ASML has an ADR in the US
but for the following I will refer to the primary Dutch listing –
ASML NA (on Bloomberg). (The 17.45 price quoted in the data above is for the ADR).
ASML is the global leader
in lithography for semiconductors with a market share of over 70% in
leading edge equipment. It also is one of the best managed technology
companies in Europe and even globally. In previous downturns it has
been one of the best recovery plays having bounced back more and
faster than its competition and won additional market share.
However I believe that
because of all the above reasons analysts and investors have been
reluctant to aggressively short it this cycle. Indeed one might argue
that the market is really looking through any downturn and valuing
ASML on the basis of a recovery valuation. I feel that there is a significant short opportunity offering 20% or more return.
I have been negative ASML
all year and been predicting negative eps for ASML for 2009. Until
recently the consensus eps has been 55 – 90 Euro cents. However,
whilst I have been waiting for holidays to get around to writing up
my thesis ASML warned on the 19th Dec and the consensus
eps fell to 5 eurocents (source bloomberg). Interestingly the share
price has not really reacted and I think partially that is due to a
lot of European investors having taken off much of this week.
I believe that actually
the company could suffer 3 -4 quarters of loss making or, at best,
break even earnings and as a consequence consensus is still too high.
Furthermore I believe that the hypothesis of a rapid recovery
afterwards is incorrect.
As a consequence I
believe that ASML will fall from its current share price of Euro12.42
to at least Euro 10 and possibly go into single digits over the
course of 2009 thus offering a return to shorts of 20% or more. My
analysis is below.
In order not to lose
members of VIC in technology babble I am going to simplify ASML's
business. In essence it makes big processing units that exposure
semiconductor wafers to light and so allow the etching of very small
structures on chips. At the 'leading edge' ASML has a 70% plus market
share – its two main rivals are Nikon and Canon.
ASML customers buy ASML
equipment for two reasons – 'technology' buys for leading edge
developments (including R&D) and capacity expansion (ie for
A lot of analysts
undertake a lot of work on the competitive environment but I think
that in the current macro environment that is missing the point.
There is a lot of focus by analysts on whether ASML will win Elpida
or how many EUV units it will sell – I think that this is missing
the point – what matters is the core market.
The big picture is that
roughly one third of semiconductors are used for telecommunications
(mainly mobile phones) and consumer electronics; a third for
computers (ie PCs etc) and the rest for industrials and automotives
The key issue for me is
that a significant percentage (rule of thumb is two thirds) of the
end demand is replacement demand – ie people replacing their mobile
phone, PC or car. I believe that mobile phone sales globally will
fall at least 10% in 2009 and PC unit sales will fall at least as
much. On this I am at a variation with many analysts who assume that
PCs will fall less than mobile phones (indeed there are some analysts
who believe unit sales will still be up in 2009). I disagree because
on average phones are cheaper than PCs and secondly corporates in
particular are likely to slow down replacement of PCs in a recession.
Both segments however are also extraordinarily sensitive to
replacement cycles – eg a 6 month lengthening of mobile phone
replacement cycle in Western Europe alone could have a 5-8% impact on
unit sales in 2009 (dependent on which bank's model you use). It is
fairly easily to actually get to units being down 15% or more in 2009
for both phones and PCs.
Note that earlier this year analysts and companies were expecting 10% growth in PC and handset units in 2009 - the delta means that in some cases (not all) manufacturers have overbuilt as a result.
I probably do not even
need to discuss the fall in units for automotives and consumer
electronics into 2009.
The second key point for
me is that for PCs in particular the average selling price in 2009 is
likely to be impacted by the shift to netbooks which are ultra
lightweight laptops at significantly lower price points than
traditional PCs. The consequence of this is that the semiconductor
cost of goods in PCs is likely to fall in 2009.
The third issue is that a
significant part of ASML's sales and backlog (on occasions over 50%)
is due to memory makers (ie DRAM and NAND). The end market for memory
makers is PCs and also other consumer electronic devices (eg digital
cameras, phones etc). Virtually every major memory maker is loss
making – and prospects for next year look poor. A number are
raising capital eg Qimonda recently. I believe that the memory makers
are slowing down ordering of new equipment and indeed are finding
that sources of finance are drying up. For instance in conversations
with ASML it has become clear over the course of this year that a
number of leasing companies that had entered the semiconductor
leasing market have withdrawn after concluding that second hand
equipment price visibility is non-existent and balance sheets and
cashflows of semiconductor companies are weak.
