2023-09-26 13:45:10 ET
Summary
- Veeco has been executing better in its core business despite downturns in areas like hard drive capex, and recently won its first laser anneal business with a memory chip company.
- The company is targeting new growth opportunities in SiC epitaxy, nanosecond anneal, and ion beam deposition, and success here could generate hundreds of millions of incremental revenue dollars.
- Veeco's core business in laser anneal and MOCVD still offers attractive opportunities in areas like advanced logic circuits, photonics, microLEDs, and GaN/AsP chips.
- Veeco isn't "can't miss" cheap with a fair value in the low-$30's, but the business has some counter-cyclical traits and opportunities to exceed my (and Street) expectations.
It’s been a little while since I’ve updated my thoughts on Veeco Instruments (VECO), but since my last article on this small semiconductor capital equipment company, the shares have offered mixed performance. Up around 19%, the shares have outperformed the SOX (not the best benchmark, but I’m not aware of a dedicated semi equipment index), but lagged more direct peers/rivals like AIXTRON (AIXXF), SCREEN Holdings (DINRF), not to mention larger semi capital equipment players like Applied Materials (AMAT) and Lam Research (LRCX).
Execution will be paramount, but I believe there’s still an argument to be made for a bullish call on Veeco shares today. The company has been executing well in laser anneal, including a recent win with a memory chip manufacturer, and will soon ship evaluation units for new nanosecond anneal. Advanced packaging still holds worthwhile long-term promise, and the company has arguably underappreciated leverage to growth opportunities in areas like GaN and SiC chip production. With a fair value in the low $30s and a business mix that should prove somewhat countercyclical, this is a name at least worth a further look.
Targeting New Growth Opportunities – The TAM Numbers Are Big, But So Are The Competitors
One of the more interesting developments in the year or so since my last update is how Veeco appears to be pivoting toward more exciting long-term growth opportunities in the equipment space – including silicon carbide (or SiC) epitaxy and nanosecond anneal.
Veeco spent $30M (with a further $35M potential earn-out) earlier this year to acquire Epiluvac and its technology for SiC epitaxy (a process of applying silicon-based crystalline films that improve the electrical performance characteristics of the underlying wafer surface). SiC has been one of the hottest areas in semiconductors recently (led by companies like Infineon (IFNNY), onsemi (ON), and STMicro ( STM ) among others), as it is a key facilitating technology for vehicle electrification (as well as other advanced high-voltage applications like industrial automation, renewable power and so on).
With those underlying demand drivers, Veeco has quoted third-party research estimates of an addressable SiC epitaxy tool market of $500M in 2027. There are “buts” though – there’s still no real product at Epiluvac (a demonstration unit is expected before year-end), and so there’s still product development and performance/acceptance risk, not to mention the risk that larger companies like AIXTRON and ASMI ( ASMIY ) will take the lion’s share of the available market.
Another important emerging opportunity is in nanosecond anneal. A follow-on of sorts to laser anneal (where Veeco has meaningfully improved its product quality/performance over the last few years), nanosecond anneal could help facilitate emerging approaches like backside power deliver networks (a chip design approach that routes power supply on the back of a chip, improving logic density and performance) and other 3D architectures, as well as allowing for reduced interconnect resistance (important as architectures continue to shrink).
I haven’t seen specific estimates of nanosecond annealing market opportunities, but given the challenges with interconnect resistance as chips become ever smaller and the value in alternative 3D structures, I can see this technology being an important facilitator for future leading edge-chips. Evaluation units for Veeco’s nanosecond appealing technology should reach customers this year and in 2024, possibly leading to meaningful orders in 2025.
Veeco is also looking to repurpose and advance some of its core ion beam deposition and etch technology into new systems for applications outside of EUV mask blanks and thin-film heads for disk drives. If these tools perform well with low resistivity metals, it could create new opportunities for Veeco at additional advanced semiconductor nodes in 2025 and beyond.
Opportunities In The Core Business Are Still Attractive
Veeco’s future isn’t tied to big wins with speculative new technologies/products. There’s still a strong core opportunity in areas like laser anneal and MOCVD (metal organic chemical vapor deposition), with the latter including opportunities in photonics, microLEDs, and GaN/AsP chips (RF, power, and sensors).
With laser annealing, the company has made arguably underappreciated progress in improving the performance of its systems (including throughput) and has both grown and stabilized its market share (in the past, there would be significant swings in market share between tool generations due to performance issues/improvements). With that progress, Veeco has solidified its position at multiple steps with multiple logic customers and has recently won business in the memory space (a first for the company). Looking ahead, I think it’s at least plausible that further wins in memory could be attainable, and I’d note that new architectures like gate-all-around (or GAA) will require the lower thermal budget and lower contact resistance that these tools offer.
With MOCVD, I’m curious to see what the company can do in markets like photonics and GaN/AsP chip production. While SiC power devices get a lot of attention, GaN in particular is likely to see significant growth in the coming years as well, while photonics are crucial to advanced networking applications. AIXTRON is a formidable competitor here, so I’m keeping my expectations low, but I do think the company could have a larger market opportunity in tools for GaN chip production than is currently appreciated.
I also believe there are ongoing opportunities in the company’s lithography systems for advanced packaging technologies. Back-end packaging was a meaningful bottleneck for many chip companies in recent years, and advanced packaging technologies remain an important option in generating better performance from semiconductors.
The Outlook
I was expecting 2023 to be a more challenging year for the semiconductor and disk drive industries, and it has been even rougher than I expected. With that, my expectations for 2023 and 2024 are lower than before (about 10% and 7%, respectively), but I do expect a stronger rebound in 2025, and I see potential upside if evaluation units shipping out this year and next translate into meaningful orders for 2025 and beyond.
Long term, I think Veeco’s pivot toward higher-growth opportunities (more advanced nodes and new markets like SiC) can drive long-term annualized revenue growth around 6% to 7%. Hitting management’s long-term margin targets (20% non-GAAP operating margin on $800M in revenue) is more of a “we’ll see”, but I do think EBITDA margins in the 20%’s and free cash flow margins in the mid-teens are possible now in the good years. Should the company succeed with these newer products (and continue to grow the base business) such that the overall scale of the business grows, I can see a path to sustainably higher profitability than what the company has managed in the past, but it will always be cyclical.
I believe Veeco is modestly undervalued on discounted cash flow, and perhaps more meaningfully undervalued on margin-driven multiples-based valuation. If Veeco can in fact get EBITDA margins into the low-20%’s in this coming recovery/up-cycle, a multiple of 2.5x on FY’25 revenue (discounted back) can support a fair value of $30.
The Bottom Line
Putting a lot of faith into words like “it’s different this time” is a good way to lose money in the stock market, but I do think Veeco has turned a corner in more than one respect. My view is that the company is no longer playing catch-up and being reactive and is instead actively looking for growth opportunities where it can repurpose, develop, and/or acquire technology that is complementary to its existing business. It’s certainly possible that equipment demand won’t rebound in 2024 as expected and/or that Veeco’s newer ventures won’t succeed, but I think today’s price still offers enough upside to be worth further due diligence.
For further details see:
Veeco Instruments: Opportunities Across The Board And Not Overvalued