AXCELIS TECHNOLOGIES INC ACLS
November 29, 2011 - 2:35pm EST by
Mason
2011 2012
Price: 1.15 EPS $0.00 $0.00
Shares Out. (in M): 108 P/E 0.0x 0.0x
Market Cap (in $M): 124 P/FCF 0.0x 0.0x
Net Debt (in $M): -94 EBIT 0 0
TEV ($): 30 TEV/EBIT 0.0x 0.0x

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Description

ACLS is a manufacturer of ion implanters, which are used in the manufacturing of semiconductors.  Market share in this niche was historically relatively evenly divided primarily between ACLS, Applied Materials (AMAT), and Varian Semiconductor (VSEA).  Almost 10 years ago, the industry went through a technology transition in which VSEA emerged as the technology leader.  As a result, AXLS lost a significant amount of market share and AMAT actually decided to exit the business until they recently decided to buy VSEA in order to reenter.  Varian has 80%+ share of the market while ACLS has about 12% share.  I believe risk/reward is asymetric given valuation (pro forma for a sale lease back which will be completed by early 2012, the stock is trading close to net cash and at a signficant discount to net working capital less debt) and you have optionality for a very outsized return if ACLS can gain share back.  There are several reasons to believe that ACLS will be successful in doing so.  Here are the highlights:

1) The company will be doing a sale lease-back on its real-estate, which will result in at least $50m of cash - significantly more than the real-estate value the company is holding on it's balance sheet.  When combined with the net cash currently on the balance sheet, the company will have over 87c per share of net cash.  Furthermore, current assets less all liabilities will be close to $2 per share so there is a signifcant margin of safety. The company generated positive 6.6m of free cash flow in q3 and is expected to slightly burn some cash in q4.
2) The company has been gaining back market share.  ACLS kept R&D relatively high (it was 15% of sales last Q and was up 15% y/y in absolute dollars even though sales were down y/y).  As a result, it has caught up technicolically.  ACLS likely gained a couple points of share in 2010 and is arguably at a point where downside to market share is very limited because some customers just want to keep another player around.  Finally, AMAT has mismanaged several prior acquisitions and it is possible that VSEA loses focus now that it is part of a much bigger organization. While VSEA has been known as the semi equipment company that offers the best customer service, AMAT is known for poor service.  VSEA management was considered to be very good and I wouldn't be surprised if they sold when they did because they were worried about their market share topping out.  I also woundn't be surprised if the top management of Varian eventually leave AMAT for better opportunities at more dynamic/less bureaucratic companies.  
3) If ACLS can continue to gain back market share, the upside can be tremendous since the business has very high operating leverage.  Operating expenses should be relatively flat in absolute dollar even if sales double. Note that VSEA was acquired by AMAT for close to $5 billion compared to ACLS' current market cap of $125m, which as I stated earlier was mostly cash.  
4) ACLS may be an attractive M&A target for several semi equipment companies that like AMAT are trying to expand their footprint within their customers fabs.  The increased footprint can bring about more service revenue opportunities. An acquitision would also potentially accelerate share gains for ACLS since one of the reasons customers shy away from ACLS is because of its small size.  
5) The increased cash from the sale lease back will likely help with getting new customers since ACLS will have close to $100m of cash and customers will be less worried about taking a chance with the company.
6) Gross margins have been steadily improving over the past several quarters.  Unlike most companies in the industry whose gross margins fluctuate with sales, ACLS' product gross margins increased 4 points y/y last Q even though sales declined due to the cyclical downturn for the industry.
7) The industry will be going through another major technology transition within the next 3-5 years.  This will give ACLS the opportunity to leapfrog AMAT in the same way that VSEA leapfrogged both AMAT and ACLS in the last transition.  Unlike AMAT, ACLS is entirely focused on this industry niche and is determined to not make the same mistake twice.  cxl
8) High barriers to entry.  Note that AMAT used to be in the industry and chose to pay close to $5b to re-enter.  ACLS has invested in 46 field offices across 12 countries to service customers.  ACLS also has close to 500 patents and over 500 patents pending. 
9) The company is a forgotten name.  There were only a few people who bothered to ask a question on the last earnings call.

