Normally, large market share would sound like a golden ticket for shareholder returns. It's not so simple when it involves the semiconductor equipment industry, and Cymer (Nasdaq:CYMI) has proven to be just as cyclical as customers like ASML (Nasdaq:ASML) and other equipment companies like Applied Materials (Nasdaq:AMAT). With the photolithography industry on the cusp of both a rebound in demand and a major new technology cycle, investors may want to revisit this story.
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The Big Dog in a Critical Step
Photolithography is an essential step in the manufacturer of semiconductors as the light source imprints the circuit pattern on the wafer. What's more, increasingly sophisticated light sources and photolithography machines have helped make Moore's Law a reality and enabled increasingly complex chips.
Cymer specializes in the guts of photolithography - the light sources. Cymer holds a large share of the market and counts all of the lithography companies such as ASML, Canon (NYSE:CAJ), Nikon (OTCBB:NINOY) as customers, as well as major semiconductor companies like Samsung and Intel (Nasdaq:INTC). While Cymer has long maintained a technology lead over its competition, virtually all of its customers dual-source light sources and there are competitive price/performance trade-offs.
What's the ETA For EUV?
One of the hot topics in semiconductor equipment is the development and commercialization of extreme ultraviolet (EUV) light sources and lithography equipment. EUV is a big jump forward in technology and should prove to be a key part of enabling even smaller circuits in the coming years.
Unfortunately, EUV is not easy and its birth has not been painless. Companies have been working on this technology for at least a decade, and while equipment with EUV light sources has shipped, it's not considered a commercial technology yet. Some of the problem is cost - EUV costs about 10 times as much as current state-of-the-art ArFi systems - but there are still kinks to be worked out (including throughput) and timelines have been sliding.
An Opening in the Armor?
Cymer has a huge share of the installed base out there, and by and large isn't all that vulnerable to its competition. After all, it is the supplier of choice for the market-leading lithography company (ASML), and these tend to be long-term installations.
That said, I do believe that technology transitions offer the rare opportunities for competitors to shift some of that share.
Gigaphoton (a wholly-owned subsidiary of Komatsu (OTCBB:KMTUY) since 2011) holds about 20% of the overall light source market, and is working on the same laser produced plasma EUV technology as Cymer. Ushio, formerly a partner with Komatsu in Gigaphoton, is taking a different course with its discharged produced plasma technology. Will either of these companies steal the march on Cymer? History says "no," but past performance has never guaranteed future results.
The Bottom Line
I like Cymer quite a lot as a company, but not so much as a stock. There's already a lot of optimism built into sell-side numbers, as several analysts are calling for over $900 million in revenue in 2014 (more than 50% above the prior peak). Certainly, a large-scale commercial roll-out of EUV could support that, but my point is rather that a lot what can go right at Cymer already seems to be in the numbers.
Assuming a multi-year cycle of strong revenue growth and improving free cash flow conversion, I could see a fair value of around $60 on Cymer shares today. That's not bad potential for existing shareholders, but I'm not sure 20% undervaluation would induce me to buy when there are cheaper growth stories in semiconductor equipment.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.