KLA-Tencor: A New Acquisition To Add To The Company's Revenues
Summary
- KLA-Tencor is a global semiconductor company.
- The company has rapidly grown through acquisitions, and its latest portfolio addition is likely to move the business ahead.
- Valuation suggests the company’s shares are substantially undervalued.
Investment thesis
KLA-Tencor (NASDAQ:KLAC) is a leading semiconductor equipment and services supplier with an extensive acquisition track record. Despite a relatively high level of debt, the company's new acquisition is set to add significant value to the company's portfolio.
Corporate profile
KLA-Tencor, rebranded as KLA Corporation earlier this month, is a leading supplier to the semiconductor manufacturing industry. The company's portfolio includes a wide range of products and services, including process control systems related to the production of wafer, reticle, integrated circuit, and other nanoelectronics solutions. The company operates two revenue segments - product and service - which currently account, respectively, for 78.3 and 21.7 percent of total revenue. In 2018, most of the company's revenue came from Korea (29 percent), China (16 percent), Japan (16 percent), Taiwan (16 percent), North America (12 percent), and Europe and Israel (7 percent).
Growth through acquisitions
Over the recent decades, KLA-Tencor has grown extensively through acquisitions, with 23 companies successfully added under the company wings. Through the years, the company developed an ability to identify and acquire compatible companies more or less consistently, with no more than three transactions in a year.
| Closed Acquisitions (the last 9) | Year |
| MicroVision | 2018 |
| Nanomechanics Inc. | 2018 |
| Nano Indenter product line from Keysight Technologies | 2018 |
| Zeta Technologies Co. Ltd | 2017 |
| Luminescent Technologies, Inc. | 2014 |
| Ambios Technology, Inc. | 2010 |
| Microelectronic Inspection Equipment business unit of Vistec Semiconductor Systems, Inc. | 2008 |
| ICOS Vision Systems Corporation NV | 2008 |
| Therma-Wave Corporation | 2007 |
Source: Author's own creation, Data Sources: Crunchbase.com, Wiki
Orbotech deal
Last year, in March, the company entered into a definitive agreement to purchase Israeli consumer electronics company called Orbotech (ORBK) for $38.86 in cash and 0.25 of a share of KLA-Tencor common stock in exchange for each ordinary share of Orbotech. Even though Orbotech is a relatively small company in terms of market cap, one can expect the company to become a strong contributing force to KLA-Tencor's financials. The combined entity is expected to generate over 5 billion in revenues and one billion in net income. According to the latest news, the KLA-Tencor Corporation-Orbotech deal is awaiting clearance from regulatory authorities.
High margin industry
In the context of the semiconductor equipment manufacturers, KLA-Tencor has one of the highest profit margins in the industry. The company's trailing twelve months gross, EBIT and net profit margin stands at 63, 37, and 27 percent, respectively - well above the industry averages.
A decreasing number of shares outstanding
From an investor's perspective, one of the company's key strengths is a shareholder-friendly policy. Since the global financial crisis in 2008, the company's number of shares outstanding has been gradually decreasing by about three percent annually. Last year, the company has announced a $2 billion buyback, of which $600 million have been already utilized, $400 million is remaining as of the close of this quarter and $1 billion share repurchase is awaiting upon completion of Orbotech acquisition.
Valuation
Plugging-in KLA-Tencor's financial statements' figures into my DCF template, the company's shares seem to be substantially undervalued. Under perpetuity growth method, with a terminal growth rate of 2 percent, constant 8 percent annual revenue growth over the next five years and 39 percent EBIT margin, fair value of the stock comes at 207 USD. Under the EBITDA multiple approach of a discounted cash flow model, the intrinsic value per share of the company stands roughly at 156.5 USD if we assume that the appropriate exit EV/EBITDA multiple in five years' time is around 10x.
Source: Author's own Excel model
From a different perspective working with operating earnings multiples, KLA-Tencor's shares seem to offer an outstanding long run return. Using the Fast Graphs forecasting calculator, with a default 7 percent adjusted operating earnings growth rate assumption, the company's intrinsic value, by the end of December FY2024, is forecasted to reach up to US$179. This implies a total annualized rate of return upside potential of more than 13 percent.
Source: F.A.S.T. Graphs
Lastly, in the light of revenue variation of Peter Lynch's popular earnings line for the projection of intrinsic per share values of the company, KLA-Tencor's shares appear attractive. According to my model, assuming 8 percent annual revenue growth, minus 3 percent annual equity dilution factor, a price-to-sales PS ratio of around 4x, the company's share price by the end of 2022 could fluctuate around US$163. This scenario suggests an annualized rate of return potential of over 10 percent in the following years.
Source: Author's own Excel model
Key risks
- If the company fails to innovate and adjust to industry changes, its financial performance may suffer.
- Customer concentration - the company has several customers accounting for a significant portion of the company's overall revenue.
- If the company fails to timely respond to the semiconductor equipment industry cycle, its operations may be adversely affected.
- If general economic conditions worsen, the company's leveraged capital structure may adversely impact financial results.
- The company is subject to various regulatory and legal risks.
- If the company loses its key personnel or fails to attract and motivate new talents, its operations could be harmed.
- The company can become a subject to cyber-attacks, which could adversely impact its reputation.
- If the company fails to successfully integrate acquired business, its financial results may be negatively impacted.
- Natural disasters or any other unexpected disruptions could negatively impact the company's operations and financial results.
- Risks stemming from foreign exchange rate fluctuations may adversely impact the company's financial results.
The bottom line
To sum up, KLA-Tencor is an outstanding company operating on the edges of science and technology. After three strong years of memory investment, the company expects this year to be a 'digestion' and remains optimistic about broader opportunities in the wafer and reticle markets. As AI and IoT industries are expanding, the company is well positioned to reap the fruits of the future.
Disclaimer: Please note that this article has an informative purpose, expresses its author's opinion, and does not constitute investment recommendation or advice. The author does not know individual investor's circumstances, portfolio constraints, etc. Readers are expected to do their own analysis prior to making any investment decisions.
This article was written by
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