Sunedison Semiconductor is a special situation investment that offers an incredibly compelling risk reward.
SEMI is a recent spin off from SUNE. SEMI is a small company that is relatively unknown but that has attracted the interest of some of the best investors in the industry. Baupost owns 20% of the Company. Greenlight also has a position in the company.
SEMI makes high grade polished wafers. Wafers are used as the basic starting material for nearly all semiconductor devices, which in turn provide the foundation for the entire electronics industry. Given how ubiquitous semiconductors are, you would expect there to be a lot of different companies supplying wafers, but the industry is actually relatively concentrated. The industry is concentrated because a lot of capacity was added in 2007, it became oversupplied which led to steep wafer price declines and many of the smaller companies in the industry were forced to exit after sustaining losses for several years.
Wafer prices have declined at an annual rate of ~ 5% - 10% since 2006. Increased demand for electronics (smart phones, autos, tablets, etc.) has driven ~9% CAGR in wafer demand. The industry is now close to equilibrium, prices have stabilized and a shortage of wafers is expected sometime next year.
Historic 300mm Wafer Pricing / Sq. Inch
Historic Global 300mm Wafer Supply / Demand
Industry supply is expected to remain constrained. Shin-etsu and SUMCO, two Japanese companies, that combined have ~60% market share have both stated on numerous occasions that they do not intend to expand capacity, unless pricing improves by at least 30%. Siltronic (~15% market share), SunEdison Semiconductor (~15% market share) and LG Siltron (~10% market share) have all stated that they are not adding capacity.
The capital intensity and IP requirements create a meaningful barrier to entry. The replacement cost for SEMI’s business is $2.5 billion. SEMI’s current EV is $800 million and comments from management suggest they would welcome a buy out offer. A company that was interested in entering this market would be better off buying SEMI than spending the $2.5 billion and the two years required to build facilities and to get qualified by semiconductor manufacturers.
Semiconductor wafer market size as a % of the overall Semiconductor market size
Wafers are an absolutely vital part of the electronics value chain and represent a very low portion of the total amount spent on semiconductors (~2.5%).
SEMI’s management is not sitting idly by and waiting for price increases to raise their EBITDA margin. The company has taken a number of steps to reduce its costs and will continue to do so. The actions that SEMI has taken since its separation from SUNE has allowed EBITDA margins to expand from 6% in 2013 to 11% today despite declines in wafer pricing. The company believes that it can get margins up to 20% over the next two years with pricing remaining constant. This margin expansion is being driven by two things: 1) consolidation of SEMI’s wafer production facilities into low cost production areas. 2) Reduced prices paid for SEMI’s primary input polysilicon (polysilicon represented ~20% of SEMI’s COGS in 2013). Historically SEMI purchased its polysilicon from SUNE at prices as high as ~$60 kg. As part of SEMI’s separation SUNE agreed to sell polysilcon to SEMI at ~$35 and to reduce that price further over time. SEMI expects to pay ~$20 per kg of polysilicon by2017. The reduction in the cost of SEMI’ polysilicon purchase cost from $60 to $20 will add a cumulative 10% to SEMI’s EBITDA margins.
The industry is relatively consolidated but there is the potential for more. SEMI’s management has expressed an interest in merging with Siltronic, the wafer manufacturing division of Wacker. Wacker, a
German chemical company sold a portion of Siltronic via an IPO earlier this summer. Wacker views Siltronic as a non-core asset and may be open to a sale of the asset to SEMI. A combined Siltronic / SEMI
company would have 30% market share, further consolidate the industry and put pricing power in the hands of SEMI’s management. Baupost also has a large stake in Siltronic.
SEMI’s management’s compensation is tied to SEMI’s EBITDA growth and a meaningful portion of their bonus is only attained when SEMI hits certain EBITDA goals. Due to a lack of wafer price increases last
year, SEMI’s management missed out on the portion of their bonus tied to their 2014 EBITDA target. That EBITDA target is higher this year. A large portion of SEMI management’s RSUs will only vest once SEMI generates over $200 million in EBITDA. (SEMI generated $75 million in EBITDA in 2014 and is expected to generate $90 million in EBITDA this year).
SUNE sold a portion of their SEMI ownership via an IPO in May 2014. SUNE retained a ~60% ownership in SEMI post the IPO. SUNE has been monetizing its ownership stake in SEMI via secondary offerings. The June 24, 2015 secondary offering is the clean-up trade for SUNE’s equity ownership of SEMI and removes the overhang.
Wafer prices are expected to rise ~10% per year for the next two years. Lower polysilicon costs and cost reductions areexpected to increase SEMI’s EBITDA margins from 10% to 20% by 2017, which would
translate to an increase in EBITDA from $90 million this year to $175 million. Assuming a 10% increase in wafer prices over the next two years, SEMI should generate ~$250 million in EBITDA, $2.40 in eps and $2.50 in FCF per share by 2017. SEMI’s closest comps (Wacker and SUMCO) trade at 9x – 11x FY15 EBITDA. If we assume a 30% discount to the multiple that those companies trade at and use a 7x EV/EBITDA multiple for 2017E EBITDA of $250 million, SEMI is worth ~$45 a share, which implies a 18x P/E multiple and a 6% FCF yield.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
Increase in wafer prices
SEMI acquires another wafer manufacturer or is acquired