I am not sure how to think about a target valuation for this stock.  It is clear that downside is very limited given the balance sheet and if market share and gross margins continue to keep moving in the right direction, there are some very large upside possibilities.  Note that the stock was over $15 in 2002 which was another very bad time for the industry and was above $3.5 even in January this year.  For now, I am going to use $2.50 as a target, which is just slightly over book value but I plan to reevaluate this as time goes on and after I get a better understanding for where market share can go to.   

Issues:
The semi equipment industry is highly cyclical and it appears to be curently in a downturn.  If the downturn is deeper than expected (the industry is  ultimately correlated with the economy) then the company will likely burn some of its cash buffer.  The company is expecting to burn a small amount of cash in q4.  Finally, since the company is primarily competing with applied materials, it needs to show long term viability to it's prospective customers and is thereby unlikely to give back it's excess cash to shareholders as long as it remains an independent company.

Catalyst

The company will close on it's sale leaseback by early next year after which I expect it to screen much better and attract new investors.  There have also been signs that the semi equipment industry may be starting an up cycle.  Asml, which has the highest visibility in the industry due to its long lead times, recently alluded to better visibility. Finally, ACLS will likely continue to post market share gains and margin improvement.  An announcement of a high profile order by a large semiconductor company such as Intel that historically has not been a meaningful customer would increase the market's confidence in the company. 
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    Description

    ACLS is a manufacturer of ion implanters, which are used in the manufacturing of semiconductors.  Market share in this niche was historically relatively evenly divided primarily between ACLS, Applied Materials (AMAT), and Varian Semiconductor (VSEA).  Almost 10 years ago, the industry went through a technology transition in which VSEA emerged as the technology leader.  As a result, AXLS lost a significant amount of market share and AMAT actually decided to exit the business until they recently decided to buy VSEA in order to reenter.  Varian has 80%+ share of the market while ACLS has about 12% share.  I believe risk/reward is asymetric given valuation (pro forma for a sale lease back which will be completed by early 2012, the stock is trading close to net cash and at a signficant discount to net working capital less debt) and you have optionality for a very outsized return if ACLS can gain share back.  There are several reasons to believe that ACLS will be successful in doing so.  Here are the highlights:

    1) The company will be doing a sale lease-back on its real-estate, which will result in at least $50m of cash - significantly more than the real-estate value the company is holding on it's balance sheet.  When combined with the net cash currently on the balance sheet, the company will have over 87c per share of net cash.  Furthermore, current assets less all liabilities will be close to $2 per share so there is a signifcant margin of safety. The company generated positive 6.6m of free cash flow in q3 and is expected to slightly burn some cash in q4.
    2) The company has been gaining back market share.  ACLS kept R&D relatively high (it was 15% of sales last Q and was up 15% y/y in absolute dollars even though sales were down y/y).  As a result, it has caught up technicolically.  ACLS likely gained a couple points of share in 2010 and is arguably at a point where downside to market share is very limited because some customers just want to keep another player around.  Finally, AMAT has mismanaged several prior acquisitions and it is possible that VSEA loses focus now that it is part of a much bigger organization. While VSEA has been known as the semi equipment company that offers the best customer service, AMAT is known for poor service.  VSEA management was considered to be very good and I wouldn't be surprised if they sold when they did because they were worried about their market share topping out.  I also woundn't be surprised if the top management of Varian eventually leave AMAT for better opportunities at more dynamic/less bureaucratic companies.  
    3) If ACLS can continue to gain back market share, the upside can be tremendous since the business has very high operating leverage.  Operating expenses should be relatively flat in absolute dollar even if sales double. Note that VSEA was acquired by AMAT for close to $5 billion compared to ACLS' current market cap of $125m, which as I stated earlier was mostly cash.  
    4) ACLS may be an attractive M&A target for several semi equipment companies that like AMAT are trying to expand their footprint within their customers fabs.  The increased footprint can bring about more service revenue opportunities. An acquitision would also potentially accelerate share gains for ACLS since one of the reasons customers shy away from ACLS is because of its small size.  
    5) The increased cash from the sale lease back will likely help with getting new customers since ACLS will have close to $100m of cash and customers will be less worried about taking a chance with the company.
    6) Gross margins have been steadily improving over the past several quarters.  Unlike most companies in the industry whose gross margins fluctuate with sales, ACLS' product gross margins increased 4 points y/y last Q even though sales declined due to the cyclical downturn for the industry.
    7) The industry will be going through another major technology transition within the next 3-5 years.  This will give ACLS the opportunity to leapfrog AMAT in the same way that VSEA leapfrogged both AMAT and ACLS in the last transition.  Unlike AMAT, ACLS is entirely focused on this industry niche and is determined to not make the same mistake twice.  cxl
    8) High barriers to entry.  Note that AMAT used to be in the industry and chose to pay close to $5b to re-enter.  ACLS has invested in 46 field offices across 12 countries to service customers.  ACLS also has close to 500 patents and over 500 patents pending. 
    9) The company is a forgotten name.  There were only a few people who bothered to ask a question on the last earnings call.

