Maybe the corporate world's never-ending capacity to surprise is what has kept me so interested in the equity markets for over 20 years. In the latest example, Intel (Nasdaq:INTC), a company famous for playing suppliers off each other and encouraging/supporting small up-and-comers, is taking a significant stake in lithography equipment maker ASML (Nasdaq:ASML) and agreeing to help fund the company's R&D efforts. While this is an unusual deal in many respects, it seems to acknowledge (if not cement) ASML's market leadership, as well as the challenges of continuing to push the leading edge of chip development.
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Although ASML had kept this pretty quiet, apparently they have been working on a program for a few months now whereby companies can acquire minority stakes in the company in exchange for commitments to support ASML's R&D (in addition to the cost of the shares). ASML intends to make up to 25% of itself available, but will seek to keep these transactions non-dilutive.
Chip giant Intel is the first to step up. Intel will initially be buying 10% of ASML for roughly $2.1 billion and subject to investor approval, another 5% (or 15% in total). Overall, that's a roughly $3.1 billion investment in ASML. On the R&D side, Intel is committing to provide non-refundable R&D support through 2017, totaling up nearly $1 billion, with the funds earmarked to accelerate development of extreme ultraviolet (EUV) and 450mm wafer technology.
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By the sounds of it, ASML does not intend to stop here. Other parties are evaluating ASML's proposal, and I would expect that Taiwan Semiconductor (NYSE:TSM) and Samsung are at the head of the line. I would be surprised if TSMC declined to participate, but I think Samsung's involvement is more of a 50/50 proposition. Should Samsung decline, I would think that companies like Hynix, GlobalFoundries and Toshiba would be the most likely alternatives.
Why Do This?
So why would Intel, a company that generally likes to encourage competition amongst its suppliers, make such a huge commitment to ASML? I think a lot of it has to do with the difficulties of keeping Moore's Law moving forward. It's getting harder and harder to develop machinery that can cram more and more circuits onto a chip, and those limitations are starting to challenge the chip companies' ability to continue pushing forward with "better, faster, cheaper" (as seen, perhaps, in the manufacturing difficulties Qualcomm (Nasdaq:QCOM) has experienced with TSMC).
ASML is arguably the furthest along with EUV technology, but it is still not a technology ready for primetime. By supporting ASML's R&D efforts, Intel (and others) should be able to accelerate the time to market as well as having perhaps a much greater input into the design/performance process.
For ASML, it seems like a sweet deal. Why not get your largest customers (or potential customers) to fund your R&D if you can? What's more, my research led me to believe that Nikon (ASML's most legitimate threat in lithography) was the only other company to have a leading-edge product placement in the market, and that was with Intel. So, this deal may be a sign that Intel was not thrilled with what Nikon was doing, and it may make it more difficult for companies like Nikon, Canon (NYSE:CAJ), Mapper or Molecular Imprints to seriously threaten ASML in the next generation of products.
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The Bottom Line
ASML has been one of my favorite names in semiconductor equipment, and the stock is not only at a 52-week high, but has substantially outperformed over the last year. The shares aren't all that cheap when compared to a company like Applied Materials (Nasdaq:AMAT), but AMAT's recent warning highlights that these two businesses aren't exactly moving in the same direction right now.
I am definitely still a fan of ASML with this new investment/R&D program, and I could also see it benefiting ASML supplier Cymer (Nasdaq:CYMI). With the stock at a high right now and looking a little pricey relative to industry peers, I'd probably wait for things to cool off, but I can see how this new program may significantly alter the company's future margins, profits and risk profile for years to come (all of which is good for valuation).
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.