There have been quite a few updates relating to Kulicke and Soffa (KLIC or “K&S”) since I sent the original thesis and the holistic investment pitch and analysis. Here I will provide a brief overview of these developments and an update of the analysis and price target. Also, mark your calendars for the Company’s Q2 earnings release on Wednesday, May 5th; the conference call will occur at 8:00am on Thursday, May 6th.
Quick Note: Please let me know if you don’t find this helpful. I feel it is part of my responsibility to keep you all up to date on the companies I write about. These updates will be quick and to the point; great practice for me as I try to make my writing more concise.
The next newsletter will be a massive earnings overview of the chip and software/Internet companies I have been following. I am working on it incrementally, so don’t want you all wondering where I am. I am also putting together an excel workbook that will contain a lot of the data and metrics I find helpful in my analysis. This will be shared with you all.
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Q2 2021 Earnings Guidance Revision
You can access the press release here. The Company announced Q2 Revenue guidance of $340MM on non-GAAP EPS guidance of $1.20 on April 19th. This was a 13% increase above consensus and my internal Revenue estimate and 30% above the EPS estimate. I received a few messages at the shock as to why the stock was then down over 4% on the day, closing around $52 a share. My response to all was somewhere along the lines of “I don’t know and I don’t care.” One day does not make a trend, daily movements in the market follow chaos theory - it’s a waste of energy to try to understand it. Notwithstanding, almost all of the chip companies were down that day. However, there was an important takeaway from the guidance revision; it was a signal that the thesis is correct.
The Company’s release noted the continued strength in General Semiconductor, Industrial & Automotive, and LED segments. These comments are in line with continued reporting at the industry level. While the Company faces competition from BESI and ASM Pacific in the advanced packaging niche, the Company hinted at progress in the adoption of its leading-edge, high-density assembly product line. After doing some checks, I found out K&S had a recent design win for its next-gen TCB tool. The customer is a Bitcoin mining company, which needs to combine different chips at different nodes. It is important to note that the TCB tool beat out flip-chip. As a reminder, flip-chip was the “next big thing” in the early 2000s and was expected to replace wire bonding in the market. Fast-forward 20 years and wire bonding still account for 80% of the market with flip-chip only at 20%. My previous write-up addressed why wire bonding will always be prevalent; the point here is that TCB may be what flip-chip never became. The widespread view is that the industry is moving towards flip-chip integrations using TCB. KLIC is making investments to execute on this trend. I’ll conclude this part with the CEO’s statement from the press release:
“We remain very focused in supporting our customers' capacity expansion plans while also delivering new solutions that address fundamental challenges within the growing assembly market. Separately, we have also made significant progress to mitigate near-term supply chain constraints, which improves our outlook into the fiscal second half.”
- Fusen Chen, President and CEO
The section that I bolded is extremely important to understand. Tightness across the Company’s supply chain had previously limited upside in performance for 2021. Availability of the materials and parts required to build the Company’s equipment allows them to expand capacity and address the growing backlog this year. The Company’s announcement was followed by revisions to financial estimates by the Street, which drove the stock higher.
Analyst Estimate Revisions
As a reminder, in the initial investment analysis I wrote:
“Consensus estimates have not appropriately adjusted to the company’s demonstrated results and guidance, partially a result of historic cyclicality… The chip and equipment shortage in the market sets the stage for upside revisions through at least mid-2022.”
Christopher Seifel, Kulicke & Soffa (KLIC) - Investment Pitch and Analysis Part I
There are two immediate takeaways: 1) notice the high correlation between the forward Revenue estimates and the stock price and 2) the spike in consensus forward Revenue estimates that occurred in mid-April. This is a quality example of deep research yielding high conviction in an outcome, which then occurs. While I attribute a lot of investing outcomes to luck, this was not one of those instances. What was surprising was the timing of course, as the press release served as a catalyst instead of the actual earnings report itself, which I referred to in the original write-up. Close enough!
Enough self-congratulation - the focus should be on why this matters? Besides providing further conviction in the thesis, the updated guidance provides an opportunity to learn about the market’s view of the Company and what that means in terms of a revised price-implied expectations (“PIE”) price. The table below summarizes both consensus estimates and my internal forecast before and after the Company increased guidance.
Guidance Revision Takeaways
While the table should be self-explanatory, there are some key takeaways that I noted.
- First and foremost was the 10% and 12.6% increase in 2021 and 2022 Revenue estimates, respectively. However, consensus still reflects modest sales growth in 2022. This runs contrary to the commentary coming from CEOs and industry insiders adamantly stating that the chip shortage will persist well into 2022. Accordingly, a backlog in demand for the Company’s assembly equipment should persist, as well. Admittedly, I may have to revise my 2022 estimate downwards slightly. I am continuing to monitor forecasted chip shipments and the adoption of the Company’s miniLED equipment.
