February 23, 1996
Lam Research (NASDAQ: LRCX)
Address : 4650 Cushing Way, Fremont, CA 94538
Phone : 510-659-0200
Closing Price, Feb 22, 1996: 47 1/4 (up 4)
Trade: Buying 100 shares
THE COMPANY
To quote a recent New York Times story, "Lam is the dominant player in the boring but lucrative and growing business of making machines that make machines."
Specifically, Lam Research is a global leader in the development, manufacture, and sales of equipment required for two critical stages in the production of semiconductors: deposition and etch. When an integrated circuit is fabricated, a thin film is deposited on the silicon wafer. Portions of the film are then selectively etched away to create the IC. The more transistors that are packed onto the chip, the more times the chip passes through these stages, and the closer the tolerances that are required.
Daniel Hutcheson, president of VLSI Research, estimates that the global market for etchers and depositors will be $2.5 billion this year and will grow to $6 billion by the end of the decade. Etch technology is Lam's particular forte, generating approximately three-fourths of its total revenues. The company controls a global market share approaching 40%.
To retain its leadership position, Lam Research plows nearly one-sixth of its revenues into R&D. The company offers three major etch products: AutoEtch (single-wafer, plasma etch); Rainbow (advanced submicron tolerances and 8-inch wafer capability); and a Transformer Coupled Plasma (TCP) product, which is described as "low-pressure, high-density, planar plasma etch source"--or as my father used to say, "Yeah, I had one, but the wheels fell off." To sum up, Lam is already on its fourth generation etch equipment in the sub-.35 micron tolerance range, while some competitors are still getting started.
On the Motley Fool boards, some folks (including me) wondered about Lam's progress on that other step in IC fabrication mentioned above: deposition. Our questions were promptly answered by one of the amazingly knowledgeable folks who drop into Fooldom. He just happened to be a senior member of the technical staff for Lam's CVD (chemical vapor deposition) business unit, and this is what he had to say:
"There are two product lines in the CVD business. The Epic is a high density plasma CVD system. It is used for depositing high quality silicon dioxide on and between the fine metal lines that make up the interconnection between devices. This system is aimed at logic devices (microproc., etc.) manufactured with sub half micron geometries. It is being or has been qualified on some of the industries top microprocessors (sorry I'm not allowed to be more specific). These devices are using 3 to 5 levels of metal these days, so the system is required at each level. The advantage that this system has is the ability to deposit high quality oxide between metal lines that are very close to each other (~0.3 micron) and have high aspect ratio (>2:1). Current technology at >0.5 micron geometry cannot do this and leaves a void (big reliability problem). So the apparent slow growth is in my opinion due to manufacturers eking out the last remains from current technology. Remember, most manufacturing today is still 0.8 micron and early in the learning curve for 0.5 micron.
"The other product line is the Integrity. This is a hot, or thermal, CVD. The main film is BPSG. This film is traditionally used after devices are formed (but before metal interconnects are put down) because of its ability to flow at elevated temperatures. As geometries shrink, though, the highest allowed temperature is reduced. The ability to flow and thus planarize the surface is diminished. The Integrity system uses a proprietary method to enhance the flow at lower temperature while still producing excellent film quality. In addition, This film is found to fill gaps between very small features, as well. This is important from a device reliability standpoint. You have probably seen increased newsbulletins on orders for this product. In a slightly different configuration, this product can deposit films of Tantalum pentoxide. This film is being considered for use in the capacitors of DRAMs because of the high dielectric constant. Several companies have been working on integrating this into there DRAMs (at 256MB and higher)."
Wow. Thanks, Steve.
Three weeks ago, Lam and IPEC/Planar announced a joint venture to develop "integrated etch/CVD/chemical mechanical polishing (CMP) process solutions that offer reduced cost of ownership and minimal risk in the migration to deep submicron chip production." During the first phase of the project, the team will use Lam's Deep SubMicron (DSM) 9900 intermetal CVD system in combination with IPEC/Planar's Avantix CMP system to optimize productivity during the CVD and CMP process steps. Subsequent work will also utilize Lam's advanced TCP etch tools to create a fully integrated etch/CVD/CMP production process.
