We are initiating coverage on Mattson Technologies with a outperform rating and a $14 price target ex cash. We believe Mattson, a small cap semiconductor equipment manufacturer with leading positions in 2 key markets, is undergoing transitory issues and has disenchanted many investors away from the stock, making it cheap on a forward earnings basis. Our bull case on Mattson is predicated on their getting to 45%+ gross margin in late 2007 and into 2008 (improved product mix, particularly next generation RTP tools), marinated with a bit of takeout speculation and valuation concerns (now trading < 13x our ‘08 EPS est). With the stock just above 10 and the small cap slice of the sector down b/c of recent order softness, we see roughly a buck in downside and 4 bucks in upside if Mattson executes as planned. Patient investors with a time horizon greater than a quarter or two should consider Mattson for their portfolios.
Mattson produces critical manufacturing equipment for use in the semiconductor industry. It sells strip systems to remove photo-resist residue without damage to insulating material. Customers included Samsung, Infineon, and Toshiba. MTSN currently controls 24% of the dry strip market (which we expect will increase to ~30%+ in 08) and ~19% of the rapid thermal processing market (which we expect will increase ~400-500 bps in 2008). The company has made some strong moves in the rapid thermal processing space and has deftly stolen share from industry bellwether Applied Materials (AMAT) (HOLD rating).
Rapid thermal processing, also known as RTP, is the process of rapidly heating and cooling chips after they have undergone the ion implantation phase. RTP, simply put, “activates” the electrical properties of a chip, much like the way you activate your cell phone after you buy it in the store. RTP should become an increasingly significant part of the chip manufacturing process over the next couple of years as device makers seek lower cycle times and improved thermal budgets. The current technology -- batch furnace – is far from gone, but industry experts agree that it will eventually phase out and make room for more cost effective practices like RTP. A late 2006 article in Semiconductor International sums up the investment case best:
Logic has traditionally been the entry point for RTP developments, with DRAM closely following behind it….now this is happening with flash memory also. As NAND flash scaling is driving shorter thermal budgets, memory market applications for RTP are expanding.
MTSN has given the Street accelerated earnings growth for 3 straight quarters, but that trend should break in Q3; investors may punish shares if Mattson misses the whisper and growth decelerates a rate higher than the Street is expecting. Our Q3 estimate is in the 10-15c range, which would implies ~40%+ EPS growth y/y.
MTSN is levered to memory spending, whose spending patterns are unpredictable. Moreover, as a smaller player, Mattson may be unable to satisfy customer demand in up cycles and suffer greater losses in down cycles due to its higher fixed cost structure.
Korean competitor PSK has made some inroads in the strip market and could take more share from Mattson, although our industry contacts assure us that Mattson possesses a technologically superior tool.
Currently trades at ~13x our ’08 EPS; MTSN, we feel, should trade in line to slightly above its peer group (front end stocks tend to trade at 15-22x forward EPS) given its leading market position, strong balance sheet, and potential for above average margins. Furthermore, its exposure to DRAM (60% of sales) makes MTSN one of the first stocks to go to when the DRAM cycle sparks.
We arrive at our $14 price target ex. cash by applying a 16x forward PE to our 2008 EPS est of 88c, which is conservatively 8c higher than consensus. Our price target does not consider a takeover premium for Mattson, which we feel would be warranted given its broad customer reach and leading position in dry strip. Mattson has no debt and would welcome a buyout, according to our conversations with management.
Mattson continues to rob share from AMAT
The currently morphing lithography landscape de-commoditizes the strip process and enables Mattson to sell at modestly higher ASPs.
Batch furnace, the incumbent technology, phases out
Market recognizes that MTSN is trading at half our projected EPS growth rate for 07 and 08 and pays a higher multiple for Mattson stock.
Mattson lands a higher margin product mix and sees incremental operating leverage. When times are good, Mattson’s earnings can explode, as they did in 2004 when gross margin was at 43% off a $245M run rate and relatively fixed SG&A. This is the direction we think they are headed towards again, but this is most likely a longer term event rather than a quarterly one.
Disclosure: Dan Jacome is an MBA candidate at the Kelley School of Business at Indiana University where he is majoring in finance and running Ceviche Fund Partners LP. He was long MTSN at the time of publication. Investors can email him anytime at firstname.lastname@example.org for copies of models or questions regarding all investment themes and suggestions. He does not give out individual investment advice, however.