Editor's note: This column was submitted by Stockpickr member Dan Jacome.
An ongoing transition at
has disenchanted many investors, some of whom have abandoned the stock. But that has made shares of this small-cap semiconductor-equipment manufacturer cheap on a forward-earnings basis.
The bullish growth outlook for the company, which has leading positions in two key markets, is predicated on the company's reaching 45%-plus gross margin in late 2007 and into 2008 due to an improved product mix, particularly next-generation, rapid thermal processing tools, along with a bit of takeout speculation and valuation concerns.
With the stock trading just above $10 and the small-cap slice of the sector down because of recent order softness, there's likely roughly a dollar in downside and up to $4 in upside (a share price of $14) if Mattson executes as planned. Patient investors with a time horizon greater than a quarter or two should consider Mattson for their portfolios.
Mattson produces critical manufacturing equipment for use in the semiconductor industry. It sells strip systems to remove photo-resist residue without damage to insulating material. Customers include
( IFX) and
Mattson currently controls 24% of the dry-strip market (with the potential to increase to 30% or more in 2008) and about 19% of the rapid thermal processing market (which could increase 400 to 500 basis points in 2008). The company has made some strong moves in the rapid thermal processing space and has deftly stolen share from industry bellwether
Under rapid thermal processing, also known as RTP, chips are quickly heated and cooled after they have undergone the ion implantation phase. RTP, simply put, "activates" the electrical properties of a chip, much like the way you activate your cell phone after you buy it in the store. RTP should become an increasingly significant part of the chip-manufacturing process over the next couple of years as device makers seek lower cycle times and improved thermal budgets.
The current technology -- batch furnace -- is far from gone, but industry experts agree that it will eventually phase out and make room for more cost-effective processes such as RTP. A late-2006 article in
sums up the investment case best in a quote from an Applied Materials executive:
Logic has traditionally been the entry point for RTP developments, with DRAM closely following behind it....Now this is happening with flash memory also. As NAND flash scaling is driving shorter thermal budgets, memory market applications for RTP are expanding.
- Mattson has delivered accelerated earnings growth for three straight quarters, but that trend is likely to break in the third quarter; investors may punish shares if Mattson misses the whisper and growth decelerates at a rate higher than the Street is expecting.
- Mattson is levered to the memory market, in which spending patterns are unpredictable. Moreover, as a smaller player, Mattson may be unable to satisfy customer demand in up cycles and may suffer greater losses in down cycles due to its higher fixed-cost structure.
- Korean competitor PSK has made some inroads in the strip market and could take more share from Mattson, although Mattson possesses a technologically superior tool.
- The stock currently trades at roughly 13 times my 2008 EPS estimate, but it should trade in line to slightly above its peer group (front-end stocks tend to trade at 15 to 22 times forward EPS) given its leading market position, strong balance sheet and potential for above-average margins. Furthermore, its exposure to DRAM (60% of sales) will likely make Mattson one of the first stocks to go to when the DRAM cycle sparks.
- I arrive at my $14 price target excluding cash by applying a 16 times forward price-to-earnings ratio to a 2008 EPS estimate of 88 cents, which is conservatively 8 cents higher than the analyst consensus figure. The price target does not consider a takeover premium for Mattson, which would be warranted given its broad customer reach and leading position in dry strip. Mattson has no debt, and management has indicated it would welcome a buyout.
- Mattson continues to rob share from Applied Materials.
- The currently morphing lithography landscape decommoditizes the strip process and enables Mattson to sell at modestly higher average selling prices.
- Batch furnace, the incumbent technology, phases out.
- The market recognizes that Mattson is trading at a price significantly less than its '07 and '08 growth rate and pays a higher multiple for Mattson stock.
- Mattson lands a higher-margin product mix and sees incremental operating leverage. When times are good, Mattson's earnings can explode, as they did in 2004 when gross margin was at 43% off a $245 million run rate and relatively fixed expenses. This is the direction I believe Mattson is headed toward again, but this is most likely a longer-term event than a quarterly one.
At time of publication, Dan Jacome was long Mattson, although positions may change at any time.
Jacome is an MBA candidate at the Kelley School of Business at Indiana University where he is majoring in finance and running Ceviche Fund Partners LP.
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