids when the industry
(excluding Intel) transitions to 90/65nm over the
next two to three years. We would not be surprised
to see a more balanced breakdown between these
two companies at that time.
Disappointing Results from CMP Business
Following SpeedFam-IPEC Acquisition
The company’s foray into the CMP (chemical
mechanical planarization) market through its acquisition
of SpeedFam-IPEC in 2002 has proved to this
point to be a major disappointment in our opinion.
The company acquired SpeedFam-IPEC to gain a
foothold in the CMP space in which Applied
Materials dominates. As a background, in 1999, two
of the leading CMP suppliers, SpeedFam and IPEC
merged to create one of the largest CMP suppliers.
Together, these two companies had about 30%-40%
share in total. However, poor execution, a bad mix
of culture and difficulties in integrating the two
varying CMP tool processes allowed Applied
Materials to gain market share at the expense of this
combined entity. As quickly as 2001, SpeedFam-
IPEC was no longer a major player in the CMP
space. We believe Novellus’ management assumed
(and we feel rightly so) that its team could turn
around the problems within SpeedFam-IPEC.
However, problems continued and only in 2004 did
the company finally release a CMP tool, the
XCEDA, which is targeting 65nm manufacturing
and below. Although our early channel checks have
returned with favorable feedback in terms of its
technology, we do not see meaningful revenue contribution
until 2006, or when the industry begins
transitioning to 65nm and 45nm (which is likely in
2006-07 period). Much of the 90nm equipment decisions
have been made, and Intel has decided on its
vendors for its 65nm manufacturing that will likely
commence in 2H05. Furthermore, although it has
contributed virtually nothing in revenues, it has
weighed on earnings, as the costs and expenses
related to it have suppressed margins.
Acquisition Strategy Heightens Risk Profile
While we support the company’s long-term strategy
to broaden its offerings across more process
steps, there are inherent risks related to any acquisition.
In fact, as we just noted, the company has
struggled with its last acquisition, SpeedFam-IPEC.
We should note that Novellus had much greater
success with its GaSonics acquisition in 2001, which
helped propel the company into the number-one
position in the dry strip marketplace. In 2004, the
Company continued to use its capital to add companies
and technology to its portfolio. Going
forward, we feel Novellus will continue to seek
opportunistic acquisitions, although we would not
be surprised at some large deal as well. In the past,
there has been speculation that Novellus would
acquire Lam Research, but given Lam’s turnaround,
we do not see this possibility occurring.
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