By Richard Tortoriello
Kulicke & Soffa Industries (KLIC ), ranked 5 S&P STARS (buy), dominates the small but dynamic market for semiconductor-assembly equipment. The Willow Grove (Pa.)-based company, also known as KNS, holds nearly 50% of the market for wire bonders, which are used to string very fine wire between tiny contacts on chips and larger electrical leads on the chip's package.
The company also makes consumables, such as the gold wire used in the assembly process, sells test-interconnect products, and licenses advanced packaging technologies. With revenues of about $500 million in calendar year 2001, KNS accounted for about a third of the $1.5 billion assembly-and-packaging market.
This segment, which represents about 5% of the total semiconductor capital-equipment market, has historically served as a leading indicator of impending changes in semiconductor demand. When semiconductor companies see chip demand slow, they put assembly equipment orders on hold. Conversely, when demand picks up, packaging subcontractors begin to place orders for the latest bonding equipment to meet demand and to gain a technological lead on competitors.
In late summer of 2000, for example, KNS was one of the first companies to report delays in orders for semiconductor equipment, foreshadowing a cyclical decline that hit sector after sector of the technology industry from late 2000 through 2001.
More recently, KNS has begun to see an increase in orders. Last October, the company received its first major order for 166 wire bonders. In January, the company got two more orders for a total of 324 bonders, followed by another order for 200 bonders in February. In addition, the outfit's materials business, which tracks semiconductor production rates, increased 16% in the December quarter, vs. the previous quarter.
S&P is of the opinion that assembly-and-packaging revenues will come back stronger than other equipment revenues. The reason is a sharp drop -- estimated at 61% -- in packaging-and-assembly equipment revenues in 2001, vs. an estimated 32% decline for the wafer-fabrication equipment market, according to trade organization Semiconductor Equipment & Materials International (SEMI).
With major technology shifts taking place in chip manufacturing, S&P believes chip-equipment companies have been focusing resources during the downturn on purchasing "front end" wafer-fabrication gear. As semiconductor production rates increase, however, S&P sees a greater proportion of spending shifting to the "back end" of the process, which comprises test, assembly, and packaging.
New orders for test-and-assembly equipment have already begun to increase relative to wafer-fab equipment orders, although from an extremely depressed base. The three-month average-order rate for test-and-assembly equipment increased 45% in December (month-to-month) and 50% in January, according to SEMI. Front-end equipment orders, by contrast, declined 6.4% in January after only a 2.3% rise in December. While S&P expects the order rate for test-and-assembly equipment to continue to outperform, S&P also expects it to moderate.
New products are also driving revenue growth. KNS recently introduced the Maxum wire bonder, which is capable of stringing over 15 wires per second, placing them as close as 45 microns apart (a human hair is about 75 to 100 microns wide). KNS estimates that the Maxum is 50% faster than its nearest competitor, the Eagle, made by Hong-Kong based ASM Pacific Technology.
During the previous upturn, leading-edge bonders sold for between $90,000 and $100,000. However, with competitors such as ASM and Japan-based Shinkawa currently selling bonders for $40,000 to $50,000, we estimate Maxum is now selling in the $70,000 to $80,000 range. Three of the largest packaging houses have already ordered leading-edge wire bonders from KNS. S&P expects more orders for Maxum to come as packaging subcontractors compete for business from the Taiwan foundries and other chipmakers.
KNS also has expanded its business with the acquisition in the fall of 2000 of two large test-interconnect companies, Probe Technology and Cerprobe. These outfits, which make products that provide the interface between large test machines and much smaller chips, now account for 26% of KNS revenues. As KNS introduced wire bonders capable of working with smaller spaces between electrical connections (also known as "pad pitch"), it found that test interconnects were becoming a bottleneck in the process. Although its bonders were capable of increasingly fine pad pitch, without matching test interconnect products, chips bonded with these ultra-fine pad pitches couldn't be tested. KNS believes the two acquisitions will solve this problem while also boosting revenues.
The company's advanced packaging segment (6% of revenues) addresses the markets for technologies such as flip-chip (or "bump") packaging, chip-scale, and wafer-level packaging. The goal of these technologies is to reduce chip size by eliminating wires. Flip-chip packaging, currently the most widely-used technology, involves the use of solder bumps to connect the electrical contacts on a chip with those on its package.
Instead of selling equipment, KNS licenses proprietary flip-chip technology to packaging houses and receives royalties based on the number of chips processed. The company estimates its technology is used for over 50% of all chips using flip-chip processing. Demand for advanced packaging technology is likely to see rapid growth over the next several years as the need for smaller chips to fit in products such as cell phones and personal digital assistants (PDAs) increases.
S&P believes that KNS's revenues will recover slowly in fiscal year 2002 (ending September), led by growth in its materials and test-interconnect segments, which are the most closely tied to semiconductor production rates. Orders for leading-edge wire bonders should turn into significant sales beginning in the June quarter. Because revenues for the first two quarters of fiscal year 2002 will be very weak, compared with the prior year, S&P sees revenues falling 19% to $448 million in fiscal year 2002, and then climbing by over 40% to $630 million in fiscal year 2003.
Following an anticipated dismal March quarter due to holidays and slow equipment sales, S&P sees gross margins rising in the latter half of fiscal year 2002 and reaching the low-40% range in late fiscal year 2003, up from the current mid-20% range. Margins should also get the full benefit of the transfer of much of the company's manufacturing operations from Pennsylvania to Singapore, which occurred just before the peak of the last cycle in fiscal year 2000.
As a result, S&P projects a loss per share of $0.81 in fiscal year 2002, followed by EPS of $0.86 in fiscal year 2003. Although it may seem early to buy the shares on this basis, the stock has a history of moving well ahead of fundamentals, as signs of a turn in industry demand occur. Although the shares have already doubled from their mid-September low of $8.16, they remain significantly down from their early-2000 high of $41 and their valuation remains attractive.
The shares currently sell at 1.8 times trailing sales and 2.4 times book value, above historical cycle trough valuations of 0.5 times and 1.0 times, respectively, but below historical cycle peak valuations of about 3.0 times sales and 5.0 to 6.0 times book value. With sales of wire bonders at unusually depressed levels, we believe that price-to-book value is the better indicator, and have set a target price of $24 (just under 4 times current book value) for the next six months to a year, implying potential price appreciation of about 25% from around $19 currently.
Analyst Tortoriello covers the semiconductor-equipment industry for Standard & Poor's