Last year, export sales represented 38% of Lam's net sales, and that is projected to increase this year. Lam equipment is being "built in" to new fabs all over the world. In December, Lam inked a strategic alliance with Taiwan's Ministry of Economic Affairs to assist in the island's efforts to vastly expand its chip-making capacity. On Feb. 12, Lam received a $53 million etch-equipment order from Singapore-based Chartered Semiconductor and TECH Semiconductor. In Korea, Lam equipment is designed into the operations of Samsung, Hyundai, and Lucky Goldstar, among others. Lam has a growing presence in Europe, as well.
Lam's expansion into new global markets may keep gross margins flat in the near term (in contrast to the company's history of steadily increasing margins). But we're talking about flat margins in the neighborhood of 49 percent! That kind of flat, I can live with.
On February 17, Lam reported fully diluted per-share earnings of $1.12 for the second quarter of its 1996 FY. That represented a 75% gain over 2Q of last year and beat consensus forecasts by seven cents. Revenues totaled $290.5 million, a 68% gain from a year ago. In the follow-up conference call, CEO Roger Emerick said that the company has over $350MM in new bookings, up 20% over the previous quarter. He went on to note that in any quarter it is routine for some customers to request "push-outs" on their orders, while others request expedited handling. In the past quarter, Lam saw more requests to speed up delivery than to delay.
Return on equity stands at 31%. Long-term debt is less than 20% of total capitalization. The company generates more cash than the Federal Bureau of Engraving ($1.34/share for FY 1995).
THE STOCK
Analysts can scarcely find enough good things to say about Lam Research, the company. Lately, though, some of them have expressed concerns about Lam Research, the stock. The bearish scenario, as articulated by Rick Whittington and others, is that the semiconductor industry has historically been highly cyclical and we are now entering a down-leg that will accelerate rapidly as the year progresses. The concern is that an oversupply of chips will cause companies first to delay, and later to cancel entirely, orders for new production equipment.
The bulls say, in effect, "it's different this time." They point to the necessity of chip manufacturers to invest in new equipment for next-generation chips despite what the market may happen to be for current chips. They also point to the rapidly expanding global demand for semiconductors and the rapidly multiplying uses of chips in everything from supercomputers to vacuum cleaners.
I fall someplace between the bulls and the bears--which can get pretty messy. What I'm quite confident of, though, is that the bear scenario is more than amply discounted in current prices of LRCX and its peers. Even after all the downgrading recently, LRCX still gets a 1.9 rating (between "Strong Buy" and "Buy") in First Call's summation of assessments by the 15 listed analysts who follow the company.
Estimated EPS for the FY ending June 1996 is $4.70-- a 58% increase over last year's $2.98. Current consensus estimate for FY 1997 is $5.56. This means that even after today's 4-pint leap, LRCX is trading at only 10 times expected EPS for the FY we are halfway through. Even the *lowest* projected EPS annualized growth rate over the coming five years is 17%, while the median is for 21% growth. I mean, how much discount does one require for a company that has routinely beaten analysts' estimates quarter after quarter, makes leading edge products, and has grown earnings at an average rate of 77% per year over the past five years?
There are 27.4 million shares of Lam Research. Institutions own perhaps as much as 90% of the shares (depending upon what Fidelity is doing on any given day), and insiders own a pretty good chunk of the balance. CEO Emerick plunked down a cool $506,000 to buy 10,000 shares on the open market late last year. Average daily volume is around 630,000 shares. The beta is actually below 1.00, not that you'd believe it from the recent volatility in the stock.
CONCLUSION
The latest S&P report on Lam Research rates the stock as four stars on a five star scale. On a scale ranging from 1 to 5 (with 5 being the most undervalued), it rates the stock as a 5, with a "plus" to indicate a favorable time to buy (i.e., the stock appears to be in a positive trend). S&P estimates current fair value for LRCX at over $80.
As for myself, even placing an industry average multiple of 15 on the expected FY96 EPS of $4.70 gives us $70 as current fair value. This stock is deeply undervalued. And I'm deeply happy to capitalize upon the situation.
--Gregory Markus (MF Boring)