    I am not sure how to think about a target valuation for this stock.  It is clear that downside is very limited given the balance sheet and if market share and gross margins continue to keep moving in the right direction, there are some very large upside possibilities.  Note that the stock was over $15 in 2002 which was another very bad time for the industry and was above $3.5 even in January this year.  For now, I am going to use $2.50 as a target, which is just slightly over book value but I plan to reevaluate this as time goes on and after I get a better understanding for where market share can go to.   

    Issues:
    The semi equipment industry is highly cyclical and it appears to be curently in a downturn.  If the downturn is deeper than expected (the industry is  ultimately correlated with the economy) then the company will likely burn some of its cash buffer.  The company is expecting to burn a small amount of cash in q4.  Finally, since the company is primarily competing with applied materials, it needs to show long term viability to it's prospective customers and is thereby unlikely to give back it's excess cash to shareholders as long as it remains an independent company.

    Catalyst

    The company will close on it's sale leaseback by early next year after which I expect it to screen much better and attract new investors.  There have also been signs that the semi equipment industry may be starting an up cycle.  Asml, which has the highest visibility in the industry due to its long lead times, recently alluded to better visibility. Finally, ACLS will likely continue to post market share gains and margin improvement.  An announcement of a high profile order by a large semiconductor company such as Intel that historically has not been a meaningful customer would increase the market's confidence in the company. 

    Messages


    Subjecta couple of points I forgot to mention
    Entry11/29/2011 05:34 PM
    MemberMason
    Sumitomo and TPG bid $6.00 per share for the company in 2008.  ACLS' board rejected the offer.  Also the company has well over $200m of NOLs.  Finally, since the company has increased gross marigns significantly, the cash burn in this downcycle should be much better than the last downcycle.  You can decide how bad you think the economy and semiconductor capex will be but I think even if the industry has a very large decline of 50% (most on the street are expecting a decline between about 10-20% next year) and the company burns a decent chunk of its cash, I don't see how liquidation value is lower than than the current stock price.  I also apologize for the typos in the writeup.  Next time I will make sure to actually use the preview function.   
     
         

    SubjectRE: a couple of points I forgot to mention
    Entry11/29/2011 06:34 PM
    Memberspecialk992
    Thanks for the idea, I actually looked at ACLS this spring but couldn't get there on higher prices.
     
    First, do you have any specific examples of them winning back share from Varian and/or any advantages over Varian for their newest products? When I did the work before I couldn't find any industry sources that were telling me they were really improving their competitive position.
     
    Any opinion on management or when the board might make a change? I was floored when I learned that Mary Puma had been CEO since January 2002 and President before that. Her tenure has been an utter disaster for the business and for shareholders. How does she still have a job? This seems like a potential activist situation.
     
    Assuming a down 20% year for semi capex, any idea how much of the cash they would burn?
     
    It does seem like the company is trading well below liquidation value, but not sure how practical a liquidation would actually be. After all, there is not a lot of demand for the inventory or PP&E of a defunct semi capital equipment supplier.

    SubjectRE: a couple of points I forgot to mention
    Entry11/29/2011 08:03 PM
    Member4maps
    Thanks specialk, I had forgotten about these guys. I did an analysis back in 07 and they were still getting their clocks cleaned by the other guys. I'll have to go back and look at this again and see if I see the same technical advances and market share stuff you do. I worked in the field for years as an engineer in my prior life, it would be nice for that to be useful on an investment some day :)

    SubjectRE: RE: a couple of points I forgot to mention
    Entry11/29/2011 08:22 PM
    MemberMason
    thanks for the questions.  
     
