Fellow Seeking Alpha contributor Ashraf Eassa and I have both written previously about Ultratech (UTEK), a semiconductor equipment company that we both like for its innovative positions in laser spike annealing (LSA) and advanced packaging lithography ("flip chips"), as well as the potential of its steppers in LED manufacturing. In particular, we have both made the case that advanced annealing technologies are likely to be a critical factor in the move to sub-20nm processes.
Ultratech isn't the only game in town, though, and there are multiple technologies and process steps that are going to play significant roles in the production of FinFETs and 3D circuits. With that, I would take a look at Mattson Technologies (MTSN), as this company has already accomplished the not-so-easy task of gaining meaningful share in the dry strip, rapid thermal processing (RTP), and etch markets despite competing with giants like Lam Research (LRCX), Applied Materials (AMAT), and Tokyo Electron (TOELY.PK).
While 2013 has proven to be a very disappointing year for semiconductor equipment orders (and much like waiting for Godot), I don't believe this stagnation is sustainable. Foundries and chip companies can only delay orders and repurpose older equipment for so long. With that, I believe orders will begin to recover in late 2013/early 2014 and bring Wall Street back to the view that Mattson has the collection of tools and technology to challenge its prior record revenue levels - an achievement that I believe could take the shares to $3 or above.
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Playing In Three Major Markets
For a small company (a market capitalization of less than $125 million as of this writing), Mattson is surprisingly diverse and holds actually meaningful share in multiple markets. Dry strip and rapid thermal processing are areas where Mattson has had a presence for som! e time now, while entry into the etch market offers the opportunity of a much larger addressable market and, if things go well, larger revenue as well.
Dry Strip
Dry strip is the largest business for Mattson today. Dry strip refers to the cleaning of wafers after photolithography in order to remove photo resist and other residues. As chip producers move to new materials, the challenges in cleaning increase and Mattson appears to have solid tools to address these more complex chips.
The major dry strip product today is Suprema - Mattson's most advanced tool, and one that uses inductively coupled plasma (ICP) technology and vacuum transfer. Two of the company's primary competitors use one but not the other, while the third uses both but charges about 20% more for its tools. According to Gartner, Mattson holds about 22% market share in this roughly $180 million/year market, with Lam Research (which acquired Novellus and dry strip IP from Axcelis (ACLS)) and PSK as the primary competitors.
RTP
Rapid thermal processing (or RTP) is the second-largest business for Mattson at present. RTP is the process of rapidly heating and cooling a wafer to essentially "lock in" the surface material properties. While RTP has historically been done with furnaces or lamps, the move to new chip designs is forcing changes in the RTP market. Put simply, the choice is coming down to millisecond annealing done with flash lamps (the approach used by Mattson) or laser spike annealing (LSA).
Mattson has built a solid business for itself in the RTP market, with about 7% overall share and higher share in the newer, more advanced markets. Applied Materials is the 800-lb gorilla of the space with over 50% market share, and Dainippon Screen is a player as well.
While Mattson has a longer history in this market, the battle between Mattson and Ultratech (and flash annealing versus LSA) will be an interesting one to watch. The engineering papers I have read seem to give the edge to LSA for ! its bette! r minimization of pattern effects (differences in energy absorption that cause nonuniformities in the chip), but Mattson argues that its new Millios tool delivers real advantages at 20nm and below in terms of process temperature flexibility, speed, and performance. To that end, both Samsung and TSMC (TSM) have been evaluating these tools in pilot production lines.
Etch
Last, and for now least, is etch equipment. Etching involves the removal of material from the wafer to create the desired pattern. This is a relatively new market for Mattson, having entered in 2008, and though they are among the top five etch companies, they have only 1% share and are well behind Lam Research, Tokyo Electron, Hitachi High-Tech, and Applied Materials.
Management is hoping that the paradigmE, launched in 2010, will change that and make the company a player in the market (and in the transition to FinFET and 3D NAND, which will expand the etching market meaningfully). Mattson claims that its shielded ICP source leads to less wafer damage with much lower capital and total ownership costs. Importantly, Mattson is targeting the mid-tier dielectric etch markets like spacer etch, pad etch, and so on where its cheaper tools ($2.5 million or so versus $4 million and up for more complex etch tools from Applied Materials, Lam, and Tokyo Electron) can offer an attractive price/value proposition.
Looking For A Bid?
As a small semiconductor tools vendor, the prospect of competing with large rivals like Applied Materials is daunting - AMAT spends more on R&D in one quarter than Mattson has earned in revenue over the last two years. But then Mattson isn't trying to be Applied Materials - AMAT touches virtually every area of the chip fabrication space and must spend aggressively to maintain its position.
Be that as it may, I think the possibility of M&A is relevant. Tokyo Electron acquired FSI International for its surface conditioning equipment, and it is not unthinkable that a larger company wo! uld consi! der Mattson for its dry strip and RTP technology. Lam Research, Tokyo Electron, and KLA-Tencor (KLAC) all lack RTP technology for FinFET, though Lam's position in dry strip and TEL's need to integrate past deals could be limiting factors for now.
A Buy To Be Sold
I'm not suggesting that Mattson is a stock to buy today with the notion of retiring with it. Semiconductor equipment spending should accelerate significantly over the next couple of years, but then it will decline again as it always has. Moreover, there's a risk here too of foundries and NAND customers reusing/repurposing prior generations of equipment in lieu of new purchases.
Even so, I believe Mattson can retest its previous revenue high-water mark ($287 million) during this next cycle, which means more than doubling revenue from today's level. Moreover, an operating efficiency initiative launched back in 2011 has reduced operating expenses and should improve the company's peak free cash flow potential - up to a high-teens free cash flow margin by my estimation.
Accordingly, I'm looking for a big spike in revenue and free cash flow from 2013 to 2017, followed by another sharp decline. With that, I see a DCF-based fair value of $3.00 per share today, though I freely admit DCF analysis in semiconductor equipment is tricky and stretching the recovery timeline out just a year takes about $0.25 out of the target price.
The Bottom Line
Mattson is already well off of its bottom and it is very reasonable to ask how this company will compete with (let alone seriously challenge) the likes of Lam, Applied Materials, and so on. For that, I would turn to the company's history - a history that has seen the company build its share in dry strip from 5% in 1993 to 22% in 20 years and establish at least a toehold in the RTP segment.
While I think Ultratech should do well in RTP with its LSA tools (which is definitely a threat to Mattson), there are multiple foundries out there, and I believe Mattson will get its share! of busin! ess as well. Moreover, I also like the fact that Mattson provides exposure to three market segments likely to benefit from the migration to sub-20nm processes.
I think Mattson is an interesting high-reward/high-risk opportunity in the equipment space, with roughly 50% upside once orders start to materialize. To that end, investors have to weigh the risk of further delays in new orders but remember as well that waiting to see orders in hand before buying will leave money on the table.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in UTEK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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