October 02, 2018 - 2:59pm EST by
2018 2019
Price: 80.41 EPS 7.94 8.64
Shares Out. (in M): 55 P/E 10.1 9.3
Market Cap (in $M): 4,406 P/FCF 0 0
Net Debt (in $M): -276 EBIT 550 603
TEV ($): 4,129 TEV/EBIT 7.5 6.9

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·        We recommend going long MKS Instruments (NasdaqGS:MKSI or the “Company”). MKSI is down 35% from its 52 week high of $124.85 and down 20% YTD, despite the broader semiconductor index (PHLX) being flat YTD (note some names in the index are also down quite a bit) due to concerns over a slowdown of spending in the semiconductor and semiconductor capital equipment markets as well as the impact of recent tariff announcements

o   MKSI’s share price has steadily dropped since hitting a 52 week high in March, in part due to lower guidance from management, who expects a moderation in Q3 revenue due to a slowdown in the industry

·       We believe the stock is currently pricing in a semi market downturn and that investors are not attributing enough value to the Company’s strong cash flow generation (even in a downturn the Company generates positive FCF), net cash position, and push in recent years to diversify to non-semi end markets such that today the semi market comprises less than 60% of MKSI’s sales vs. ~70% three years ago, with the remainder of sales coming from the industrial, medical, and research and defense markets which are less cyclical and deserve a higher multiple

·      We believe MKSI has 60% upside by next year based on a 15x P/E multiple on 2019E EPS

·       Company Overview

·        MKSI provides instruments, subsystems, and process control solutions that measure, control, power, deliver, monitor, and analyze critical parameters of manufacturing processes worldwide

·        The Company operates through two segments, Vacuum & Analysis (“V&A”) and Light & Motion (“L&M”)

o   The V&A segment provides analytical and control solutions products, including gas analyzers, automation control products, I/O modules, automation software, and precision machined components and electromechanical assemblies; and materials delivery solutions products comprising flow and valve technologies, as well as integrated pressure measurement and control subsystems to provide customers with precise control capabilities that are optimized for a given application

o   The L&M segment offers lasers and laser-based systems, including lasers and amplifiers, fiber lasers, diode-pumped solid-state lasers, high-energy pulsed lasers, and tunable lasers, as well as accessories; optics products, such as precision optics, thin-film filters and coatings, replicated mirrors, and ruled and holographic diffraction gratings; and photonics products comprising optical components, vibration, lens assemblies, and isolation solutions, as well as three-dimensional non-contact measurement sensors and equipment

o   1H 2018 sales were split 64% from V&A and 36% from L&M

o   Gross margins are 46% for the V&A segment and 51% for the L&M segment

o   1H 2018 gross profit was split 61% from V&A and 39% from L&M

·        V&A Segment

o   Analytical and Control Solutions Products

§  6% of total sales

o   Power, Plasma and Reactive Gas Solutions Products

§  31% of total sales

o   Vacuum Solutions Products

§  26% of total sales

·        L&M Segment

o   Lasers Products

§  13% of total sales

o   Optics Products

§  10% of total sales

o   Photonics Products

§  14% of total sales

·        All of the above product lines grew year over year

·        50% of sales come from the U.S., 11% from Korea, 10% from Japan, 19% from Asia (excluding Korea and Japan), and 11% from Europe (this split is virtually unchanged from the prior year)

·        MKSI’s diversified end markets include semiconductor capital equipment and device manufacturers, industrial technologies, life and health sciences, and research and defense

o   MKSI’s products are used in the major semiconductor processing steps such as depositing thin films of material onto silicon wafer substrates, etching, cleaning, lithography, metrology and inspection

§  Sales to semi industry comprised 58% of sales in 2017, down from 69% in 2015

o   Industrial technologies include applications such as glass coating, laser marking, measurement and scribing, natural gas and oil production, environmental monitoring and electronic thin films

o   The Company’s products for Life and Health Sciences are used in bioimaging, medical instrument sterilization, medical device manufacturing, analytical, diagnostic and surgical instrumentation, consumable medical supply manufacturing and pharmaceutical production

o   The Company’s research and defense products are sold to government, university and industrial laboratories for applications involving research and development in materials science, physical chemistry, photonics, optics and electronics materials. MKSI’s products are also sold for monitoring and defense applications including surveillance, imaging and infrastructure protection

o   Sales from non-semi markets increased from 31% in 2015 to 42% in 2017

§  This is a catalyst we think investors are not fully appreciating given earnings from non-semi markets are more stable and deserve a higher multiple


