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Shares of Applied Materials (AMAT) hardly moved following the release of its fourth quarter earnings report. The results and outlook look fine, as the investment thesis for Applied Materials continues to be dominated by the mega-deal with Tokyo Electron.

While the deal can create a lot of long term value, I remain on the sidelines for now given the many integration challenges on the road ahead and current issues in the wider sector.

Fourth Quarter Results

Applied Materials generated fourth quarter revenues of $1.99 billion, up 20.8% on the year before. Analysts were looking for revenues of $1.97 billion.

The company reported earnings of $183 million, compared to a $515 million loss last year. Last year's results were impacted by a $421 million impairment of goodwill and other intangible assets.

Reported earnings came in at $0.15 per share on a GAAP basis, compared to a loss of $0.42 per share last year.

Non-GAAP earnings came in at $228 million, or $0.19 per share. Earnings were up significantly from reported earnings of $0.06 per share last year, and rose by a penny compared to the third quarter. Earnings beat consensus estimates by a penny as well.

CEO Gary Dickerson commented on the fourth quarter developments, "This has been a transformative year for Applied Materials as we shaped a more competitive company, reduced overhead expenses, stepped up investment in product development and built momentum for profitable growth."

Looking Into The Results ...

While revenue growth for the quarter was spectacular on an annual basis, Applied Materials ended the full year of 2013 with a lot less revenues compared to the full year of 2012. The near term future continues to look a bit better.

Order intake was $2.09 billion, up by 5% compared to the previous quarter, resulting in a book-to-bill ratio of 1.05 as the backlog increased by some $100 million to nearly $2.4 billion. This represents little over a quarter's worth of revenues, indicating just how little visibility Applied Material has in terms of its forward guidance.

GAAP gross margins rose by 440 basis points to 40.0% of total sales, mostly on the back of operating leverage. The company saw great leverage in other costs as well as absolute marketing and selling costs, as well as general and administrative costs were down compared to a year ago, despite the growth in revenues.

... And Ahead

For the first quarter of its fiscal 2014, Applied Materials sees revenues up by 3 to 10% on a sequential basis. At the midpoint of the range, revenues are seen around $2.12 billion, which compares to consensus estimates of $2.19 billion.

Non-GAAP earnings per share are seen between $0.20 and $0.24 per share, versus consensus estimates of $0.23 per share.

Valuation

Applied Materials ended its fourth quarter with $1.89 billion in cash, equivalents and marketable securities. Total debt stood at $1.95 billion, resulting in a roughly flat net cash position.

Full year sales for 2013 came in at $7.51 billion, down 13.9% on the year before. Net earnings more than doubled to $256 million in the meantime, with earnings coming in at $0.21 per share.

Trading around $17.50 per share, the market values Applied Materials at $21 billion. This values operating assets of the firm at 2.8 times annual revenues and over 80 times GAAP earnings.

Applied Materials currently pays a quarterly dividend of $0.10 per share, for an annual dividend yield of 2.3%.

Some Historical Perspective

Long term holders in Applied Materials have seen very poor returns. Over the past decade investors have lost a quarter of their investment, with shares trading in a $10-$25 trading range. Note that shares peaked around $60 amidst the internet bubble at the turn of the century.

Between 2009 and 2013, Applied Materials has increased its annual revenues by some 50% to $7.5 billion. Revenues peaked around $10.5 billion in 2011. Peak earnings of $1.9 billion in that year have mostly evaporated in 2012 and 2013. The company has retired roughly 8% of its shares outstanding over the past four years.

Investment Thesis

While investors traditionally focus on the outlook for chip manufacturers, the focus for Applied is still on the announced deal in September with Japanese Tokyo Electron. The deal is still expected to be approved on the middle or second half of 2014.

With every round of upgrades, investments to manufacture ever complex chips increases. Not many companies can afford these investments, resulting in consolidation of customers as well as suppliers, being the major rationale behind the deal.

Applied saw a solid fourth quarter order intake, driven by contract manufacturers, known as foundries and NAND chipmakers. Demand is partially driven by TSMC's preparation of the new 20 nanometer manufacturing line. Logic chipmakers which are hurt by PC demand, like names of Intel Corporation (INTC) continue to suffer.

Back at the end of September, when Applied Materials announced the acquisition of Tokyo Electron, I last took a look at Applied Material's prospects. The "defensive" deal driven by cost synergies, allows Applied Material to restore the current suboptimal profitability. Synergy estimates stand at $250 million in the first year after closing, increasing towards $500 million per annum in year three.

The newly created $30 billion company generates pro-forma revenues of $12-$13 billion per annum, as current earnings are still subdued. For the long term, Applied Materials sees combined annual revenues of around $18 billion by 2017. Earnings could top $3 billion according to Applied's deal presentation, or around $2.50 per share. The $3 billion share repurchase program, targeted to be completed in the year following the deal closing, should boost earnings per share already sooner, after which synergies will drive the value going forwards.

Note however that these projections are quite upbeat, still four years ahead in time, and assume a smooth integration. This might however not be the case given the integration challenges accompanied by a cross-cultural deal.

While the stock is very appealing if these projections become the reality, I am cautious for the short to medium term, as I am not convinced this best-case scenario will play out.

Source: Applied Materials - Long-Term Investment Case Is Dominated By Tokyo Electron Deal