Varian: A Rare High-Tech Company With Unassailable Market Position

Dec.19.08 | About: Varian Semiconductor (VSEA)

Varian Semiconductor Equipment Associates (NASDAQ:VSEA) is the undisputed leader in a small but important segment of the semiconductor cap equipment industry. Several years ago, the company positioned itself to take advantage of an industry shift to single wafer implanters. It gained market share as a result and moved closer to a quasi-monopolistic position (only remaining credible competitor is struggling Axcelis). The implanter segment has high barriers to entry and should exhibit mid to high single-digit growth in the long term. While the industry is undergoing a cyclical downturn, we believe Varian shares offer compelling value.

BUSINESS OVERVIEW

Varian is a semiconductor capital equipment maker and the leading producer of ion implantation equipment.

SELECTED OPERATING DATA

FYE September 30

2006
2007
2008

% of revenue by geography:

North America
22%
22%
22%
Asia Pacific
67%
71%
70%
Europe
11%
7%
8%

Revenue growth by geography:

North America
20%
45%
-21%
Asia Pacific
20%
53%
-22%
Europe
39%
-10%
-12%
D revenue
22%
44%
-21%
D unit shipments of tools
33%
51%
n/a
D deferred revenue (period end)
6%
10%
-41%

% of revenue by type:

Product
88%
91%
90%
Service
11%
8%
10%
Royalty
1%
1%
0%

% of shipments by market:

Memory
51%
70%
n/a
Logic
19%
14%
n/a
Foundry
30%
16%
n/a

% of shipments by wafer size:

300 mm
75%
91%
n/a
200 mm
25%
9%
n/a

Top 10 customers (% of revenue)

63%
72%
n/a
Click to enlarge

VARIAN’S SHARE OF GLOBAL IMPLANTER MARKET1

Market Size
Varian Market Share
($ in millions)
CY06
CY07
CY06
CY07

Medium current

$414
$454
53%
57%

High current

720
672
46%
78%
High energy
230
147
17%
13%

Ultra high dose

na
64
na
100%
Overall
$1,364
$1,337
43%
65%
Click to enlarge

1Source: Garter Dataquest, VLSI Research, Company.

INVESTMENT HIGHLIGHTS

  • #1 in $1 billion implantation equipment market, with share up from 43% in CY06 to 65% in CY07. Varian has grown share—and is likely to continue to do so—in the largest segments while maintaining 100% of the fast-growing, ultra high-dose market.
  • Gained high-current share due to industry shift from batch ion to single wafer implanters. Varian began developing the technology in 1994, giving it large lead over Applied Materials (NASDAQ:AMAT) and Axcelis (NASDAQ:ACLS). AMAT was effectively forced to exit the high-current segment in 2007, with Varian benefiting.
  • Large barriers to entry due to role of patents and technical expertise. Implanters weigh 20+ tonnes and sell for roughly $4 million each. The industry has seen no credible new entrants in decades.
  • PLAD plasma tool expands addressable market through creation of ultra high-dose segment, with sales potentially surpassing $100 million in FY09.
  • Little risk of commoditization, due to advances in implanter technology and changes in wafer and chip size. Implantation has become a higher-value step in semi production, giving Varian more pricing power.
  • Gary Dickerson (50) joined Varian as CEO in 2004, having served for ten years in roles at KLA-Tencor, including as Group VP, EVP, and COO.
  • $209 million of net cash and short-term securities.
  • Repurchased $179 million of stock in FY08, $427 million in FY07 and $109 million in FY06.

INVESTMENT RISKS & CONCERNS

  • Sharp drop-off in business, driven by drop in capital spending, particularly by manufacturers of DRAM devices. Revenue fell 37% and 52% y-y in the June and September quarter, respectively. The company expects to post a small loss in 1Q09.
  • Cyclical business, dependent on semi makers’ capacity investments, which exhibit large volatility (particularly in the case of memory manufacturers).
  • Axcelis may become strong competitor if bought. Sumitomo Heavy Industries made a hostile bid for Axcelis in February, but shelved its proposal after Axcelis rejected a sweetened $616 million offer. ACLS now has a market value of $54 million, practically crying out for an activist to come in and force a sale.

COMPARABLE PUBLIC COMPANY ANALYSIS

($mn)
MV
EV
EV/Rev
P/TB
08 P/E
09 P/E
ACLS
64
97
.3x
0.2x
n/m
n/m
AMAT
13,725
11,827
1.5x
2.3x
13x
9x
KLAC
3,067
2,505
1.1x
1.7x
36x
14x
LRCX
2,248
1,488
.7x
1.6x
138x
15x
VSEA
1,269
1,063
1.3x
2.5x
250x
22x
Click to enlarge

MAJOR HOLDERS

CEO Dickerson <1% │ Other insiders 2% │ Fidelity 15% │ Oppenheimer Funds 10% │ Wellington 7% │ Turner 3%

THE MANUAL OF IDEAS RATINGS

VALUE: Intrinsic value materially higher than market value? 4 stars

MANAGEMENT: Capable and properly incentivized? 4 stars

FINANCIAL STRENGTH: Solid balance sheet? 5 stars

MOAT: Able to sustain high returns on invested capital? 4 stars

EARNINGS MOMENTUM: Fundamentals improving? 2 stars

MACRO: Poised to benefit from economic and secular trends? 2 stars

EXPLOSIVENESS: 5%+ probability of 5x upside in one year? 3 stars

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