·        Recent Performance

·        Business has not slowed down yet and is still demonstrating growth:

o   1H 2018 sales were up 23% over prior year

o   1H 2018 EBIT was up 60% over prior year

o   Q2 2018 sales were up 19% over prior year

o   Q2 2018 EBIT was up 63% over prior year

o   Q2 2018 sales were up 3% over Q1 2018

o   Q2 2018 EBIT was up 14% over Q1 2018

·        Strong Financials

·        LTM financials (as of 6/30/2018) were $2.1bn sales, $600mm EBITDA, and $6.91 EPS

·        MKSI generates significant FCF (LTM levered FCF of $319mm, of which $274mm was used to pay down debt and $7mm was used to pay dividends)

·        Since 2010 gross margins have remained steady in the 41%-47% range, while the Company’s EBITDA margin and levered FCF margin have averaged 22% and 12%, respectively

o   Since 2010 ROA and ROE have averaged 9% and 13%, respectively

·        MKSI has $355mm debt (vs. $600mm in 2016 so the Company has done a good job of deleveraging) and $631mm cash for a net cash position of $276mm (debt/LTM EBITDA <1x)

·        The Company has operated with net cash position for all of the last 10 years except for 2016 when management acquired Newport Corporation for $980mm and used debt to help fund the acquisition

o   With a large net cash position, a catalyst could be the Company paying a special dividend or executing a large buyback

o   However, we would not recommend management do a dividend recap given low leverage in a cyclical industry is a good thing, but we do think the Company is being cautious by holding onto such a large cash balance

o   For example, paying a $276mm special dividend would result in the Company’s pro forma net debt position being zero and would allow investors to immediately receive 6% of the current market cap

·        Management has done a good job with its recent acquisition of Newport in 2016

o   In 2016 the combined company was expected to produce revenue of $1.4bn compared to LTM revenue of $2.1bn, so the business has grown organically as well as through acquisitions

o   Newport was the only major acquisition management has done in the past 15 years, demonstrating management's discipline in making large acquisitions

·        Valuation

·        MKSI is cheap today

o   Trading at 13.8x LTM levered FCF, 6.9x LTM EBITDA and 11.6x LTM P/E, which are discounts to the 5 year averages of 11.2x EBITDA (38% discount) and 26.0x P/E (55% discount)

o   Recognizing the headwinds from potential oversupply in the semi market and tariffs, we acknowledge MKSI should trade below its historical average multiple range to be conservative, but EBITDA and P/E discounts of 38% and 55%, respectively, seem overly punitive

·        Relative to LTM EBITDA of $600mm and LTM EPS of $6.91, analysts are currently projecting 2019E EBITDA of $682mm (6.1x EBITDA) and EPS of $8.64 (9.3x P/E)

o   Placing a 15x P/E multiple on $8.64 of earnings would result in a target share price of $129.60 at year-end 2019, representing ~60% of upside

o   A 15x P/E multiple is well below the Company’s 26x historical average multiple and on a sum of the parts would imply a ~13x P/E multiple on the portion of the business exposed to the semi market and a ~18x multiple on the portion of the business exposed to non-semi markets which are less cyclical

§  Discounting analyst estimates of $8.64 EPS in 2019E by 20% at a 15x P/E multiple would result in a target share price of $104, which is still ~30% greater than today’s price

o   Our target price is only 4% higher than the 52-week high which occurred in March

·        Risks

·        The biggest risk is a downturn in the semi market happens, but history has shown that the Company recovers quickly in downturns, and its net cash position should allow it to withstand a downturn (note the Company was cash flow positive in the last downturn)

o   During the financial crisis, revenues declined 50% from $781mm in 2007 to $393mm in 2009 before rebounding sharply to $853mm in 2010, surpassing 2007 levels

§  While the gross margin held fairly steady at 42% in 2007, 38% in 2009, and 44% in 2010, the EBITDA margin did take a hit and dropped from 18% in 2007 to 4% in 2009 before rebounding to 24% in 2010

·        During the financial crisis, MKSI’s cash conversion cycle increased from 149 days in 2007 to 235 days in 2009 (due to inflated inventory and AR days) before dropping back down to 133 days in 2010

o   Current cash conversion cycle is 140 days and would likely worsen in a downturn, which would negatively impact FCF

·        Customer concentration

o   Semiconductor customers Applied Materials and Lam Research (both of which are also down YTD) comprised 13% and 12% of 2017 sales, respectively

o   Top 10 customers comprised 43% of sales in 2017


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


  • Semi market does not undergo a sharp reduction in spending like the market predicts
  • Net cash position is used in shareholder friendly ways like a special dividend or large buyback
  • MKSI continues to diversify towards non-semi end markets which should increase the stability of the overall business and could result in multiple expansion
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