    First, I have done several channel checks and believe ACLS is getting much more exposure to clients than they have in a long time.  The evidence is also there in reported numbers.  ACLS claims several technology advantages but my channel checks indicate that the company's increased traction is mainly because ACLS has just more or less caught up and customers prefer another source especially after AMAT acquired VSEA.  Customers also generally do not like the customer service of AMAT.  JNK securities, who has an analyst that came from industry, has also written about some recent wins ACLS has had. 
     
    Regarding cash burn, I think incremental fall through of lost revenue would be close to 50% assuming slight gross margin detioration and relatively fixed operating expenses.  The service and spare parts business should be more resilient and not decline as much as the equipment business (it also doesn't increase as much in up years).  I therefore think the cash burn in a -20% capex year would be around $15m or less than 14c per share. 
        
    I agree with you on the CEO although the company does appear to be finally on the right track.  The board not accepting the buyout offer at $6 per share in March, 2008 seems moronic in hindsight.  I am impressed with the CFO who joined the company just this year.  He has been better with guidance.  The company has executed on improving gross margins and the sale lease back was a good move.  I think if they get confident regarding an upturn, they would also be willing to buy back some stock.      
     
    regarding liquidation value - PPE is a relatively minor part of book value especially after the sale lease back.  most of the liquidation value actually comes from cash, recievables and inventory and most of the inventory is for product that has already been ordered.  The patents and NOLs would also be valuable to any acquiror in the industry.        


    SubjectRE: RE: RE: a couple of points I forgot to mention
    Entry11/29/2011 08:25 PM
    MemberMason
    sorry when i say evidence is there in reported numbers i mean that ACLS will have revenue grow 18% this year when most in the industry have declining revenue.  Credit Suisse is expecting industry capex to be down 10% this year.  

    SubjectRE: Revenue growth and market share
    Entry11/29/2011 08:58 PM
    Member4maps
    Hi Mason- 
     
    Maybe you can help me see the gains you're seeing. I updated my previous look at this just now and pulled VSEA data until the very end. I'm pasting in a table here of market split by revenue for VSEA and ACLS from 2000 when they were evenly split until Q3 2011 when VSEA vanished into AMAT. ACLS loses market share right up until the very end, with the most recent data the worst for ACLS.
     
     

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2010

    Q1 2011

    Q2 2011

    Q3 2011

    Total Sales (mm)

     $  1,368.1

     $    981.9

     $    645.2

     $    684.5

     $        1,023.7

     $    973.1

     $       1,192.4

     $      1,459.7

     $          1,084.3

     $    495.1

     $     1,107.0

     $         375.8

     $         423.4

     $         400.9

    VSEA percent

    50%

    63%

    52%

    53%

    52%

    62%

    61%

    72%

    77%

    73%

    75%

    75%

    78%

    82%

    ACLS percent

    50%

    37%

    48%

    47%

    48%

    38%

    39%

    28%

    23%

    27%

    25%

    25%

    22%

    18%

     
    Yes, ACLS did rebound in 2010 as the implanter market shot up over 100%, but VSEA picked up more growth than ACLS and took away a few more percent of market share. Full spreadsheet is here for you: http://goo.gl/9k6Lx  , please do let me know if I pulled some wrong data or something. It looks to me like the profitability and COGS for ACLS is still bouncing around within historic ranges and their market share is the worst it's been and in a continuing downward trend. I don't think you can compare ACLS growth to general semiconductor tooling market and say ACLS is taking share in their market, the competition is between ACLS and VSEA.
     
    Counter-view?

    SubjectRE: RE: Revenue growth and market share
    Entry11/29/2011 08:59 PM
    Member4maps
    Okay, my table gets cut off unless you extend the browser several screen-widths, but the excel should work :)

    SubjectRE: RE: Revenue growth and market share
    Entry11/29/2011 10:04 PM
    MemberMason
    first, VSEA's fiscal year ended in september and ACLS' fiscal year is december and given the fact that the industry can have high quarter to quarter volatility, this comparison is not accurate.  for example, your numbers actually show a decent amount of market share gain in 2009 for ACLS which I don't think is reflective of their competive position at that time.  2nd, your quarterly analysis is off by 1 Q for VSEA.  What you put for Q3 for VSEA is actually calendar q2.  Using your own numbers appropriately shifted by a Q, I actually show ACLS gaining about 4 points of share vs VSEA in calendar q2.  AMAT acquired VSEA during calendar q3.  Third, ACLS always had higher relative exposure to the memory sector which underperformed other areas of semis like foundry this year in capex.  My checks indicate that several customers who previously would not give ACLS the time of day are now talking to them.  The quarter to quarter or even annual numbers will be lumpy however depending on which customers do the ordering in any given time period.  Finally, these total sales numbers incorporate services revenue which has a lag effect on market share gains. 
     
