Niche markets are often spoken of poorly, as they don't typically offer the sort of huge addressable revenue opportunities that tech investors value. In the case of Ultratech (Nasdaq:UTEK), however, I wouldn't be so quick to dismiss the company as just a niche player. With opportunities to expand the utilization of market-leading tools for advanced packaging, laser annealing and LED production, Ultratech could be looking at several years of above-market growth or a takeout offer.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Not Another ASML
While Ultratech is, broadly speaking, in the lithography business, that doesn't make it a head-to-head competitor with ASML (Nasdaq:ASML). Where companies like ASML, Canon (NYSE:CAJ) and Nikon sell immersion steppers (at over $30 million a pop) for critical features, Ultratech's products are used in the process of fabricating non-critical layers of the circuit.

More to the point, Ultratech's advanced packaging products are used to make flip chips - chips that use conductive bumps instead of wire bonding, leading to smaller assemblies, faster speeds and less heat. Only a relatively small percentage of chips use this technology today, but some in the industry believe it could grow at a double-digit clip through the decade, particularly if memory makers adopt it. While Ultratech's leading share may be hard to maintain against Canon, Nikon, SUSS Microtech and Ushio, it's still a pretty solid growth opportunity.

SEE: A Primer On Investing In The Tech Industry

Strong Share at the Edge in Laser Annealing
Ultratech is also a meaningful player in laser annealing, where it is replacing rapid thermal processing in the activation of transistors on microchips. Traditional RTP systems sold by the likes of Dainippon Screen and Applied Materials (Nasdaq:AMAT) sometimes struggle with millisecond annealing, leading to lower yields and performance with higher-end chips such as smartphone and tablet processors. Right now, Ultratech's gear is the equipment of choice for laser annealing at Taiwan Semiconductor (NYSE:TSM), Samsung and Intel (Nasdaq:INTC) (which make up more than half of the semiconductor equipment market) at the 28nm level. As sizes continue to shrink, Ultratech should have more opportunities to sell high-end LSA equipment.

Not Making LEDs, but Making the Making of LEDs Better
Last but not least, Ultratech has opportunities for growth in the LED business. As LEDs become more commoditized, manufacturing yields are becoming more and more important. Ultratech's tools help improve yields and throughput and seem to be used more often as yield-enhancing tools (as opposed to front-end production capacity). The challenge here is displacing old gear. Ultratech's tools cost about $1 million new, and compete with new contact aligners and used reduction steppers. While reduction steppers are considered obsolete for regular semiconductor manufacturing, a grey market has emerged in taking old Nikon steppers, refurbishing them and repurposing them into LED production. Although these old machines have lower throughput (due in part to higher rework rates) and need more maintenance, the upfront costs (about $500,000) are lower.

Continuing to Build the Business
Ultratech is not just standing pat with its current business. The company recently bought a collection of patents ((including some from IBM (NYSE:IBM)) covering C4 bumping, ball grid arrays, 3D packaging and so on. What's more, the company continues to look at incremental markets such as overlay metrology ((presently dominated by KLA-Tencor (Nasdaq:KLAC) and Nanometrics (Nasdaq:NANO)) that aren't huge (maybe $200 million), but could be meaningful to a company of Ultratech's size.

The Bottom Line
I think the fact that Samsung, Intel and Taiwan Semi use Ultratech's gear is testament to the quality of the machinery and its utility in various parts of the semi manufacturing process. Likewise, I'm impressed with the company's solid share in what today look like niche markets, though they do offer meaningful growth. All in all, I wouldn't be surprised to see this company go the way of FSI International (Nasdaq:FSII) and attract a bid from a larger player such as Applied Materials or Tokyo Electron.

On its own, I think Ultratech works as a stock, even with the strong run seen to date. Growth expectations do look pretty hefty for the next few years, but that's tempered by the fact that Ultratech is one of the few equipment companies to continue growing (and growing profitably) during this difficult stretch in semiconductor capital spending. So, low-to-mid teens free cash flow growth is indeed a demanding target, but the shares could be more than 30% undervalued if the company can hit this mark.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    In Search of the Rate-Proof Portfolio

    After October’s better-than-expected employment report, a December Federal Reserve (Fed) liftoff is looking more likely than it was earlier this fall.
  2. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  3. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  4. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  5. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  6. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  7. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  8. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  9. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  10. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  5. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  6. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

You May Also Like

Trading Center