Description

Note:  We drafted this write up last week before the news of Chinese stimulus so the share price in the write up is $17 per share while the current price is $20 per share.  Please assume the share price is $20 per share throughout the write up.

We think ACMR is a long with 100-300% upside and relatively limited downside over the long term.  The company is (a) under-followed (never written up on VIC before), (b) cheap (single digit earnings multiple), (c) rapidly growing (+20% top line growth for years to come), (d) well-capitalized (net cash balance sheet), (e) owner-operated (founding CEO is the largest shareholder) and (f) has an attractive potential catalyst in the monetization of its publicly traded subsidiary is is valued at 2x its market cap.  That being said, let us be clear:  this is NOT a widow-and-orphans stock.  This is a highly volatile, unusual U.S. based company with semiconductor capital equipment manufacturing assets in China.  Please see the appendix for the risks related to the US-China geopolitical tensions related to the semiconductor industry.

We believe that ACM Research (ACMR) is a very attractive long-term investment with the potential to be a multi-bagger due primarily to (a) it being a significant beneficiary of Chinese domestic substitution in the wafer fabrication equipment (WFE) market and (2) a nascent international business opportunity that you are not paying for but could be very valuable if management executes.  We think the downside is rather limited but the upside could be 100% to 300% over time with an incentivized US-based management team, a healthy balance sheet and normalized multiples that are double or triple the current US listing valuation (including the company’s own Shanghai subsidiary)

The tenets of our investment thesis are:

• China WFE market is in its early innings of its shift to domestic substitution - a strategic geopolitical imperative – and ACMR has a dominant position in cleaning equipment with chances to expand in deposition, advanced packaging and other areas. ACMR exists in a unique zone: benefitting from domestic-substitution related growth driven by geopolitical imperiatives, yet relatively safe from US and Western sanctions because it focuses on mature-node equipment outside of the leading-edge nodes that have security concerns.
• There is clear line of sight to Company’s formerly-ambitious domestic target, which has been credibly raised recently. It's long-term international targets are ambitious.  Even partial achievement could result in multi-bagger upside for stock
• ACMR is the only US-listed semiconductor company directly benefiting from the theme of domestic Chinese substation. Its Delaware corporate structure is far less risky than typical VIE (even if some VIE’s have been able to recently repatriate cash)
• Management is well-aligned (owning significant amount of US-listed shares), incentivized and has executed well to date with attractive proxy compensation milestones
• Normalized valuation multiple is double or triple the current US listing valuation – as evidenced by the company’s Shanghai listing – but US stock is depressed based on fears of Chinese WFE spending slow down. The stock is cheap on an absolute basis, and very cheap relative to 1) it's own Chinese listing 2) other Chinese semicap companies 3) US-listed global semicap companies
• Rebuttal to a now-obsolete short seller report provides a fine-toothed-comb dissection of many of the risks in the investment

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China WFE market is in the early innings of its shift to “domestic substitution”

China has set out to replace its reliance on foreign semiconductor capital equipment vendors with home-grown national champions

• The Goal for China’s Chip Giant:  Cut Out the US: https://www.wsj.com/tech/chinese-semiconductor-industry-smic-self-sufficient-5210abf8
• China Intensifies Push to ‘Delete America’ From Its Technology:  https://www.wsj.com/world/china/china-technology-software-delete-america-2b8ea89f
• China Tells Telecom Carriers to Phase Out Foreign Chips in Blow to Intel, AMD: https://www.wsj.com/tech/china-telecom-intel-amd-chips-99ae99a9
• YMTC Refines Chip Tech With Chinese Tools https://www.bloomberg.com/news/articles/2024-09-18/ymtc-advances-chip-tech-with-chinese-tools-techinsights-says

The result is that China – through public, quasi-public and private foundries – has been spending an enormous amount of money on building their own national versions of Lam Research, Applied Materials, Tokyo Electron and others.  For that reason, the revenue growth in China for these global peers has been close to zero while the growth rates of Chinese competitors is 30%, 40% or greater:

Currently, there is enormous concern and controversy about what future China WFE spending is – and whether it stays at or above the current $35 - $40 billion level or not.  Some analysts (Bernstein) are relatively optimistic, while others (Needham) are pessimistic, but the important thing in our analysis is that we believe that ACMR (and its Chinese peers) can grow even if there is a sharp decline in the overall China WFE market because of the greater importance in market share gains that will likely accrue to them:

Some excerpts from various sell-side reports on the China WFE market:

Needham: 

While we acknowledge that we have no way of knowing whether China WFE grows or shrinks and by how much in 2025, we believe that the long-term outcome is clear that China wants self-sufficiency in semiconductor manufacturing and that $30 or $40 billion is largely nothing compared to China’s national and economic strategic interests.  History has taught us that many nations (including the US, Japan, many European nations, Korea and Taiwan) are willing to spend extraordinary sums to develop domestic capacity in this increasingly important industry, and with indirect means (subsidies, nudges, directed defense spend, etc). The recently-popular book Chip Wars provides a quick chronicle of this history, which we think is rhyming in China today.

