Description

The common stock of Axcelis Technologies, Inc. (ACLS) is currently trading at below half our estimate of its net liquidation value.  At this price, the stock offers a substantial margin of safety plus a valuable - yet negatively priced - option on the business of a one-time technological leader with substantial operating leverage to a recovery within the highly cyclical semiconductor capital equipment space.  

Liquidation Value

Our summary analysis of Axcelis' liquidation value, based upon the company's latest quarterly filing for the period ending June 30, 2009, is presented below. 

Net liquidated assets of $117mm after burn equates to $1.12 per share on 104mm shares outstanding.

Notes:

1.  Balance sheet receivables and inventories are recorded net of reserves, but are nonetheless haircut further as shown above.

2.  Current Liabilities include $8mm in deferred revenue, which presumably would be offset by undiscounted inventories, but the offsetting assets are nonetheless discounted again in this analysis.

3.  Axcelis' 417,000 square foot, owned building in Beverly, Massachusetts was appraised at above $80mm in the 4^th quarter of 2008, but is valued here at $34mm.  Our information indicates that the building is currently being marketed to corporations in the healthcare industry that are interested in the facility's cleanroom buildout.

4.  The company has state and federal net operating loss carryforwards (NOLs) in excess of $230mm, and foreign NOLs in excess of $10mm.  These are fully reserved against, but would be available to the shield future operating income of a going concern as they do not begin to expire until 2018.  We assigned zero value to the NOLs in this analysis.

5.  In March, 2008, Sumitomo Heavy Industries and Texas Pacific Group bid $6.00 per share for the company.  Axcelis' board rejected the bid, stating, "...the proposal undervalues Axcelis and is not in the best interests of Axcelis and its shareholders."

6.  The company has over 1,100 employees but no pension funding issues as its only retirement program is a defined contribution plan.

So here we have an enterprise that had a $600mm bid on the table just 18 months ago, with a liquidation value in excess of $115mm, now trading at a market value of approximately $50mm. 

Clearly the market anticipates a longer, deeper additional burn than the $40mm we are projecting.  While the $20.8mm loss in the latest quarter lends credence to the market's view, when we adjust for one-time items associated with the sale of their SEN joint venture interest, the repayment of a convertible note, and the business' ongoing restructuring, the actual burn was less than $15mm.  Mathematically, our $40mm burn estimate to breakeven will prove conservative if next quarter's burn falls below $10mm and the company trends towards profitability over the following three quarters.  We are fairly confident that this will be the case. 

Our discussions with management and industry participants, along with information on capacity utilization among the foundries provided by reports from Axcelis' customers (Taiwan Semi) and competitors (Mattson and Varian), strongly indicate that the industry is in the early stages of a new order cycle and that Axcelis should garner its fair share of this demand.  Some discussion about Axcelis' industry, its position in the industry, and the events that led to its current distress will help clarify our investment case.

Business Overview and History

Axcelis was spun out of Eaton Corp in 2000.  Its main business is the provision of ion implantation equipment to semiconductor chip manufacturers.  The company also offers dry strip equipment, curing systems, and aftermarket support to its customers.

Ion implantation is a central process in embedding transistors into silicon chips.  An ion implanter is a large, technologically advanced machine that injects electrically charged particles into the wafer.  Typical process flows require twenty implant steps, and the most advanced processes require 30 or more steps.  Three different types of implanters have been developed to cover the range of these processes required in chip fabrication: medium current, high current and high energy.  Axcelis' major competitor in the high current and high energy systems is Varian Semiconductor Equipment Associates.  These machines cost between two and three million dollars per unit.

Axcelis was caught without a leading edge product in 2005 when it maintained its position in "multi-wafer" or "batch" high current implantation devices and its customers shifted from multi-wafer tools to single-wafer tools for those devices.  By the time Axcelis could develop and ship their single-wafer high current and high energy products, the damage was already done.  The recession had depressed demand for this expensive capital equipment and Axcelis had no opportunity to recapture its lost market share.

The financial impact from this loss of position was devastating.  Revenues declined from over $500mm in 2004 to $250mm in 2008.  Gross profits receded from $212mm to $63mm over the same time period.  Axcelis believes it now has competitive products in all of its lines, and that they will be able to reverse a meaningful portion of their market share loss.  Indeed, when Sumitomo bid $5.20 and later $6.00 per share for the company in early 2008, Axcelis accused Sumitomo of trying to take advantage of a temporarily depressed share price.

 Unfortunately things got even worse as we entered 2009.  The recession and credit crisis left Axcelis without the liquidity to pay off an $85mm note that came due on January 15, 2009.  The issue was ultimately resolved when the company negotiated the sale of its interest in SEN, its Japanese JV, to its joint venture partner, Sumitomo Heavy Industries, for net proceeds of $122mm.

 With the SEN sale, Axcelis is out of the woods as far as bankruptcy risk goes, at least for the next year.  Furthermore, significant partnerships and product wins have recently been announced:  on July 14 the company announced an agreement with Shanghai-based Kingstone Semiconductor to jointly develop advanced ion implantation equipment; on July 22 they reported that China-based Semiconductor Manufacturing International Corporation (SMIC) made Axcelis' Optima HD high dose implanter its tool of record for that process in its advance logic production; on July 30 they announced multiple wins for their Optima XE high energy implanter from two major manufacturers in Asia; and on August 5 they announced a sales and support agreement with France-based Ion Beam Services (IBS). 

A wide confluence of industry information further confirms our view of a turnaround in Axcelis' end markets.  In its July earnings conference call, Applied Materials provided much higher guidance and reported a substantial rebound in silicon orders.  On August 3, Gartner reported soaring DRAM spot prices and cited concerns about shortages in the latter half of this year, particularly with regard to DDR3 technologies where Axcelis' devices are heavily exposed.  On July 30 Taiwan Semi announced a substantial year over year increase in its capex budget, with second half spending up $1.7bb from the $600mm it spent in the first half.

Price Target

Our conversations with management suggest that with even modest normalization, service and spare parts revenue should be expected to grow to $150mm annually (from $92mm annualized in the June quarter), and product revenue should grow to $100mm annually (from $45mm annualized in the June quarter).  With 50% margins on service/spare parts revenues and a 40% margin on product revenues, gross margin should total $115mm.  Subtracting Research, Selling, General, and Admin expenses of $90mm yields EBIT of $25mm, which should equate to cash earnings given the lack of debt and the tax shields. 

An eight to ten multiple on cash earnings or a two multiple on gross margin puts a reasonable valuation on the company of $200mm-$250mm, or $2.00 to $2.50 per share.  Finally, if one adds 10 cents on the dollar for the NOLs, or $23mm, to the latest undiscounted tangible book of $236mm from the latest quarter, the sum is $260mm, or $2.50 per share.  An acquirer could use any of these valuation techniques to justify a $2.25 purchase price and still regard it as a lowball takeout given the easy synergies available in reducing the SG&A and R&D expense lines.

Catalyst

Greater visibility on order book over the next several months

Order deliveries consummated toward year end

Cashflow and profitability appears towards the middle of 2010

Strategic buyer for company appears by the end of 2010