Description

KLIC ($50, market cap $3.15B)

I believe Kulicke & Soffa (KLIC) is a long here. KLIC trades at <12x CY21 EPS ex-cash and represents a cheap way to play the current strength in semiconductor capital equipment spending generally, and the high growth in advanced packaging and advanced display (mini-LED) equipment specifically. I believe that as the market appreciates the shift in KLIC’s business mix towards higher growth segments, it can trade closer to inline with semicap equipment peers, yielding the potential for 75%+ upside in the stock. 

Key points:

• Above-trend semi unit growth is expected over the next several years (5G, AI, auto are drivers) after a 2 year period of below trend growth in 2019-2020. Semi unit growth is a direct driver of KLIC’s business, therefore the recent strength seen in KLIC’s results should have a multi-year runway. This above trend semi growth also comes at a time when there has been an under-investment in global semiconductor capacity (as a result of the recent subpar unit growth). This virtuous combination has the wafer fab equipment (WFE) poised for a multi-year period of unusual strength.

• New products (advanced packaging, mini/micro-LED) introduced over the last several years have expanded KLIC’s market opportunity and are starting to meaningfully contribute to KLIC’s overall revenue growth beyond its core market-leading wire bonder business 

• Market perception of the company is of a 'high market share in a low to no-growth' business. This is reflected in the well below peer multiple KLIC trades at today (<12x vs >20x for peers) -> expect this to converge with peers as market better appreciates the rapidly growing products here and/or the market sees current strength as sustainable

• At the median peer multiple on CY21 EPS (ex-cash), KLIC would trade at $87 (75% upside)

• Consensus seems to be building in the US around the need for subsidies to increase domestic semiconductor production capacity, including assembly/advanced packaging capacity (where KLIC supplies) -> large US subsidies have the potential to further push up already strong industry demand as (subsidized) US capacity gets built out 

• Street estimates give KLIC a relatively low bar moving forward as consensus is modeling the March ’21 quarter as a peak quarter; given the still nascent cyclical strength in the core business (upturn really only began in the Dec ’20 quarter after ~2 years of cyclically depressed results) and KLIC’s newer high-growth products, it seems more likely results can continue flat to higher, rather than declining. 

Business

KLIC has long been the global market leader in wire bonder equipment. Wire bonding is the process of connecting a chip/die to its packaging. This is a ~$1B market, with KLIC maintaining about 65% market share. Wire bonding is a low growth segment within capital equipment due to the trend over time towards more ‘advanced packaging’ technologies that don’t use traditional wire bonding processes such as wafer-level packaging and flip-chip technologies. 

KLIC also has a smaller but faster growing business in advanced packaging equipment. While forecasts call for just a 1%-2% CAGR in the traditional wire bonder business, the advanced packaging market is expected to grow at a double-digit CAGR for the foreseeable future. KLIC’s dedicated advanced packaging products are the APAMA (wafer-level packaging, flip chip) and KATALYST (flip chip) product lines. These products that have have been introduced over the last several years are expected to generate $100M+ in annual revenue within the next year or so. 

KLIC has another smaller, high growth business addressing advanced packaging for the mini- and micro-LED market (advanced display market). Mini-LEDs (with micro- to follow) are, as the name would suggest, smaller LED chips used for TVs and other displays that seek to replace/compete with the currently dominant OLED display technology in high end displays. Forecasts are for a 20%+ CAGR for mini-LEDs over the next decade, from a currently low base. KLIC’s mini-LED product line is called PIXALUX and it’s grown rapidly since its first revenue in 2019 to being an expected high single digit % of overall KLIC revenue in FY21 ($80M Revenue). 

Mini- and Micro-LEDs https://www.tomsguide.com/news/micro-led-vs-mini-led

Apple adoption https://www.androidauthority.com/mini-led-display-1161376/

Lastly, like other semicap equipment suppliers, KLIC has a stable, highly profitable aftermarket parts & services (APS) business that represents about 20% of revenue, though that % can vary depending on the level of equipment revenues.  This business runs consistently at 20%+ EBIT margins with limited cyclicality.  

