By David Sterman
Thanks to recent troubles, I knew shares of Axcelis Technologies (Nasdaq: ACLS) were cheap. But I had no idea how cheap. When Applied Materials (Nasdaq: AMAT) announced plans to buy a rival, an apples-to-apples comparison revealed a massive gap in how investors are assessing these firms. After a closer look, I'm betting Axcelis could double or even triple with just a few breaks.
I'm a big fan of Applied Materials, as I've noted before. The chip equipment maker has such a broad array of products that it routinely snares some of the best contracts in the business. Applied Materials' move this week to acquire Varian Semiconductor (Nasdaq: VSEA) for a hefty $4.9 billion looks like a wise move. Not just because it's added a $1 billion revenue stream to its income statement, but also because the company can now offer customers an even broader range of chip equipment in just one place. That makes life even more difficult for rivals such as Novellus Systems (Nasdaq: NVLS) and KLA-Tencor (Nasdaq: KLAC).
A leader acquires a leader
Varian is also a leader in its field. The company's machines are used to stimulate ions in an electric field, a key process in the building of semiconductors out of large wafers. To gain access to Varian's technology and customer base, Applied Materials is paying a hefty five times trailing sales. To justify that price, Applied Materials notes Varian is in the midst of a heavy growth spurt -- sales are expected to rise roughly 50% this year. Varian's gross margins -- in the 50%-range -- are also quite impressive.
Axcelis is a distant No. 2 in this field. But the company also has strong technology and a solid customer base. Yet shares trade for just a fraction of their potential worth -- at least in relation to what Applied Materials is paying for Varian Semi. Shares trade for just 0.6 times trailing sales on an enterprise value basis. A lower multiple than Varian is warranted, especially in light of the company's weaker gross margins, but the margin gap (shown in the table above) can largely be explained away by a lower level of absorbed overhead. Rising sales should push gross margins back into the low 40%-range in a year or two, as was the case in the middle of the past decade.
Wheels in motion
Applied Materials' acquisition has kicked off a game of musical chairs. As we've often seen in the world of high-tech, once a specific niche technology provider is acquired, a frenzy of consolidation begins where all other players are snapped up. Said another way, if Applied Materials will now have a strong grip on the ion implantation market, rivals like Novellus and KLA-Tencor need to have a similar offering to retain or lure customers.
Axcelis surely is no gem. The company's stock has fallen from the $6-8 range during the last upswing of the semiconductor equipment cycle and now trade for just $2 (even after a 13% spike on Wednesday, May 4). Axcelis released weak fourth quarter results in early February, causing shares to drop 23% in just one day. Fourth-quarter sales were up more than 100% from the year-ago period, but they still lagged forecasts by more than 10%. The subsequent selloff led a group of seven insiders to purchase a collective 144,000 shares at an average price of around $2.60. The insiders were premature with their bullishness: shares slid well lower in subsequent weeks.
First quarter sales of $93 million were flat sequentially but were below forecasts again. Yet even if the company can simply maintain that quarterly sales pace, annual revenue should still be up more than 30% from a year ago. That spike is coming from a pair of freshly-introduced product lines that hit the market in late 2010.
Shares of Axcleis trade for around 12 times projected 2012 profits. If the company is acquired, a buyer could lop off a good chunk of overhead, pushing profitability even higher. While Applied Materials paid nearly five times trailing sales for Varian, Axcelis, with its lagging market share and still subpar gross margins, could fetch at least two times trailing sales in a buyout. This means shares have anywhere from 150-250% upside from here.
That recent spate of insider buying may turn to be a wise move after all. Insiders likely know that Axcelis can boost sales on its own -- a clear panacea for the lagging stock price -- or the company can shop itself to the highest bidder. Look for speculation to build in coming weeks and months.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.