Kulicke And Soffa Industries: An Unappreciated, Undervalued Market Leader

Feb.26.13 | About: Kulicke and (KLIC)

Company Overview

Kulicke and Soffa Industries (NASDAQ:KLIC) is a global provider of equipment (~90% of sales) and tools (~10% of sales) used in the manufacturing of semiconductors. Their customers include semiconductor device manufacturers, outsourced semiconductor assembly and test providers, other electronics manufacturers and automotive electronics suppliers. End products that use these semiconductors include smartphones, tablets, laptops, cameras, televisions, pacemakers, and cars.

In a highly competitive industry, KLIC's success can be credited to its focus on long-term results (each business unit is to launch one new product per year), and its commitment to R&D. This commitment allows KLIC to continually take advantage of new market trends by matching its future products to customers projected requirements. For example, KLIC recently developed extensions of its ball bonding platforms specifically for LED assembly, a market expected to grow 21% annually through 2016.

Market Overview

With 88% of its sales in Asia, KLIC touts itself as the market share leader in four different markets: automatic ball bonders, heavy wire wedge bonders, wafer level stud bump bonders and capillaries. As the manufacturer of equipment and not the semiconductors themselves, KLIC operates in a very cyclical industry based on the capacity requirements and capital expenditure decisions of the semiconductor manufacturers. These decisions are mainly driven by two factors: 1) semiconductor demand; and 2) replacement orders.

After a slight decrease in semiconductor demand in 2012 due to a weak global economy, growth is expected to resume in 2013 driven by mobile devices. This is a continuation of a 2012 trend which saw Samsung surpass Apple (NASDAQ:AAPL) to be the largest consumer of semiconductors in the world with purchases increasing by 28.9% versus Apple's 13.6%. KLIC is positioned to benefit from growth in all existing semiconductor applications as well as two other trends. One is the expected increase in semiconductor devices used per person, which is projected to rise by 55% through 2016. KLIC also looks ahead for any new applications it could take advantage of. For example, it is currently researching the use of wedge bonding in solar panel fabrication. New applications like this could become future opportunities not accounted for by semiconductor industry forecasts.

A unique replacement opportunity is also unfolding. As the price of gold has risen, many wire bonders have begun to use copper wire to lower costs (15-25% average copper package cost savings). KLIC estimated that about 30% of bonders currently in production across the industry are copper capable with that number expected to rise to over 50% by 2016. KLIC seems to be ahead of this curve with 84.5% of their ball bonders sold in 2012 being copper capable. It should continue to enjoy growth in replacement demand as semiconductor manufacturers continue to meet customers' demands to lower costs and upgrade their bonding equipment to be copper capable.

One potential threat KLIC is monitoring is that of alternative packaging technologies like flip chip and wafer level packaging, which reduce the need for wires. Alternatives are not expected to greatly disrupt the market with 83% of all integrated circuit packages forecast to still be wire bonded in 2016. KLIC should also be able to stay ahead of this trend by integrating these technologies into its own products or through an acquisition.

Financial Overview

KLIC recently strengthened its balance sheet by repaying $110MM of convertible subordinated notes, leaving them with no debt and $494MM in cash ($6.57/share). 2013 capital expenditures are expected to rise to $30-31MM with $15MM for leasehold improvements in its Singapore facility, and the rest for R&D and enhancements of manufacturing/IT. One of the reasons it is able to keep Capex and inventory so low is that KLIC uses an outsourcing model so that its main function is to integrate parts and test the assemblies. This does represent a potential quality control and supply risk, but so far has not proved to be a problem. Beyond potential acquisitions, discussions about KLIC's large cash pile have also suggested there might be share repurchases. Dividends are not likely due to the cyclicality and seasonality of the business and need to maintain flexibility.

Valuation

A Discounted Cash Flow valuation suggests the market is undervaluing KLIC's solid balance sheet and strong cash flow generation. In its January conference call, management revealed $114MM in revenue for Q113 and forecast $90-100MM for Q213 (note these are typically the lowest two quarters for this seasonal business). Although demand is expected to pick up in the latter half of the year, to remain conservative, I estimated 2013 revenue of $650MM (a 17% decline from 2012). The DCF valuation forecast yearly cash flow for the first ten years and then a terminal value based on the perpetuity growth method (discount period for 2013 starting at 0.75).