Opportunity

The opportunity in the stock is primarily two-fold:

1. Early in the cyclical upturn after a prolonged downturn

2. Relative undervaluation compared to peers

KLIC’s business has only recently come out of a prolonged cyclical downturn that coincided with two years of anemic, below-trend growth in global semiconductor unit volumes. Global semiconductor unit volumes were negative/flat during roughly a two year period coinciding with KLIC’s fiscal years FY19-20 versus the long term average of 6.5% unit growth and the expected above-trend 10%+ in growth in CY21-CY22. Trade tensions, then Covid were the primary reasons for the weaker unit growth over this period. This slide from KLIC’s February earnings illustrates this dynamic:

While these trends should be broadly favorable for all semicap equipment companies in the near to medium term, KLIC also trades at a steep and, in my opinion, unjustified discount to semicap peers. The reason, I believe, for this discount is the perception that KLIC has maxed out its market share in a no-growth/cyclical piece of the equipment market (core wire bonders), thus has less than exciting overall growth prospects relative to the group. I think this is wrong. While KLIC’s core bonder business is indeed lower growth and cyclical, what the market is failing to appreciate is the strong growth in new products for advanced packaging and mini-/micro-LED that should continue regardless of the cyclicality/limited growth in the core bonder business. These new products contributed just 5% of Revenue in FY18 (prior cycle peak), 13% of Revenue in FY20, and should approach 20% of combined Revenue in FY22. These new growth products are a big reason why Revenue in FY21 is expected to be ~25% higher than the prior (FY18) cyclical peak ($1.1B+ in FY21 vs $890M in FY18). 

KLIC currently trades at just 14x FY21/CY21 EPS (<12x ex-cash) versus peers at 24x/22x. 

If we take the following estimates for KLIC…

…and apply the group median P/E (ex-cash) multiple of 21.6x to KLIC’s EPS and add expected YE21 net cash of $12/share, we arrive at an $87 PT for KLIC, 75% upside. If we were to apply the same multiple rolled forward a year to CY22 estimates, we’d arrive at well over $100/share.

Wafer Fab Equipment (WFE) is Booming

Have you heard of the current “semi shortage”? I’m guessing you have. The overall market for semiconductor capital equipment (wafer fab equipment) appears set for strength over the next couple years, by most (perhaps all?) accounts, after a couple years of under-investment, that has culminated in the “semi shortage” headlines in the news today. Overall, WFE is a growth market with a cyclical overlay, as can be seen below. Here are slightly dated actuals/estimates of annual WFE spend (from Cowen). Consensus for CY21 WFE has since moved up to closer to $68B-$70B in CY21 (+15% y/y) with continued growth expected in CY22. KLIC results should generally follow the overall WFE trends. 

From Tokyo Electron in January 2021:

KLIC CEO in February 2021:

LRCX CFO in March 2021:

Wire bonder capacity continues to tighten (from last week):

Likely US Subsidies?

US subsidies have the potential to drive even more upside here. Part of the NDAA (Defense Authorization Act) approved by Congress in January authorized investments broadly in US domestic semiconductor manufacturing and assembly/advanced packaging specifically (ie KLIC equipment). It now awaits allocation of funding, with total potential subsidies of $30B being discussed (see below). Because the subsidies would likely cover only a portion of cost of these subsidized factories, the potential impact on the WFE market could be multiples of that $30B, over a multi-year period. I don’t believe these massive subsidies are at all incorporated into estimates or investor thinking at this point, but could be soon, and the impact should be big, even relative to the already large $60B-$70B annual WFE market. The Reuters article below indicates that these subsidies, which have bipartisan support, could come up for a full vote as soon as April.

https://spectrum.ieee.org/tech-talk/semiconductors/processors/us-takes-strategic-step-to-onshore-electronics-manufacturing

https://www.reuters.com/article/us-usa-congress-chips-idUSKBN2AW2EK?taid=604124dc9e53a40001b1ff3b&utm_campaign=trueAnthem:+Trending+Content&utm_medium=trueAnthem&utm_source=twitter

Balance Sheet & Capital Allocation

KLIC ended the Dec ‘’20 quarter with $577M of net cash, or $9+ per share. Assuming no buybacks, KLIC should end CY21 with ~$12/share in net cash. Due to the company paying a regular quarterly dividend (current yield 1.1%) and history of aggressive buybacks (share count down 20% since FY14), I give KLIC full credit for their large net cash position when thinking about valuation, thus my preferred P/E ex-cash methodology that has KLIC trading at <12x. 

KLIC has made a few smaller acquisitions over the years, including most recently a technology buy (Uniqarta, $26M cash) that will be incorporated into KLIC’s upcoming next generation PIXALUX advanced display products, focused on micro-LEDs, further bolstering growth in advanced display. 

Annual Results/Model

Analyst Estimates

Analysts are modeling a 15%+ drop in KLIC revenues from the March ’21 quarter (fiscal Q2) through YE21. I believe flattish or even up is more likely than a large drop-off, especially given the continued extreme tightness in wire bonder capacity noted above (Mar 9 Digitimes article above). Analysts are not particularly good at calling turns in semicap cycles and I don’t believe they’ve got this modeling (calling for a decline) correct either. Given that KLIC is really only 2+ quarters into the real cyclical upturn, I don’t believe we’ll see sequential revenue declines again so soon. The sell-side has given KLIC a low bar here. 

Catalyst

- US semi subsidies

- Upside to CY21 estimates