It is also important to note that if China is serious about its self-suffiency aspiration in a reasonable time horizon, it needs to keep WFE investment up or risk an accumulating deficit of needed spend in the future. An examination of mature-logic below illustrates this below:

Company’s ambitious long term targets may be credible and would results in multi-bagger upside for stock

While we are not downplaying the importance of near-term China WFE trends, we think that there company’s long-term potential could yield to truly incredible results.

In 2022, the company introduced its first set of long-term financials targets, with a long term goal of $1 billion when it’s current revenues were $385 million:

Even though this was quite ambitious at the time, the company is on track to reach $1 billion in revenues likely by early 2026.  

In 2Q24, the company updated their long term targets with an even more ambitious target of $3.0 billion in revenues, with $1.5 billion from China and $1.5 billion from the rest of the world.

*IF* (and it’s still a big IF) ACMR can get anywhere close to these targets, then the potential upside could be based on $3 to $6 per share in earnings with the right multiples being 20x to 30x, in line global platform peers like Lam Research and Applied Materials:

Delaware corporate structure is far less risky than typical VIE (even if some VIE’s have been able to recently repatriate cash)

While many investors may shudder at the mention of a US listed company with semiconductor operations in China and at the heart of the current US – China trade tension, we think that ACM Research’s corporate structure is as favorable as possible to US shareholders.  Unlike most other Chinese technology stocks, ACMR is NOT a variable interest entity (VIE) but a Delaware incorporated company with direct ownership of its Chinese assets.  We are not suggesting that there is no geopolitical or corporate risk to ACMR, but we think that if investors can take the time to get passed the headline risk, the corporate structure is actually rather protective for US shareholders. We also note that the founder is US based, the company is California headquartered, and the insiders own US-listed shares.

Management is incentivized and has executed well to date with attractive proxy compensation milestones

Likewise, unlike many Chinese stocks or ADRs, the management and board here own the same US-listed shares as we do.  Founder David Wang has been the long-time CEO and chairman and is the largest shareholder.  His stake of roughly 8 million shares (the proxy statement double counts the Class B as Class A too) is worth more than $140 million, which is a considerable sum relative to his $400k salary and bonus. 

CEO Wang has been granted stock and options in the past, including 2023, but some earlier options (2020) have performance based milestones that are favorable to all shareholders, specifically stock price targets of $40 and $55 per share:

Option was granted on March 20, 2020. An initial 545,397 shares vested and became exercisable on August 5, 2020, which was the first trading day as of which the Issuer’s market capitalization equaled or exceeded $1,553,383,586. The remaining shares will vest and become exercise in two equal installments upon the first trading days, if any, on which the Issuer’s market capitalization equals or exceeds $2,553,383,586 and $3,553,383,586, respectively.

Normalized valuation multiple is double or triple the current US listing valuation – as evidenced by the company’s Shanghai listing

A quick glance of the Chinese (and global peers) shows that ACMR’s valuation is wildly discounted:  Chinese peers trade at 30-40x earnings and US/Global peers trade at 20x or greater with significantly lower growth rates, while having significant exposure to the Chinese WFE market.  The valuation of ACMR relative to any of these peers is clearly an outlier:

An even more bizarre comparison is the value of ACMR (US) and its Chinese listed subsidiary – ACM Research Shanghai (ticker 688082 in China).  ACMR US owns 82% of ACMR Shanghai and ACMR Shanghai represents the overwhelming portion of ACMR US’s value and operations . . . yet ACMR Shanghai trades at 29x earnings and ACMR US trades at 9x! We note that ACMR Shanghai's valuation is not an outlier amongst Chinese-listed peers like Naura, AMEC and Piotech.

Of course, there are important differences in legal, country, regulatory and other risks, but from a fundamental business perspective, this is literally the same company. 