Assumptions

Revenue growth rate

0%

EBITDA margin

22%

EBIT margin

20.50%

D&A (% of sales)

2.50%

Tax rate

15%

CAPEX (as % of sales)

2.50%

Inc. in NWC (as % of sales)

1.50%

WACC

11.1%

Click to enlarge

Source: Financial data from Kulicke and Soffa SEC Filings.

With a base case forecasting zero growth over the next ten years and 2.5% growth in perpetuity, the result was an implied share price of $20.75, approximately 90% above KLIC's current price of $10.93 (as of 2/21/13).

Implied Equity Value

Cumulative Present Value of FCF

626,971

Terminal Year Free Cash Flow (2022E)

107,738

WACC

11.10%

Perpetuity Growth Rate

2.50%

Terminal Value

1,284,081

Discount Factor

0.36

Present Value of Terminal Value

460,130

% of Enterprise Value

42%

Enterprise Value

1,087,101

Less: Total Debt

0

Less: Preferred Securities

0

Less: Noncontrolling Interest

0

Plus: Cash and Cash Equivalents

494,170

Implied Equity Value

1,581,271

Fully Diluted Shares Outstanding

76,209

Implied Share Price

$20.75

Click to enlarge

To check the reasonableness of the DCF result, we can look at the results of a couple other valuation methods. The implied share price using a P/E of 15 times 2014 EPS of $1.41 was $21.21, very close to the DCF value. The DCF model also resulted in an Implied EV/LTM EBITDA of only 5.8, still low for a cash cow expected to enjoy strong growth.

KLIC is also undervalued relative to its peers. With a current EV/LTM EBITDA less than 2 and a P/E less than 6, market expectations appear to be extremely poor. Peer averages based on enterprise value and share price ratios suggest KLIC is close to half of its instrinsic value. As a market leader with a strong financial position, KLIC should not be valued so low compared to its peers.

Company

Kulicke and Soffa Industries

Amkor Technologies Inc.

ATMI Inc.

Cabot Microelectronics Corp.

Tessera Technologies

ChipMos Technologies

ASM International

Average

Ticker

KLIC

AMKR

ATMI

CCMP

TSRA

IMOS

ASMI

Current Price (as of 2/21/13)

10.93

4.39

21.89

34.51

17.53

10.67

38.82

% of 52-week high

80%

65%

91%

66%

97%

55%

95%

78%

Latest Financials

12/31/12

9/30/12

9/30/12

12/31/12

9/30/12

9/30/12

9/30/12

Source

SEC Filings

Yahoo Finance

Yahoo Finance

Yahoo Finance

Yahoo Finance

SEC Filings

SEC Filings

Market Cap ($MM)

844

704

717

805

891

294

2,140

914

Profit Margin

20%

2%

-5%

20%

-3%

3%

6%

6%

LTM EV/EBITDA

1.9

3.4

-97.7

8.6

16.3

1.8

9.7

5.1

LTM EV/EBIT

2.0

11.3

-17.2

11.7

-38.6

18.3

14.2

11.5

P/B

1.3

1.1

1.5

5.0

1.3

0.8

2.5

1.9

P/S

1.1

0.3

1.8

3.9

3.7

0.5

1.1

1.8

P/E

5.4

11.7

-39.8

19.6

-148.5

16.3

19.1

14.5

EPS Growth

15.0%

10.0%

12.0%

10.8%

24.0%

n/a

2.3%

12.4%

Click to enlarge

Note: ASMI numbers are based on a USD:EUR exchange rate of 1.30:1. Negative P/E and EV ratios and TSRA's LTM EV/EBITDA were not used in calculating averages.

Conclusion

Driven by a dual focus on profitability and innovation through strong R&D, KLIC is poised to continue its role as a market leader in providing semiconductor manufacturing equipment. Its ability to generate large amounts of cash while maintaining a rock-solid balance sheet is significantly undervalued by the market. After a 15% drop in share price following their Q113 results and lower-than-expected Q213 forecast, now appears to be a good time to enter a long position to take advantage of growth in the second half of 2013 and the next several years. In this market, an acquisition or LBO is also possible at such low prices. Bottom line, the upside at this point appears to be significantly greater than the downside with a double in share price not being unreasonable (even in a no-growth scenario).

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KLIC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.