The KLAM deal has died now how will KLAC and LRCX recover? (2 of 3)

In our view this was likely Lam’s one and only chance of catching Applied in size and market breadth so it is very disappointing to say the least.

As we have suggested in previous notes we think KLAC has a better path as a stand alone, independent company and LRCX likely now needs a new plan to offset issues ahead.

Lam will have a conference call tomorrow, Oct 6th, at 9AM EDT. The conference call can be joined by dialing 1-800-967-7187, Conference ID 9322807, within the U.S. and 1-719-325-2289, Conference ID 9322807, for all other locations.

Autopsy…
It seems of little consequence what caused the death of the deal. It is likely many contributing factors. We will likely not get an exact run down on the call as AMAT never told us officially what killed their deal.

It is clear however that its highly unlikely that anyone in the semiconductor equipment space will attempt another large deal given these last two attempts ended in failure.

What we will hear…
Much as we heard from AMAT, Lam will likely try to reassure us that things are rosy without KLAC and it makes little difference to Lam’s growth plans and abilities.

We would not be entirely surprised to hear Lam pre-announce a great quarter as a way to put salve on the wound of the failed deal and make up for it in the eyes of investors. As we previously said, we think both Lam and KLA are having great quarters and Lam will likely use that fact to offset any potential negative reaction in the stock.

How long a recovery time?
We think that it was close to a years worth of recovery for the AMAT/TEL deal. We think the recovery here will likely be shorter but still at least two to three quarters to get fully back on track. We would expect a follow on analyst meeting after this period to chart the new course much as Applied did (and they executed well on their new course and model without TEL). The shortly upcoming planned analyst meeting is too soon to have a fully planned out story.

The damage….
There was obviously a lot of shuffling of personnel planned, with some expected departures and some coming out on top. Its likely that many knew what new role they would play in the combined KLAM and now may or may not be happy with that not happening. There will likely be a different set of departures and reshuffling without the deal.

There was also likely planning for projects and products that may have already started. Some may be able to continue as “just friends”, others not.

The direct financial damage is likely several hundred million but obviously more extensive damage in lost opportunity.

This is all water under the bridge and of little consequence in the grand scheme of things.

AMAT has gained while Lam & KLA were engaged…

Applied has done very, very well while Lam & KLA were tied up. Gaining share and pushing forward. This is exactly opposite of Lam’s share gains against Applied likely peaking while Applied was tied up with TEL. Lam is going to have a difficult time slowing Applied current momentum.

Collateral impact…
We are hard pressed to think of who/what Lam or KLA could/would/should buy here to make up for he lack of merger. The pickings are somewhat slim. Nanometrics or Nova are the obvious answer on the metrology side and there is always ASMI on the process side. The problem is that these deals would likely have been done already had they made a lot of sense. Perhaps ACLS would be a good acquisition as they have had good results and nice momentum of late. Would someone be willing to take a chance on Veeco now that Aixtron has been bought by the Chinese.

Many of these companies stocks are trading at a perceived takeover premium as well.

The stocks…
Given the spread, we think that many investors already got the idea that the deal was not going to happen. We had suggested “buy on the barf” when the deal imploded but now we think that there will likely not be much downside , especially for KLAC which should easily trade up from here.

LRCX stock is another story. Its had a good run and at leats part of the valuation is based on the acquisition. The bigger question is will Lam’s Q3 performance offset the downside potential from losing the deal. It may in the short term but we think Lam now has bigger long term challenges ahead of it.

KLAC stock likely has much better longer term prospects as fundamental investors get a refresher on the story. The stock has been trading at an artifical discount to its typical historical valuation.

A good pair trade might be to go long KLAC against a short on LRCX (assuming there is still time to get in).

We would expect both management teams to be out on the road explaining things to investors shortly after the quarter is reported