EUR 850.00 For Business Accounts Only

Morningstar | Applied Materials Intends to Acquire Kokusai Electric for $2.2 Billion; No Change to $49 FVE

On July 1, Applied Materials announced the acquisition of Kokusai Electric, which specializes in batch processing applications in niche deposition, diffusion, and oxidation areas, for $2.2 billion in cash from investment firm KKR. Although the Japanese firm is a relatively minor player in the broader wafer fabrication equipment industry, Applied’s management contends that its batch products complements Applied’s single-wafer processing systems (particularly in the memory market). Furthermore, the acquisition is expected to be immediately accretive to Applied’s non-GAAP EPS at close (within 12 months). We don’t believe other potential bidders (such as Tokyo Electron or Lam Research) will make competing offers. Despite current tensions between the U.S. and China, we don’t believe this deal will face major regulatory scrutiny from either nation, particularly given the successful combination of KLA and Orbotech in February.

In February 2019, the Financial Times reported that KKR had been exploring a sale of the chip equipment unit, which it purchased in December 2017 for $2.2 billion. Consequently, the deal appears promising on the surface, especially as Kokusai has benefited from the surge in WFE in recent years as revenue rose from $733 million in 2016 to $1.486 billion in 2018. However, we don’t anticipate revenue synergies, so we think the purchase price is reasonable for the recent and expected levels of growth. We believe calendar 2019 will be a challenging year for Kokusai (as memory spending has been weak). Both gross and operating margins for Kokusai are dilutive relative to Applied’s corporate average. After our initial assessment of the deal, we are maintaining our $49 fair value estimate for wide-moat Applied, and we view shares as fairly valued at current levels.

CFO Dan Durn said the offer represents a purchase price multiple of 7.3 on fiscal 2019 estimated adjusted EBITDA, after synergies, which compares favorably to recent tuck-in acquisitions in the WFE industry, including KLA-Orbotech at 15 times and ASML-Hermes Microvision at 40. The deal will be financed via cash on Applied’s balance sheet and a term loan facility, with the latter expected to be paid down within 24 months after close.

In both DRAM and NAND, batch processing can offer substantial performance and cost benefits, as these tools can process multiple wafers at once to drive productivity increases. Applied’s management outlined the recent surge in batch processing, as the total addressable market grew an average 35% from 2016 to 2018 (versus a 26% CAGR for WFE). We are somewhat concerned with Applied further entrenching its business into the memory market as opposed to diversifying more into logic and foundry arenas. For 2019, Applied is already poised to underperform peers such as ASML and KLA-Tencor, due to the sharp decline in memory spending. Kokusai does count Samsung, TSMC, and Intel as key customers, but we think logic and foundry equipment sales is only a fraction of total revenue.

Kokusai recorded about $300 million in service revenue in 2018, which represented 20% of total sales. We normally view this subsegment as a sticky revenue source that helps firms navigate cyclical equipment purchasing trends. Kokusai has an installed base of over 10,000 systems, which will be a nice addition to Applied’s existing 40,000-tool installed base.