- The ~300 basis point EBIT margin bump by the Street is profound, but also reflects the inherent operating leverage in the business model, which I discussed in the prior write-up. That leverage is what drives the entire EBIT increase in my internal model.
- The difference in EPS estimates can be somewhat crosswalked via the differences and changes in Revenue and EBIT margins.
Impact on Price-Implied Expectations and Valuation
The importance of upward revisions in consensus estimates is the resulting impact on the Company’s valuation in the market. The image below is from the original write-up:
Remember the comment above on brevity? I’m not going to revisit all of the nuances of the valuation work, but rather I will simply provide updates to these figures:
- P/E: At 17.5x NTM EPS: Analyst Estimates ($4.02) = $70.35; Seifel Forecast ($4.58) = $80.15
- EV/EBITDA: At 11.5x NTM EBITDA: Analyst Estimates ($314.9MM) = $67; Seifel Forecast ($345.8MM) = $73
- Price-Implied Expectations(“PIE”): Analyst Median Estimates - $69.60; Seifel Forecast - $77.96
While I believe the EPS and EBITDA multiples are extremely reasonable to possibly slightly conservative, no one knows how the market will value these companies in the next year or so. The most helpful part of the analysis is the change in PIE resulting from the increase in the consensus EBIT estimate (resulting from sales increase and operating leverage). The consensus PIE increased by 22.7% as a result of the upward revision to estimates; meaning the stock should be trading around $70 based on current expectations. I went through an exercise of my own to arrive at a general idea of where I think the price should shake out over the next 1-2 years, which you can read here:
“I was admittedly conservative in my initial thesis, underwriting too much risk in my probability assessment of future performance and not appreciating the Company’s ability to expand capacity to meet demand. KLIC’s updated Q2 2021 guidance of $340MM Revenue and $1.20 EPS greatly exceeded even my own expectations.
This PT raise factors in the company’s expected ability to meet the unprecedented demand for its products resulting from the structural tightness in the market, discussed in my original report. I have a growing confidence in the sustainability of the chip and equipment shortage into 2022 based on the commentary coming from earnings reports of the chip companies. Kulicke and Soffa is representative of one of the right tail strategies that I learned by studying Yen Liow: Secular within Cyclical.
Given the inherent inaccuracy of forecasts and price targets, directionality is the key. To mitigate the illusion of control and precision, I triangulate an average price target based on a variety of valuation methodologies.
1. Fwd P/E Multiple: $5.50 expected 2022 Diluted EPS at 19x: $104.5
2. Earnings Power Value (EPV): $122.8
3. 2023 NOPAT: $96.71
Average 2022 Price: $108
Note: I have still not factored in what is expected to be robust upside from its miniLED business. Needham’s latest report indicates they expect the company to be the leader in miniLED placement equipment. Updates will follow related to this business vertical.
miniLED Business Update
That serves as a nice segway into the final component of this broader update on K&S. As mentioned above and in the original write-up, I did not give the Company much credit or upside for its miniLED business comprised of its Pixalux machine (and partnership with Rohinni) or the advanced LEAP technology it acquired in the Uniqarta acquisition. My biggest concern, and rationale for not underwriting this upside, is that Epistar is the elephant in the miniLED market and the discussions I had with those outside the Company were mixed as to Kulicke & Soffa’s ability to carve out a meaningful position in the market.
Fast-forward to Apple’s product announcement during its “Spring Loaded” event the day following the Company’s press release. Of the many product announcements, one stood out, in particular, that will prove meaningful to K&S: the M-1 powered iPad Pro. It’s remarkable to me that they will have the M-1 in the iPad, it’s staggering to think about how fast the machine will be. But more important is the display component, featuring a new Liquid Retina XDR display based on miniLED technology.
Here is the link - Kulicke & Soffa was chosen as (at least one of) the supplier of miniLED placement equipment used for the iPad’s production. I have not yet been able to confirm if they are or are not the sole supplier. Additionally, I had this helpful exchange with @MadThunderdome (really smart, great follow) on Twitter who knows K&S pretty well and has done some deeper work than I have on the miniLED business:
So, you see why I gave them no upside in the model for miniLED - I can’t gain conviction! When market participants provide mixed feedback, I lean on the side of conservatism. But with all that being said, winning the Apple iPad contract (or one of them) positions the Company well to win not only the Mac business (as it moves to miniLED, as well) but also for the Android family which is expected to begin production next year. It’s just like in your career, getting your foot in the door can open up a whole new world of opportunities. This could be the launching-off point for Kulicke & Soffa’s miniLED business. Recall, the miniLED market is expected to grow at a CAGR of over 40% through 2025. Next year, in 2022 alone, 1 trillion miniLED dies are expected to be placed, provided an estimated 15% share of the overall display market. I am not going to do the math to get everyone excited about the Revenue opportunity since I can’t speak to the likelihood, but it could be roughly double the current Revenue base.
