Bald Spots
Carl Johnson, INFRASTRUCTURE -- Semiconductor International, 10/1/2000
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Why all the concern? We've had "seasonal weakness" announcements from some large contract manufacturers, prompting several analysts to worry about the final demand for chips. Some are still positive on the sector, but that negative call we heard earlier this summer is not standing alone anymore.
In the capital equipment arena, PRI Automation, SpeedFam/Ipec, Robotic Vision Systems and Kulicke & Soffa have made headlines with disheartening earnings pre-announcements. With the first two, execution issues have delayed product deliveries. The penalties for this are high: loss of customer confidence and loss of profits rise to the top of the list. With the cycle moving forward at a blazing pace, no company can afford to misfire. Wall Street has given both companies' shares a very bad haircut. It's going to take a long time for confidence to grow back.
Not everyone is having problems meeting demand. The butchering received by shares of Kulicke & Soffa and Robotic Vision Systems stems from factors beyond their control. Basically, the final manufacturing subcontractors have been buying test, assembly and packaging equipment ahead of the curve so they can handle the increased outsourcing trend. Now these subcontractors are in a "digestion" or capacity assimilation phase. We're seeing a brief pause in back-end tool consumption as front-end wafer capacity is installed. In the next month we probably will hear from more companies that sell products for final manufacturing.
I have had numerous talks with industry executives in the past few weeks, and there is a pretty consistent view that front-end wafer processing capacity is constrained, demand is still healthy, and final manufacturing equipment demand will pull through after this settling period. Kulicke & Soffa and Robotic Vision Systems are on my purchase list along with several other final manufacturing suppliers because I think we soon will see stronger demand for their equipment as processed wafers head out the door. Today's weakness presents an opportunity for the forward-thinking investor.
It probably pays to reiterate what I said about valuations and the cycle last month. When buying or selling semiconductor equipment stocks, price earnings ratios and other standard metrics become much more valuable in the mid-part of the capital spending cycle. I suggest investors downsize expectations by realizing 40 and 50 price to earnings multiples are an event that takes place at bottoms and the very beginning of a growth cycle. These valuation metrics are contracting because the pace of growth in the capital equipment business is moderating, and we simply are not going to see the large quarter-to-quarter gains in bookings and shipments we saw last year and early this year. Ask any big name in the supply chain if they are capable of supporting another 40%-50% jump in tool shipments over the next year, and I am almost certain they will say it is impossible. Yes, we may see 20% year-to-year growth for large equipment companies. Yes, we may see higher growth for some smaller companies. Set your expectations to a reasonable level, and you will not be disappointed.