(As an aside one should
note that DRAM bit count per PC has traditionally grown each year
however for Windows based PCs there is no real benefit going beyond
3GB (the current average is around 2GB) until we move to 64 bit
computing – which is really unlikely to hit the mainstream until
2010; in the Apple world 'Snow Leopard' might lead the way in 2009).
semiconductor industry has been moving from being vertically
integrated to a horizontally based industry with design and
manufacturing being separated. Manufacturing is being focussed more
and more in foundries of which the biggest, by far is Taiwan
Semiconductor (TSMC). It is clear talking to TSMC that the company is
not expecting a rapid recovery in 2009; indeed some analysts covering
the company are now suggesting utilisation at TSMC could fall as low
as 41% in Q1 2009. This is important as TSMC is considered the
bellwether of the foundry industry – for reference at peak
utilisation TSMC has hit over 100% utilisation. It is clear that
except for specific technology buys TSMC will not be making major
purchase decisions, certainly not for capacity, for a number of
quarters. TSMC is in a better condition than many foundries and the
remaining vertically integrated semiconductor manufacturers. The key
point is that it is going to be a long time before capacity buyers
return to the market. Discussions with various semiconductor
companies it appears that semiconductor equipment capex next year
could be down 30% on 2008 – I do not believe analysts have
modelled this properly. Within this ASML's segment (lithography) may
be relatively protected but I believe analysts are still too bullish.
protestations to the contrary there appears to be significant amounts
of inventory of all kinds throughout the electronics chain. It is
very hard to get a finger on this but I think the easiest way to
assess this is actually to go to a local supermarket or electronics
retailer and look at the price reductions – as a rule of thumb
electronics fall 17%-19% per year in price – beyond that usually
indicates surplus inventory.
Sixth analysts are
modelling the present semiconductor downturn on the 2001 downturn. At
that time there was a relative quick recovery and ASML was gaining
significant amounts of market share with a new product range. In the
current downturn ASML is now the dominant player and I believe that
it is going to take significantly longer for an economic recovery to
lead to increased semiconductor foundry utilisation.
My conclusion putting all
the above together is that I expect a recovery in volume (ie
capacity) sales by ASML to take until 2010 at the earliest (I think
2011 may be more realistic). In 2009 revenues could be 15-20% down or
more; 2010 may a low single digit growth year. I have discussed this
scenario with management and they agree it is a possible scenario. In
the best case in this scenario the management suggests at least 3
quarters of breakeven. Worst case will be significant losses and
restructuring. At my last meeting in November management talked about
reassessing the situation in Q1. However since then they have warned
on 19th December 2008.
Based on the press
release and my conversations with management I feel that the
situation is even worse than I anticipated. The consequence is that I
believe we could be looking at negative 40 eurocents or so in 2009. I
also believe that a restructuring and losses will lead to an impact
on the cash pile the company has. I also believe that many sector
analysts did brief summaries following the warning but will not fully
adjust their models until January.
For 2010 the outcome
really depends on if there is a recovery in the economy but it is
hard to imagine ASML achieving more than 20-40 eurocents of earnings
in a best case; and actually near zero is quite possible. Thus
investors trying to look through the trough to recovery earnings are
likely to be disappointed.
I have in the past tried
to model number of units for ASML by product line but actually I have
found it much better to be 'roughly right rather than precisely
wrong' by looking at the customers, what they are saying for capex
and also what their end customers are saying in turn.
I believe that
realisation of these issues will come in Q1 as the company does its
results roadshow with its Q4 and 2008 full year results (15 Jan
2009). At that time I think analysts will have to push back a
recovery into 2010 at the best and possibly into 2011. This will lead
to a reassessment of the valuation and drive the stock price to below
The risks for a short
position in ASML are acquisition risk – it is clear that a number
of potential buyers exist – including Applied Materials (AMAT), Lam
Research (LRCX) and Tokyo Electron.
Company roadshow for Q4 result on and after 15 Jan 2009. Also weak results from consumer electronics, PC and handset makers; and reduction in capex forecasts for 2009 from semiconductor companies during Jan 2009.