5. AMAT’s Business
Overview
AMAT is working in the upper part of the semiconductor value chain. It provides the semiconductor industry with the machinery it needs to produce chips. The company employs 31,900 people and generates a total of $25B in annual revenue. AMAT manages most of its sales directly, not relying on distributors.
The company specializes in equipment for the semiconductor industry, but also for a few other sectors. This includes Display (screens), Solar, Roll-to-Roll coating (electronic printing on flexible film), and Automation software/Smart Factory.
Almost 3/4 of revenues come from the semiconductors segment. AMAT experienced explosive growth in the 2020-2021 period, before coming back to the previous growth trend:
| TTM | 2021 | 2020 | 2019 | |
|---|---|---|---|---|
| Semiconductors | – | $16.2B | $11.4B | $9B |
| Solar and others | – | $5.2B | $4.2B | $3.9B |
| Display | – | $1.6B | $1.6B | $1.7B |
| Total | $25.2B | $23B | $17.2B | $14.6B |
Most of the sales (86%) are to customers in Asia, notably China (33%), Korea (22%), Taiwan (20%), Japan (8%), and South-East Asia (3%).
AMAT’s headquarters is in Santa Clara, California. Its semiconductor-related products are manufactured in California, Texas, Montana, Israel, and Singapore.
So while the company’s clients might be in Taiwan, China, or Korea its production facilities are in much safer locations. This makes AMAT a rare haven of safety regarding geopolitical risk in the semiconductor industry.
If anything happened to AMAT’s clients in East Asia (like a China-Taiwan war), the loss of revenue would be offset by a massive and panicked build-up of capacity in other regions.
AMAT’s Moats
Besides its safety from a geopolitical point of view, AMAT is a high-quality company.
It is a leading supplier in the industry and sells directly to the most prominent companies in the sector. 20% of its business is done with Samsung, 15% with TSMC, and a bit below 10% with Intel.
The industry is inherently “moaty”, as good products lead to a dominance of the market, leading to more revenue, giving more money to keep innovating, and leading to more dominance. The same dynamic that has led TSMC to control half of the industry revenue is at play with AMAT.
The industry demands extremely high levels of capital and expertise, making it difficult for competitors to enter.
On top of this “general” moat, you can add the substitution cost. Any competitors need to prove an outstanding superiority to an existing user of AMAT’s tools. Anything less than that would make the risks of substitution too high.
The only risk for AMAT’s market position would be a technological shift away from its current and future offerings.
If we are to believe the company’s management, this is not a threat but an opportunity. The company seems to be the leader in the yet-to-be-implemented next technological progress.
The major technology roadmap inflections—including Gate All Around transistors, Backside Power Distribution Networks, new materials for interconnect and contact, and Heterogeneous Integration of chips and chiplets—are enabled by materials engineering where Applied Materials is the leader, and this shifts more dollars to our available market over time.
As I said, I am not a semiconductor engineer, so I am honestly not qualified to judge if AMAT is truly the leader in “Backside Power Distribution Networks” or “Heterogenous Integration”. But considering Samsung, TSMC and Intel are currently trusting AMAT to deliver high performance, I think we can expect them to stay the same in the next 3-5 years at least.
AMAT’s Operations
The company is offering tools and software for virtually every step of the chip manufacturing process. It is spending a large $2.5B/year in R&D, up from $2.2B in 2020 and $2B in 2019.
As AMAT products encompass all of the activities of a foundry, they can also offer integrated solutions. Each of its machinery lines can be integrated with each other, using AMAT’s software. That creates an incentive for buyers to add more AMAT products.
This level of synergy makes the substitution costs an especially strong moat. Replacing an AMAT tool or software can mean redesigning a whole part of the foundry operation, retraining technicians, ironing out bugs, needing extra checks to detect faults in the chips produced, etc.
Marketing & sales operations are remarkably lean, with a total cost of only $0.6B in 2021, compared to the $23B in sales. Or a sales cost-to-revenues ratio of just 2.6%. It seems to me that at this point, sales are more based on established relationships, reputation, and innovation rather than on the sale process itself. Because the industry is dominated by a relatively small number of established manufacturers, existing relationships matter more than developing new customers.
Similarly, overhead is just $0.6B. This means that the company could scale up sales up to its maximum production capacity without much increase in sales or administrative costs.
Overall, AMAT operation seems very efficient, with a very lean sales and administrative side, and most of the money going to innovation and maintaining high margins (more on that in the valuation chapter).
AMAT Investments
Relying on its expertise with silicon and manufacturing at the nanometer scale, AMAT is also investing in promising companies. The company invests around $100M per year in startups through its Venture Investment Branch.
AMAT has currently invested in a venture portfolio of 90 different companies. A complete analysis of this portfolio would turn into a report in itself, so I will have to keep it short.
What I find interesting is the presence of next-generation computing technology, like printed electronics, silicon photonics, and optical communication (via lasers). It is also touching new fields, like 3D printing/additive manufacturing, lithium-ion batteries, and electric motors.
It might seem like a very diverse portfolio, but every single one of these ventures relies on precise, atomic-level re-arranging of matter. That exact same field has been the center of AMAT’s expertise since the 1960s. So while applications might diverge, this is actually right at the core competency of the company. AMAT is uniquely qualified to evaluate startups in these industries.
Quite a few of these startups have been acquired, offering AMAT successful exits.
While this is surely profitable, I think it could be interesting for shareholders to maybe see the company going all in for at least one new application, adding a new segment to the current solar+display+semiconductors. 3D printing equipment has the most potential in my opinion.
AMAT is also partnering with multiple universities, research institutes, and companies. These partnerships seem to work together with venture investment in fields like battery technology, 3D printing, and medical treatments using nanotechnology.
AMAT Outlook
AMAT’s moat from a supply chain and technology point of view looks secure. So how is the business outlook?
While I assume new foundries built up all over the world should be good news, I preferred to check it up. I mentioned AMAT revenues jumped in 2021, and so did its backlog:
| 2021 | 2020 | |
|---|---|---|
| Semiconductor | $6.7B | $2.9B |
| Solar and others | $4.3B | $2.6B |
| Display | $0.7B | $1.1B |
| Total | $11.7B | $6.6B |
Despite the generally cooling global economy, the backlog has only grown. At this point, it is beyond 12 months, with AMAT clients providing longer than usual visibility about future demand. And that was before the USA decided to provide an additional $50B in subsidies for new foundries.
We expect Applied to remain supply constrained for the next several quarters, we are working through our very substantial backlog of orders which provides a buffer to in-year demand fluctuations and, in addition, customers are providing us with longer-term visibility and commitments in response to their own customers’ actions to lock in the strategic capacity they need.
The Twelve-Trailing-Months (TTM) revenues also seem to indicate that demand is not slowing down. The only sector slowing down is Display, which makes sense as people are buying fewer TVs and computers.
I think the need to improve the efficiency of current foundries was a big reason for the jump in sales in 2021, along with AMAT’s clients being flush with cash and overwhelmed by demand.
Because consumers of chips are also likely to start building a much larger inventory, I think chip demand is going to stay somewhat elevated for a while, at least outside of the consumer electronic markets. This should give AMAT’s client the cash and confidence needed to go forward with the plans for new foundries.
So going forward, the demand will be driven by the need to keep current foundries running, along with building new ones.