    regarding gross margins, the only other times ACLS gross margins were above 40% like they were last Q was when the revenue run-rate was well above $400m.  Revenue was 72.5m last Q or less than $290m annualized and ACLS was still able to get a 40%+ gm which indicates structural improvement to me. 

    SubjectRE: RE: RE: Revenue growth and market share
    Entry11/30/2011 11:18 AM
    Member4maps
    Hi Mason-
     
    Thanks for the feedback, I really would like to find this is a good place to invest.
     
    I did the calendar-wise adjustment you suggested and it does improve the ACLS market share 4 percent from the initial analysis. That market share is still lower than the previous year and the year before. Essentially it looks a few points better because we now are not analyzing the latest ACLS quarter which dropped substantially, yet it still shows YoY and longer term decreases.
     
    I did notice the gross margin change, and as you say, things are very volatile qtr-to-qtr. Notably the net receivables are also down a ton for the qtr. If you've walked through the accounting to figure out what's going on that is a lot more useful to hear than just that you think this metric that is up while others are down is significant. It looks like revenue and accounts payable is also down and overall cash conversion cycle is up (very rough metric there, I'm not fixated on it).
     
    With the above this basically come down to whether they are getting more market traction, I don't suppose your sources are something you can cite like industry articles or interviews? I'm sure you understand that I wouldn't invest based on unsourced rumors :)
     
    Good discussion, thanks
     
    4maps
     

    SubjectRE: RE: RE: RE: Revenue growth and market share
    Entry11/30/2011 09:36 PM
    MemberMason
    Note that like all semi equipment companies, working capital is a source of cash during the down cycle and a use of cash during an up cycle. Regarding sources, one person I can refer you too is the jnk securities analyst who comes from industry. He is talking about a couple of recent wins acls has with Samsung and global foundries for example.

    SubjectRE: Sumitomo and TPG bid
    Entry11/30/2011 09:39 PM
    MemberMason
    Thanks. I forgot about that. I still think the company has strategic value however.

    SubjectUpdate?
    Entry08/15/2012 03:03 PM
    MemberWains21
    Mason-
     
    Seems like an attractively priced option.  Any update on ACLS ability to increase market share?  Thanks.

    SubjectRE: Update?
    Entry08/16/2012 09:18 AM
    MemberMason
    Hi wains21, market share gains have been slower to materialize than I originally expected.  This is partially because the customers that acls is more exposed to (memory and non Japanese companies) have underperformed with respect to spending this year.  I expect this to reverse next year given the number of nand based tablets expected to be sold in q4 and 2013.  A big market share change won't happen until the 450mm transition in a few years.  The 300mm transition several years ago resulted in varian's share going from 30% to 80%.  Given that varian is now a division in a large company and acls' future depends on the transition and given that customers fear becoming overly reliant on amat, I think acls has a good chance to boost its market share.  While that catalyst is a few years off, I still think acls is a cheap option with several ways to win in the medium term.  First, the stock should at least get above liquidation value once it has little more cash on the balance sheet and is cash flow positive.  The company is guiding for being cash flow positive this q.  The company is also still exploring the sale lease back which would add at least 40m to the balance sheet.  2nd, the stock will do well whenever the industry upturn starts.  Amat guided down last night but said that this q will be the bottom and that is consistent with what other companies like Asml are saying.  The main weakness this year has come from memory and if the recent performance of SNDK and MU is any indication, it would imply a stronger year next year from this segment.  Third, the company talked on their last conf call about how they are open to being consolidated.  The semi equpiment industry is consolidating.  VSEA and nvls were acquired in the last year.  Consolidation will continue and development costs for the 450m transition will be the motivation to sell.  Synergies are very high since they all sell to the same customers and combination can yield more services revenue. 

    SubjectRE: RE: Update?
    Entry08/20/2012 01:23 PM
    MemberWains21
    Thanks for the comprehensive response Mason. 
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