This morning, ASML (ASML) reported uninspiring results. The stock fell 4% on the Dutch market opening in Amsterdam at 3:00 AM EST and flat lined for a couple of hours at -4%. At around 6:30 AM EST, the stock started a scorching rally of 13%. The sudden rally has all the hallmarks of a short squeeze. The short interest had indeed risen since last September from 2 million shares to 14 million at year end. It is not uncommon for ASML to show an extraordinary price movement in the opposite direction of the result announcement. Over the following days, the share price usually adjusts to the underlying fundamentals. Although it is a liquid stock, ASML often challenges market efficiency laws to the limit.
Uninspiring results and weak outlook
Sales were down almost 12% YoY and ASML guides for flat sales in 2013. The company actually needs a strong second half to keep sales flat. It specifically refers to the recovery of PC demand as a catalyst. Intel (INTC) will report its capex figures tonight and will most likely cut back on spending as it has been struggling with overcapacity. The book to bill ratio only amounted to 0.66x and sales are expected to decline 15% QoQ.
Foundries are slowing down
Sales to Taiwan amounted to 55% of sales. It is clear that TSMC has been ordering as Apple will shift its chip production from Samsung to another foundry. These shipments increase the total production capacity in the market. TSMC has benefited from the fabless trend that has swept the semiconductor space over the last 3 years. This article by Digitimes indicates capacity utilization declined over 4Q in Taiwan. The decline is stronger than last year. The rumors of component cutbacks by Apple (AAPL) could push the capacity utilization further down. Foundries are very capital intensive and will postpone tool shipments in order to protect their cash levels. This is usually the news that takes down the shares of ASML and semiconductor capital equipment segment.
New high when EPS falls 20% and counting
ASML hit a new high today, while it reported EPS down 20% YoY. The outlook is negative as costs will increase on the integration of Cymer (CYMI). This $3 billion deal was announced last October. Cymer is the light source manufacturer that works closely with ASML for the development of the next generation of EUV tools. The deal at 58x PE is dilutive for ASML shareholders and will create stock overhang when it gets approved in February.
Who needs EUV anyway
The limits of physics can be stretched, but it demands an exponential cost for a marginal improvement. The current manufacturing technology at 22nm uses immersion tools that cost around $40 million. An EUV tool that will enable 14nm line widths will cost closer to $90 million. Although it is clear that 14nm will give new yield gains in production. The question is whether the market needs such a large amount of faster chips. Most consumers are fine with tablets that browse for shopping and social networks. It is not enough to make a faster tablet. You need to sell 500 million of them to recover the cost. If consumers are fine with the current level of performance at a cheaper price, the whole investment backfires. If the EUV new tools are only used for yield gains, than the investment will not make a positive ROI. I believe that there will still be technological improvements like power tablets or faster ultrabooks, but they won't sell more than a 100 million units.
Shorts were right in the first place
This year will create a lot of uncertainty for ASML. We need to see new demanding consumer applications and a PC market recovery or foundry utilizations will fall further. This will lead to order cancellations. The Cymer integration and stock swap will create disruption. The stock is now trading on 20x PE12 and the valuation will increase as the expectations for 2013 decline. The EUV tool reminds me of the Dreamliner. Plenty of orders, but getting the tool in full operation will not be that easy. The development of 450mm wafers is also scary as it will create a quantum step in productivity, while the world production capacity might only require some fine tuning. Once the short squeeze loses its grip on the market, I expect a 20% correction. If the volume gets to 10 million shares today, I expect that 20% of the shorts will have covered. That should calm the panic. The buyback program is now officially cancelled till after the Cymer deal. That is also a relief.
Disclosure: I am short ASML.