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Surprisingly Strong 2005 Demand a Key Topic of Wall Street Transcript Semiconductor Equipment Review
Wednesday April 13, 10:29 am ET

http://biz.yahoo.com/twst/050413/yas802.html

67 WALL STREET, New York--April 13, 2005--The Wall Street Transcript has just published its SEMICONDUCTOR EQUIPMENT REVIEW, a report offering a timely review of the sector to serious investors and industry executives. This 40-page feature contains commentary from 3 leading industry analysts, plus in-depth interviews with top management from 12 firms. The full issue is available by calling [phone] or via The Wall Street Transcript Online.

There are some mega trends from the demand side that will persist for a long time, such as digital TV, digital content, audio and video. Technology inventories are being cleared out of the supply chain for chips and we are seeing more strength in equipment orders from major chip companies in the logic and memory market segments. Topics include: Trends driving the industry, new innovations and technology, the Taiwanese players, industry spending, process firms, and the ramifications of more devices containing more silicon content, Stock picks, Companies to Avoid.

Companies include: Intel (INTC). Taiwan Semiconductor Manufacturing (TSM); United Microelectronics (UMC); Samsung; Applied Materials (AMAT); Novellus Systems (NVLS); Lam Research (LRCX). KLA-Tencor (KLAC); Nanometrics (NANO); ADE (ADEX); Rudolph Technologies (RTEC); ICOS Vision Systems (IVIS); Teradyne (TER); Semitool (SMTL); Aetrium Incorporated (ATRM); Brooks Automation (BRKS); Cohu, Inc.(COHU); FEI Company (FEIC); inTEST Corporation (INTT); Kulicke & Soffa Industries (KLIC); MEMC Electronic Materials (WFR); QuickLogic Corporation (QUIK); Genesis Microchip (GNSS); Silicon Image (SIMG); Trident Microsystems (TRID); PortalPlayer (PLAY); SigmaTel (SGTL); Napster (NAPS); Diodes (DIOD); Apple Computer (AAPL). Analysts include: Gerald S. Fleming of WR Hambrecht + Co, Gavin X. Duffy of A.G. Edwards & Sons, Christopher A. Chaney, of Stanford Group Company

In the following brief excerpt, Gavin Duffy discusses the near-term demand outlook for semiconductor equipment manufacturers.

TWST: As you launched coverage, what baseline were you using? What was your framework for the industry outlook?

Mr. Duffy: I think that when I picked up coverage, there was a lot of confusion about what was going on in both the semiconductor and the semi equipment market segments because we had such a very good beginning in 2004 and things had definitely slowed late in the year. We had strong semiconductor shipments of units for the first three quarters and therefore the equipment market really had taken off, but we had seen some weakness in the semiconductor end markets in Q4. I think there was a lot of confusion in terms of what people expected for semiconductors and then the semiconductor equipment market for 2005.

Originally when I picked up coverage, I was projecting 2005 equipment revenues to probably be flat to down 10% on a year-over-year basis, with a 10% decline the more likely scenario. However, we have seen some surprisingly healthy capital spending budgets announced by some of the major equipment buyers like Intel (INTC), Samsung and TSMC (TSM). I think that consensus is slowly moving back more toward equipment spending to be flat to down 5% for the year. The semi equipment space could wind up being flat in 2005 versus 2004 if most of the large buyers hold true to their announced capital spending budgets.

TWST: What's changed?

Mr. Duffy: I think it's a couple of different things. One obviously was the surprising number of increased capital spending budgets. We saw the semi equipment market grow over 60% last year, so many people expected to see big spenders from 2004 pull in the reins a bit this year. However, Intel, for instance, is going to spend $1 billion more this year and it's all going to be on technology buys as they push toward 65-nanometer manufacturing. The memory guys are continuing to spend, and TSMC, the biggest foundry in the world, is also boosting their spending this year versus 2004. I think that's one aspect.

Another aspect is the fact that technology inventories are being cleared out of the supply chain at a decent clip early in 2005. We do a pretty detailed study of technology inventories through the supply chain, from the box makers down through the semi guys themselves, as well as semi distribution and contract manufacturing. What we saw in Q3 was a buildup in inventories, especially in semiconductors and communication chips. We break the two segments out separately in our analysis due to the different ways they impact semi equipment spending. Semi companies with their own fabs obviously buy equipment directly, while communication chip companies outsource their manufacturing needs to foundries, which in turn buy equipment.

What we saw in Q4 (which I thought was kind of surprising) was the degree to which semiconductor guys (and I'm talking about non-communication chip companies) pulled back on production. They essentially bit the bullet in Q4, cut back on wafer starts, basically took the hit to gross margins but got their inventories back in line pretty quickly. We think they will have the remainder of inventories pretty much cleared out by the end of the first quarter.

The communication chip guys, which basically outsource everything to people like TSMC, are probably going to take at least until Q2 before they have their inventories cleared out. What we're seeing at the beginning of this year is more strength in equipment orders from big chip companies in the logic and memory market segments as opposed to the foundry guys, which I would expect to pick up ordering in Q2 as communication chip inventories return to more acceptable levels.

TWST: So that will be a little longer.

Mr. Duffy: Yes. Because the general semis (everybody from the memory guys through analog and microprocessors) in Q4 of last year had revenues increase while inventories decreased, so you had a double positive. But if you look at the communication chip companies, back in the third quarter of 2004, they had revenues decline sequentially while inventories grew, which has a doubly negative impact on growth. In Q4, however, communication chip inventories finally held flat but revenues declined again. I think they're still going to be selling out of inventory levels for the first couple of quarters, especially since Q1 is typically a weaker quarter for most communication end markets.

TWST: What are you telling investors to do at this point?

Mr. Duffy: I think investors at this point should take advantage of pullbacks. I think what's slightly different about this cycle is that there are more opportunities to pick stocks than there have been in previous cycles. I know a lot of investors historically have just bought or sold a basket of semiconductor equipment stocks as they expected all of the companies to trade in the same range. I think this time around, investors should instead bet on companies that are leaders in those segments that are going to grow faster than the overall market.

Those two reasons are why KLA-Tencor is our number one pick. They have a 75%-80% share in most of the markets they address and they're the leading guys in inspection and measurement. If you think about it, without those tools working, chip production grinds to a halt. KLA's tools are some of the first pieces of equipment that a semi manufacturer puts in its fab. If you think about it, KLA is in the business of improving yields. Their tools are probably the least "optional" for chip makers versus other kinds of equipment.

I also like Lam Research. They don't have as dominant a market share position in the etch space that KLA does in inspection, but they are the leader there. They also have a good streamlined business model. I think that etch is also going to grow faster than the overall equipment market. I think the two big things driving that, as everybody knows, is the shift to 300mm, which is driving the complexity (number of layers) of chips, and the shrinking of the line widths on each die. The etch tools will have to get more and more precise.

Overall, I believe equipment companies whose tools really add value, especially in front-end manufacturing, are going to lead the market.

The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This 40-page special issue is available by calling [phone] or via The Wall Street Transcript Online .