Semiconductor investors tend to be nervous types. The Philadelphia Semiconductor Index, which peaked at about 550 early this year, has since fallen to around 450 -- for a decline of 18%. In comparison, the Nasdaq has fallen by 10% from its peak this year.
Investors in this niche are concerned about a potential slowdown in consumer spending, as well as about an inventory buildup at some semiconductor makers and elsewhere throughout the supply chain. While the decline has been painful, it also makes the stocks far more attractive from a valuation standpoint, so this actually appears to be a good time to look at semiconductor-related companies. One company that I have watched for some time is Ultratech (NASDAQ:UTEK). If the carnage continues among semiconductor stocks, this is one company that may just be worth buying.
Ultratech's business
After semiconductor devices are manufactured, the delicate chip, referred to as a die, must be enclosed inside a tough case so that it can be easily integrated into an electronic device, such as a cell phone or DVD player. Enclosing the die inside a case is referred to as packaging.
Most of Ultratech's business is focused on what's known as advanced packaging, involving a stepper, a piece of equipment used in the packaging process. Ultratech makes and sells the steppers, many of which are used in the production of the driver chips for flat panel displays. This is a business that Ultratech dominates, with roughly 90% market share.
The wild card
While Ultratech is well established in advanced packaging, it is trying to drum up more business with a new technology called laser spike annealing, or LSA. Ultratech hopes that it can convince chip manufacturers that LSA can help them solve one of the big problems facing chip makers today: leakage. Transistors behave like an old water faucet -- they "leak" after being turned off. And the result is that chips consume far more power than they should. That leads to excessive heating and drains batteries in mobile devices. Some of the same changes that allow chips to run faster also cause them to leak even more, and transistor leakage is therefore a significant enough problem that it's helping to slow down technological advancements. As a result, the semiconductor industry is investigating a variety of new technologies to reduce the leakage problem.
Ultratech's LSA tool uses a laser to very quickly heat a specific portion of a device to any desired temperature up to around 1,300 degrees Celsius. The fast heating causes a desired physical change that reduces one contributor to the leakage problem. Just as importantly, since the heating is performed very quickly, surrounding areas of the chip don't get too hot.
Competitors Applied Materials (NASDAQ:AMAT) and Dainippon Screen make competing systems that use a laser diode and a flash lamp, respectively, to heat chips. These light sources cannot heat the devices as quickly as Ultratech's LSA, thereby making the whole process slower and less precise, which leads to problems.
The ongoing chip transition from 90 nanometers to 65 will take more time than the transition from 130 to 90 several years ago, in part because of the transistor-leakage problem. But Ultratech is focused on helping semiconductor manufacturers transition to the 65-nanometer node, and it believes that reducing the leakage problem will raise yields. (Many large semiconductor companies, like Intel (NASDAQ:INTC) and Texas Instruments (NASDAQ:TXN), are currently trying to ramp up their manufacturing of 65-nanometer devices.) Once the technology proves itself at 65 nanometers, Ultratech is hoping that semiconductor manufacturers will want to use it at the well-established 90-nanometer geometry as well.
So, how could LSA affect Ultratech's financials?
Ultratech's trailing-12-month sales are nearly $130 million. Each LSA system sells for $4 million or more. If the technology becomes well accepted, semiconductor manufacturers could use three or four systems per production line -- and a large semiconductor fabrication facility will certainly have more than one production line. In short, the effect would be significant.
Risks
There is certainly some risk to owning shares in Ultratech. More than 13% of the float is sold short, according to Yahoo! Finance, so some investors are betting that Ultratech is headed for a fall.
One risk is inherent to any company that sells semiconductor equipment -- namely, the cyclicality of the semiconductor industry. And the cycle may be about to turn down, if recent reports of excessive chip inventory is any indication. Furthermore, Ultratech is exposed to the LCD market, which is also suffering from inventory problems. Any decisions to put off additional capacity expansion would probably negatively affect Ultratech's advanced packaging business, and since Ultratech realizes most of its revenue from advanced packaging products, the revenue falloff could be significant.
Another risk is that the LSA technology may not become widely accepted. Although Ultratech has sold some LSA systems, chipmakers have not yet demonstrated a strong commitment to the technology, and there's always the chance that orders for LSA systems may continue to just trickle in. Furthermore, a senior vice president who was important to the development of the LSA technology left the company last August -- worrisome timing, given that Ultratech was, and is, still working to prove that its LSA tools work.
The upside
Countering both of these risks, somewhat, is Ultratech's fine balance sheet. Ultratech currently has a net cash position of $120 million, a significant percentage of Ultratech's market cap of $380 million. The cash cushion may support the share price at some point, although that support is likely lower than the current $16 tab per share.
Given Ultratech's small size and the risks outlined above, Ultratech is not a stock in which to put 10% of your net worth. However, a small position does have the potential to give your portfolio a nice upward jolt without hurting it too badly if the LSA tool goes the way of the dodo bird.
Related Links:
- The Race for Zero in Flat Panels
- Chipping Away at Chip Industry Turmoil
- Texas Instruments Gets Tinier
- Cash In the Chips?
Intel is a Motley Fool Inside Value recommendation. For more coverage of stocks trading at less than their fair value, try out Inside Value free for 30 days.
Fool contributor Dan Bloom owns shares of Intel and would love to buy more if he could avoid mentioning it in his columns long enough to fall subject to The Motley Fool's disclosure policy.
