Wednesday, August 15, 2007

Applied Materials and Technology Business Insights

Applied Materials (AMAT) reported its results for the quarter ending July 29, 2007 (their 3rd quarter fiscal 2007) yesterday. With revenues essentially flat both sequentially and year-over-year, this is not a company that investors are likely to get excited about at the moment.

Yet if you are investing in technology stocks Applied Materials is an important company to watch for insights into technology and its economics. Applied Materials is one of a small group of companies that makes a broad range of equipment for manufacturing semiconductor circuits. In the July quarter revenues were $2.56 billion. KLA Tencor (KLAC) is a competitor with $736 million in revenues last quarter; companies like Samsung and IBM make semiconductor equipment, but that is a relatively small part of their overall business; and there are a variety of smaller specialty competitors. It is reasonable to look at Applied Materials as a single-company proxy for the industry.

With Cisco reporting strong growth in the router and switch market I have to wonder if the slump we have seen this last year in revenues at semiconductor chip companies is hiding a trend towards stronger long-term growth. Cisco believes the transition to Internet telephony and video-over Internet are propelling its growth. Internet trunk line capacity was overbuilt in the late 1990's, but now we are seeing fiber optic cable being run all the way into people's homes. Certainly the bandwidth requirements of video are far higher than those of text and picture Web pages.

You might think that Applied Materials would be seeing demand for new semiconductor manufacturing equipment leading demand for chips, but that is not the case so far. Chip makers, including the increasingly important companies that run fabs for fabless and fab-light chip companies, are buying as slowly as possible. The only area where demand was characterized by Applied Materials as good was RAM or memory production. The increased use of memory in cell phones and other devices is a clear trend people are willing to bet on; no one wants to risk losing a supply contract with a cell-phone maker because they did not buy enough equipment six months ago to get it up and running and ready for next-month's demand.

But in non-memory silicon their has been caution. Demand hit 95% of capacity in 2006, then slumped, and is not back up to 95% quite yet. Discussions with customers indicate that, whereas a few years ago hitting 85% of capacity was a signal to start expanding plant, today manufacturers are delaying their costs by waiting until the 95% mark is reached.

In flat-panel display manufacturing Applied Materials management believes they are in the bottom of a short-term cycle that should end soon. In contrast to chip manufacturers, display manufacturers bought a lot of equipment in 2005-2006 and still have reasonable capacity. However, consumer demand for flat panels is exploding as prices fall, so soon more manufacturing capacity will be needed.

Applied Materials is also into creating the equipment to make both traditional solar cells and the new thin film cells; revenues in the area are growing and should be a larger percentage of revenues in 2008.

Another trend to not is the shift from 200 mm silicon wafers to 300 mm. Much is still done with 200 mm wafers, but Applied Materials believes the cost advantages of 300 mm are such that in the 2008 - 2009 time frame 200 mm wafers will no longer be cost-competitive, so those who have delayed shifting will have to buy 300 mm equipment.

You can tweek your models however you like, but no one is sure when video demand is going to help anyone much besides Cisco. Older personal computers don't do a good job with video; there are always people who (wisely) change computers only when they get a major performance benefit out of doing so. High-end cell phones are becoming more popular, driving demand for low-energy, high-capacity digital and analog chips. Increases in overall demand will show up eventually in semiconductor equipment maker revenues. Macroeconomics aside, I expect demand to be healthy as display screen sizes, memory requirments, and processing capacity for video all continue to attract end consumers (including businesses who want to save money by using telepresence technology).

More Data:

My summary of the Applied Materials analyst conference (August 14, 2007)
Applied Materials home page
KLA-Tencor home page

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