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Kulicke & Soffa - A Good Business At A Great Price

|Includes:Kulicke and Soffa Industries, Inc. (KLIC)

Kulicke & Soffa ($11.45) - Long term target around $18.20

Incorporated in 1951, Kulicke & Soffa (NASDAQ: KLIC) is a global leader in the design and manufacturing of semiconductor assembly equipment. KLIC specializes in the production of ball, wedge and die bonders for the integrated circuit (IC) and light emitting diode (LED) end-markets. The company's primary customers are outsourced assembly and test manufacturers (OSAT) and integrated device manufacturers (IDM); largest customers include Advance Semiconductor Engineering, Siliconware Percision Industries, and Haoseng Industrial.

Industry Overview: KLIC operates in two industries, Equipment (wire, ball, & die bonders) and Expendable Tools (10% of revenues). Equipment business (90% of revenues) is inherently cyclical as it depends on capital investment cycles of its customers (OSATs). However, the growth trend of the end products created with KLIC equipment, integrated circuits, has been positive because of technological innovations (better performance) and price declines (new applications). The list of end-use products for wire-bonded integrated circuits continues to grow and includes: smartphones, tablets, laptops, memory, computers, cameras, TVs, automotive electronics, others.

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Industry/Company Strategy: KLIC has focused on producing the best bonding equipment (95% of equipment revenue) and continues to spend consistently on R&D ($50-$60 mln) even during economic and cyclical downturns.

















All figures in $US 000s 2008 2009 2010 2011 2012
Net Revenues 328,050 225,240 762,784 830,401 791,023
Gross Margin 40.8% 39.4% 44.0% 46.7% 46.4%
SG&A Margin 27.2% 47.1% 17.2% 18.4% 15.8%
R&D Margin 18.3% 23.7% 7.4% 7.8% 8.0%
Operating Margin -4.7% -31.4% 19.4% 20.5% 22.7%
Operating Income (15,480) (70,815) 148,035 170,060 179,226
Interest Expense (8,601) (8,188) (8,333) (8,280) (5,808)
Earnings before Taxes (28,501) (76,641) 140,105 162,428 174,251
Adjusted Earnings (15,739) (64,868) 142,142 127,610 160,580
EBITDA (3,185) (48,484) 165,969 188,469 197,324
Depreciation 7,563 21,225 17,531 17,761 17,265
Cashflow to D+E 425 (35,455) 168,006 153,651 183,653
PPE (7,851) (5,263) (6,271) (7,688) (6,902)
FCF to D+E (7,426) (40,718) 161,735 145,963 176,751
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Traditionally, semiconductor bonds were formed using gold; however with gold prices rising ~5x over the last decade, alternatives were required. Various materials were considered to replace gold, such as copper and aluminum, each with their own set of pros and cons. KLIC was first to provide a viable alternative in 2010 with their copper bonding specialized equipment, copper bonding requires the use of nitrogen gas in order to prevent copper oxidation in the process. KLIC's main competitor, ASM Pacific Technologies, has been focusing its R&D on LED bonding (LED is one of the fastest growing markets). With customers shifting to copper enabled bonders and ASM focusing on LED, KLIC emerged as the clear leader in the IC bonding market. This is evident in the company's #1 market share position in all types of IC bonders and in its healthy operational margins and return on invested capital. Overall penetration of copper capable bonders still remains low at under 35%, suggesting there is still room for increasing market share.

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Cash Flows: KLIC is not a part of a capital intensive business but rather a R&D led industry; the company's PPE, cap-ex, and depreciation are extremely low. Cumulatively from 2008-2012 the company has spent just $34m on PPE representing a mere 7% of the $470m in after-tax cash flows generated during the period. For 2013 the company is forecasting $30-31m in capital expenditures due to $15m in facility improvements at their Singapore facility.

Investment Thesis: Being conscious of the fact that the IC capital investment business is cyclical and technology moats vanish over night; I use a 10x free cash flow multiple to the last 5 year cycle for a value of $11.62/sh, slightly higher than the current price of $11.45. However, this overlooks the free call option imbedded in KLIC. The company is debt free and has $494m or $6.52/sh in cash. Not only does the cash provide downside protection, but at its current price you are getting that cash for free. If used for an accretive acquisition or returned to shareholders, this free cash option will end in-the-money. There are not many businesses that trade at under 10x free cash flow and KLIC does have a number attractive qualities like its industry leading technology, broad market shift to copper, high growth end-market, low capital intensity, and industry duopoly. I arrive at my target price using a 10x free cash flow multiple to the previous 5 year cycle $11.62 + cash $6.52 =$18.20. This assumes the management can find a 10% FCF yielding investment.

Investment killers checklist (checks out 5/5)

1) Bad management

Management has shown caution or restrain towards acquisitions even with their enormous cash-pile. They also issued convertible-bonds at incredibly low interest rates securing extremely cheap financing.

2) Intense competition

Low competition - duopoly industry structure and both companies are growing and profitable, significant R&D, unsexy cyclical industry. However KLIC does boast high margins during cycle booms .

3) Too high of a price

5.5x trailing p/e, 2.0x ev/ebitda and still a number of underweight recommendations, the stock is definitely not a darling

4) Debt
No debt

5) Complexity
The business model itself definitely isn't complex but the technology to make copper bonding feasible is.

Disclaimer: I am long KLIC and may exit my position at any point

I post other investment ideas on my blog:

Disclosure: I am long KLIC.

Stocks: KLIC