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EUV transition comes into focus

EUV transition comes into focus
by Robert Maire on 11-04-2016 at 12:00 pm

 We attended ASML’s analyst day in New York on Halloween. We were very impressed with the quality, content and clarity of the presentations and thought it was one of the best strategic positioning presentations we have seen in the semi industry. We also had an opportunity to meet with several members of senior management after the official presentation to have more detailed and candid discussions.

We came away with the view that after many years of hard work and obstacles that we are to the point where we have a clearer sense of the timing and remaining issues to be worked through to get into production in a “predictable” timeframe.

The vision of the EUV promise finally coming into focus is also amplified by the potential upside offered by the synergistic combination of the Hermes acquisition which recently passed its final hurdles.

Not an “imaging” company but rather a “patterning” company
Although ASML has spoken about this in the past, the length and content of the analyst meeting was able to articulate ASML’s desire and potential roadmap to dominate the entire patterning process rather than just the litho step and litho cell.

While Yieldstar has been a successful first step in growing into the overall space, the addition of Hermes adds the foundation of a much larger footprint and marketshare of the overall patterning market.

It is also clear that ASML is doing what Lam had attempted to do with the KLA acquisition, and that is put together more processes within the patterning arena to dominate this critical area. Without the KLAM combination ASML is somewhat unopposed in stringing together more processes.

Although it would never pass in todays regulatory environment (especially post KLAM) Lam itself would be a potential acquisition target of ASML to complete its full circle of the patterning process, but there are still other things that ASML can do to seal the deal.

Building a “Wall”…
One can think of ASML trying to build a “walled garden” around this patterning technology in order to try to keep others out, such as KLAC , NANO and NVMI etc;. Given that they “own” the litho process they can indeed limit others access to it and more tightly integrate Hermes much as they did with Yieldstar with great success.

In a way it is very interesting to note that this combination sailed through regulatory approval unopposed as compared to KLAM. This would imply that customers don’t have a problem with giving ASML more dominance in patterning even though they couldn’t stomach KLA and Lam together (obviously Nikon and Canon are too weak and far behind to even matter…as compared to TEL, Hitachi and ASMI etc;)

Not just sidestepping KLA but taking them head on…

ASML is not just content about finding a way around the KLAC “actininc” blockade, in which KLA halted development of an at wavelength EUV mask inspection tool, but rather ASML wants to take on KLAC (and NANO, NVMI and others) directly in the CD market by moving the E beam tool of Hermes out of just being a slow, R&D development tool into the arena of HVM monitoring and control which is the wheelhouse of KLA.

This frontal assault could be significant as ASML has the financial and technical wherewithall to execute on the needed work to get to multi beam and faster E beam tools. In addition since ASML owns the litho process they hold the keys to the information and control knobs which impact the process as compared to KLA which is just an observer. (obviously all this applies to both NANO and NVMI as well…)

The financial model…
Even though it sounded like a shock to many in the room the EUV had negative gross margins of 75% it should come as no surprise given where we are in the process. It should also not be a great surprise to expect 50% plus gross margins, similar to other products, when EUV finally gets up and running given ASML’s dominance in litho.

From a very simplistic perspective EUV tools cost roughly twice that of DUV tools but you need half as many EUV tools because of double patterning issues. This makes EUV somewhat of a “wash” in Litho cost but overall litho intensity keeps increasing which supports the overall revenue increases in the litho space. Essentially, all you need to do is get EUV on a more normal run rate and thus gross margin and EPS growth will fall in line with revenue growth to get to the 8 Euro per share in 2020 as suggested by the company.

You add to that another billion in revenues and one Euro in EPS for Hermes and you get to a total of 11 billion Euros in revenues and 9 Euros in EPSin 2020.

The stock…
Although we are more positively biased over the last 6-9 months the stock is still not cheap. If we assume 9 Euros of EPS in 2020 and use a 15X multiple, we get to a $137 stock price in 2020 (or 2019). Given that we are 3 years away from that with significant execution risk ahead of us, the stock is fairly valued.

For longer term investors, collecting a dividend with the patience to wait a few years is not too bad either as the certainty of EUV has increased and thus reduced the overall risk model.

On a relative basis it seems like a reasonably safe long term investment as compared to others in the industry.

PS; For those who were not able to attend in person , you missed a very politically incorrect halloween costume worn by the head of IR, Craig DeYoung……

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