General Thoughts and Analysis
This section contains some of the thoughts I had and journaled, resulting in a riff on the current state of the market and company. I touched on some of these items above, but thought it may be helpful to see how my thoughts somewhat evolve.
So, I couldn't care less about a move from a day or a week. The real value will come when the Company re-rates as the market realizes this Company is 1) a secular in cyclical right tail investment with 2) lower future volatility. Both drive a higher multiple for the stock - look at front-end WFE, all trade at a premium to KLIC. Which, based on history, makes sense - it should. The front-end equipment market was historically plagued by similar exacerbated oscillations that the back-end has continued to experience; these equipment cycles are levered (high beta) to chip shipments. However, around the beginning of the last decade, a variety of necessary advancements in production technologies drove value to the front-end; the follow-on effect being more stable cycles as a result of faster equipment upgrade cycles and the ever-growing share of maintenance & service business on the equipment (more on this later). Value in the equipment market, even with advanced packaging, has mostly accrued to the front-end. But as I mentioned in my write-up, that is changing now.
It is this inflection point that is driving a fundamental change in Kulicke and Soffa's business model and is grounds for the oncoming rerating. Packaging equipment is now a necessary part of the front-end along with most other parts of the chip production process. This is a necessary requirement as packaging is now being used to improve PPAC (power, performance, area, cost) through tighter integrations and connectivity. Especially as we move towards a heterogeneous packaging paradigm, combining all different types of processors and components onto a single substrate (or even chip), the packaging needs to be contemplated on the front-end. This will not happen immediately, as design capabilities continue to develop to incorporate packaging, and customers build out these capabilities. This will drive more stability in the Company's order flow and faster upgrade cycles, just like the front-end has experienced. $AMAT $KLAC $LRCX and Tokyo Electron all trade at NTM EBITDA multiples around 17-18x; $KLIC trades at 9.7x (on light consensus). I'm leaving out $ASML from these multiple discussions because it trades at a rightful premium to all (more than happy to elaborate on this). K&S is trading at a 35% discount to its peers larger peers. $FORM is trading at 30.5x NTM P/E and BE Semiconductor, a leader in flip-chip packaging, is trading at 23.5x. There is no other way for me to say this except KLIC IS GOING TO RERATE HIGHER. Assuming just 20x on my 2022 earnings estimate of $5.50, $KLIC should be trading at $110... just quick BOE analysis that triangulates nicely with my EPV analysis of $105.
Furthermore, I just got an update from IR on all things, they just had a big TCB design win for a 7nm crypto mining use case - which beat out flip-chip. This is important to understand given the industry dynamics. When flip-chip came around in the early 2000s, it was supposed to supplant wire bond (which KLIC is the undisputed industry leader). Fast forward 20 years, wire bonding is still the packaging methodology for 80% of all ICs. So now with TCB, which will be the logical method for SiC and other advanced packaging techniques, KLIC has the durability of wire bond and upside from TCB (they also have flip-chip but BESI is the leader in the room).
Ok, all of this being said, I don't even contemplate the massive growth driver percolating in the company... miniLED. The Company's miniLED line is a result of its acquisition of Assembleon back in 2015 (for 1.1x revenue, no less). Without going into the details, miniLED is the next-gen OLED and enables the resurgence of LCD. Apple just announced miniLED screen for the iPad right? I'm still trying to confirm, but am pretty sure KLIC won the design for the packaging equipment for the miniLED screens used for the iPad. This is MASSIVE. Because then they will be the logical choice for when this transitions over to the MacBook and given the experience, I'd give it a high probability they win the Android business next year. This is ALL upside for me though, with just the base case display and core packaging business, the stock should be at $70 right now.
I promised brevity but am not sure I achieved that. I hope these updates were helpful for you all. It is important to see that the thesis is playing out: the Company is executing on its plans and the Street is starting to catch up with its consensus estimates. With that being said, there is still upside here (along with the risks, of course). I do think there is at least a year of upside for K&S before the market cools down. With that being said, the falsifiable and quantitative thesis provides a mechanism through which we can track the thesis and make sure our forward return profile exceeds the 20%-25% benchmark.