Has anyone else read this? Looks good for DPMI - comments/questions?
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Semiconductor Market Focus
Investors Are Getting Interested In Chip Equipment Stocks
Thur., Mar. 5, 1998
After two full weeks of travel, we have arrived back at the desk with a pile of research and notes from the semiconductor equipment front. At SEMInvest 98, we saw quite a few new faces from the investment community. A number of people attending the conference represented the growth and value sectors of the mutual fund industry.
With the market touching new highs and many consumer growth stocks priced higher than Jack's beanstalk, semiconductor equipment stocks have been popping up on many radar screens. While many of these investors hold only a peripheral interest in the equipment industry, they have cash to apply to the market. In the search for value, they have decided to allocate assets to the sector in anticipation of the next upturn. Without a doubt, we are a bit nervous about these new participants. Will they have the patience to hang tight during the difficult quarters that lie ahead?
The long-term picture can always be called "rosy" because semiconductor content continues to rise. Profitability is another issue. The No-Limit Poker Game will take a toll on many semiconductor companies this year. Like the equipment industry, those with the strongest financial positions will be able to make investments and move forward along the Semiconductor Industry Association's road map. Short term, we have been expecting another correction in the group. The industry is still saddled with overcapacity in commodity parts (memory) and the financial implosion of Southeast Asia. We have also seen some indications of weakening unit volumes. If the recent trend in unit volumes continues, one can expect much lower earnings for the sector.
In our previous article, we wrote a bit about the discounting process -- the race to get invested before the next upturn. Since that time, we have received data from the Semiconductor Equipment and Materials International's most recent Express Report. The report showed (after factoring out the revisions) a rather dramatic decline in equipment bookings and shipments. On the heels of this news, several companies announced production-line shutdowns and head-count reductions. Most of this decline is related to a collapse in purchases by Southeast Asia device manufacturers. Late last night, we received a phone call from one of our Japanese counterparts who said its projects were grinding to a complete standstill. In upcoming reports, we would not be surprised to hear about slower business conditions in Taiwan and North America.
Despite the coming weakness, we feel it is foolish to blanket the sector with a negative recommendation. Clearly, most of the equipment sector will be affected by this decline, but there are segments of the business with bright futures -- the photomask industry strikes us as one of the more visible examples. We would also suggest investors keep a finger on the pulse of front- and back-end equipment vendors that have experienced and survived industry downturns. Larger players such as Applied Materials [AMAT], KLA-Tencor [KLAC], and Teradyne [TER] should remain on everyone's shopping list.
In our view, the positive tone presented by the photomask manufacturers continues to support the commitment of investment dollars. Today, one can hardly discuss the photomask industry without mentioning the breakthrough announcement that hit the wires last week. A University of Texas research team printed 0.08-micron feature sizes using a stepper made by Integrated Solutions and photomasks manufactured by Dupont Photomasks [DPMI]. Yes, this is a wonderful announcement, great for optical lithography fans, but application in a mass production environment is years away. The major hurdle, in our view, is developing the materials to produce suitable optics.
The photomask industry has been growing more than 20 percent per year, and was one of the strongest segments during the 1996 downturn. The industry is divided between captive and merchant manufacturers. Captive manufacturers can be defined as in-house operations maintained by semiconductor companies, and merchants are independently owned and operated. Members of the merchant market generate 58 percent of all photomask revenues. The merchant segment is dominated by Dupont Photomask, Photronics [PLAB], and Toppan.
Low-end and midrange photomask prices have risen at a 10 percent compound annual growth rate, from $2,750 to $4,500, over the past five years. It is worthwhile to note that photomask prices rise in parallel with device complexity. Each masking step requires a different photomask, so these prices multiply by the number of layers. A single photomask used to manufacture a device with 0.25-micron feature sizes has a price tag approaching $21,000. A photomask used to manufacture devices with 0.18- micron feature sizes sports a price of $47,000. Which company would we buy? If one were to visit Photronics or Dupont Photomask, one would see a number of similarities. At this time, we feel both companies present excellent opportunities.
At SEMInvest 98, a panel of Wall Street semiconductor equipment analysts covered some of the critical issues confronting the front-end segment of the industry. Subjects such as photomasks, lithography, etch, dual damascene, and copper interconnects were highlighted during the discussion. In terms of 300 millimeters, the panel agreed that pilot lines will be equipped this year, but they will be small and not a big driver for equipment company growth.
Even though there is a delay in 300 mm, equipment companies must make investments to position themselves for the coming transition. Milind Bedekar, Prudential's semiconductor equipment analyst, says, "I view the delay of 300 mm as very big negative for the whole industry. Smaller equipment companies, especially those who tried to gain an edge on the competition by quickly developing 300-mm tools, will be forced to maintain their investments throughout this delay. The slowdown of 200-mm sales will cramp their ability to spend and their profitability will be negatively impacted."
No doubt, the large companies in the equipment industry have the advantage with a 300-mm delay. How can a small player compete with the output from Applied's R&D budget? Hmmm -- perhaps some consolidation is in order.
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