Why Is Everybody Investing In This Chipmaker?

| About: ASML Holding (ASML)

Including Samsung's (OTC:SSNLF) recent deal, three very large tech companies have now invested considerable resources in ASML's (NASDAQ:ASML) research and development division. ASML is a Dutch chipmaker specialized in the fabrication of semiconductors and semiconductor-related equipment. With a market cap of 23.7 billion dollars, the firm is the world's top producer of chip equipment. Intel (NASDAQ:INTC), TSMC (NYSE:TSM) and Samsung together have now invested 3.85 billion Euros in this chipmaker which equals about 23% of a minority equity stake. In this article I will explore how this influx of cash may affect the company.

The original goal for R&D funding set at 1.38 billion Euros has now easily been met. To meet this funding goal the company approached its three major clients, a deal which has now been finalized by Samsung's purchase. Most of this vast cash reservoir is destined for research into lithography systems, used for attaching circuitry to silicon wafers. Specifically, these systems are 450mm wafer support and EUV (extreme ultra-violet) lithography. Silicon wafers are then used for the production of microchips which power computers, telephones and a range of other devices. As these lithography systems are very high-tech and very expensive, large capital investments are necessary to fund research.

This huge injection of cash will according to analysts allow ASML to speed up the adoption of a new generation of chip making equipment by up to two years. Reassuringly, ASML management has reported that all the proceeds from the new share issuance will be returned to shareholders. For Intel, the biggest R&D investor, the consequences of the deal could provide them with the edge necessary to stay ahead of the competition, as it may entail a significant cost saving. Analysts reckon Intel could save up to 40% on manufacturing costs, or up to $2 billion. However, as a large, up-front deal, the tech giant is also taking on a considerable bit of risk.

Due to its size and competitive advantages, ASML is managing to stay ahead of its only competitors Canon and Nikon. ASML now has a market share of well over 50%. The influx of capital from the company's three main clients is expected to solidify ASML's dominance in the sector. From a strategic point of view, the company appears to be doing very well. The company is also attractive looking at a number of valuation metrics. The stock is priced at 16x earnings compared to the industry average of 18.5x. It has a huge return on equity of 50% and has a very high 29.3% operating margin. The LT debt to equity ratio is only 21.3, although price to book is up there at 5.2. 2012 Q2 results were more or less in line with expectations although these were set quite low. The company reported a 20% YoY decrease in revenue and a 32% decrease in profit. ASML also adjusted outlook slightly to the downside.

As a company in a highly cyclical sector and with a beta of 1.57, the stock is more suitable for those willing to take on more risk. Also, the adjusted guidance for the remainder of 2012 is somewhat worrying. Slowing demand for microprocessors and other chips may hurt ASML's earnings in the near future. Overall though, the company seems to have a very dominant position in its field.

In the extremely high-tech industry of chip manufacture, large up-front capital injections are sometimes necessary for the development of new technology and the solidification of companies' competitive positions. In this arena, it seems as if ASML is far ahead of the competition. With these newly secured R&D funds the company's balance sheet is looking even stronger. Also, the company is valued quite attractively at the moment. However, semiconductors are a highly cyclical industry and as such this kind of investment is inherently more risky. Therefore, additional scrutiny would be required of investors looking to profit from this deal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

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Tagged: , , , Semiconductor Equipment & Materials, Netherlands
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