We do not believe that a large-scale monetization of ACMR Shanghai is likely but the valuation gap here is so large that even a small monetization of the Shanghai interest could move the needle and with the aligned incentives of insiders, we believe it would be done in a manner that creates value for all US shareholders. We note that the Shanghai listed share lockup for ACMR parent expires in early 2025.

Rebuttal to short seller report provides a fine-toothed-comb dissection of many of the risks in the investment

In October 2020, there was a short report (https://www.jcapitalresearch.com/acmr.html) that was published on ACM Research with many serious allegations. Instead of the typical company response of a one-paragraph blanket denial, ACM Research issued a 112 page response (https://www.sec.gov/Archives/edgar/data/1680062/000114036120028466/brhc10017901_ex99-01.htm) that calmly went through every detail with a fine-toothed comb, pointing out where there were factual mistakes in the short report (like miscalculating peer net margin when trying to compare company gross margins) or clarifications that nullify the claims made (a “related party” supplier was actually arms-length and has been a highly profitable investment for the company). Some concerns and skepticism around the company's prospects were correct and warranted at the time, but have been allayed by ACMR's traction and sales cadence domestically and internationally.

Regardless, the comprehensiveness of the company’s response has afforded us some additional comfort, given how attentive we are to the warnings from many activist short selling research reports.

Conclusion:

We believe that ACMR has several potential outcomes, with a wide range of possibilities:

• Base Case:                           20x on $2 EPS next year = $40 stock for more than 100% upside
• Bull Case:                             20x on $4 EPS in a few years if they can get any serious traction internationally = $80 stock for 5x upside
• Downside Case:                 10x on $1.00 EPS in draconian WFE market = $10 for 45% downside

Appendix

Customer Concentration

Select Chinese “Blacklist” / Entity List excerpts

CXMT Blacklist Bloomberg:  https://www.bloomberg.com/news/articles/2024-03-09/us-mulls-blacklisting-cxmt-to-further-curb-china-s-chip-advance

ACM has been operating under this environment for more than 3 years and seems to have navigated it well.

• ACMR’s current good results (+40% 2023 topline growth) was *despite* being hurt by these restrictions and the 28% growth forecasted in 2024 anticipates continued negative impact

• We believe that as a result of the October 2022 and October 2023 restrictions, several ACM Shanghai customers have significantly reduced production and related capital spending at facilities meeting the restricted advanced node capabilities. In addition, ACM Shanghai has experienced challenges as the companies in its supply chain adapt their policies to the new regulations. These factors had an adverse impact on ACM Shanghai’s shipments and sales in the twelve months ended December 31, 2023. We anticipate these factors will continue to have an adverse impact on ACM Shanghai’s shipments and sales in future periods, including as a result of any impacts from the October 2023 revisions.

• Even sales to SMIC – the most high profile target on the list – have *grown* despite these restrictions

• $93 million in 2023 from $19 million in 2020, despite the challenges above à imagine what those revenues could have been with no restrictions
• In December 2020, SMIC, one of the largest chip manufacturers in mainland China and one of our key customers, was one of numerous entities added to the Entity List. Challenges faced by SMIC and its key suppliers as a result of the listing have indirectly impacted SMIC’s demand for, and ACM Shanghai’s ability to supply, ACM Shanghai products.

• YMTC was added to the list in 2022 and revenues from this customer have stagnated since 2020, but ACMR as a whole has grown well

• More recently, in October 2022, YMTC, a leading mainland China memory chip company and one of our key customers, was added to the Unverified List of the EAR alongside a number of other Chinese entities. The Unverified List identifies parties for whom BIS has been unable to confirm their bona fides (i.e., legitimacy and reliability about the end-use and end-user of items subject to the EAR). Entities listed on the Unverified List are ineligible to receive items subject to the EAR by means of a license exception if a U.S. export license is required. In December 2022, YMTC was moved from the Unverified List to the Entity List. Challenges faced by YMTC and its key suppliers as a result of the listing could indirectly impact YMTC’s demand for, or ACM Shanghai’s ability to supply, ACM Shanghai products.

Disclaimer:  I, my firm, or my firm’s clients may have a position (long or short) in the securities discussed herein and may change such position without further notice.  This is not a recommendation to buy or sell any security.

Catalyst

- Continued growth in revenues and earnings

- Expansion of US and non-China Rest of World business, which would lead to significant multiple expansion 

- Potential monetization of ACM Research Shanghai stake 

- Increasing US investor awareness of stock