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Cash in on the semiconductor revolution with this low-priced growth stock!
by James Passin
Semiconductors!
I know what you're thinking: why mess around with those boring old commodity tech stocks, when the big, bad Internets are down 50% from their peaks?
I'll tell you why: the semiconductor industry has begun a powerful recovery -- and it will trigger gains of 5x or more in the right stocks. And unlike the Internets, you don't have to pay insane prices to play the game.
Semiconductors are usually regarded as cyclical stocks. It is now fashionable to make fun of, deride, despise cyclicals. Even after the recent ramp-up in industrial cyclicals (like CAT), they are still viewed as equity graveyards by mainstream investors. Most of the experts on CNBC shrug off the recent rotations into cyclicals -- a sign that the rotation is just beginning...
Insiders are loading up
Insiders at semiconductor companies turned into aggressive net buyers about six months ago -- and they're still buying.
This is a clear signal that company insiders expect semiconductor earnings to surprise to the upside over the next few quarters. What's good for semiconductor companies is good for semiconductor capital spending (capex). Semiconductor capital equipment manufacturers will benefit from a cyclical upswing in semiconductor capex.
I am particularly bullish on DRAM, the most "commoditized" of all memory chips. DRAM (Dynamic Random Access Memory) is positioned to begin a recovery trend following the 1998 industry shakeout. The key to playing the DRAM recovery is finding companies that will benefit from a cyclical bull market in DRAM capex, without being exposed to the inevitable long-term erosion of memory chip prices.
The most compelling play on semiconductor capex is Genus (GGNS-NASDAQ). At just over 1x book value and 1x annual sales, Genus is a screaming buy. I just got back from a meeting with top management at Genus's headquarters in Silicon Valley.
Given the company's solid balance sheet and strong management team, the current low share price is unjustified. I consider Genus as a strong buy under $3.00 with a one-year target of US$6 and a three-year target of US$15.
End of the PC
In 1965, Gordon Moore, the co-founder of Intel, proposed Moore's Law: Technology processing power doubles every 18 months -- and, therefore, the cost of technology declines 35% per year. Moore's Law has not only been empirically validated over the last three decades, but it has become the primary planning assumption for all semiconductor corporate strategy.
Could it be more than mere coincidence that Moore is the co-founder of Intel?
Moore's Law traps the semiconductor industry in a deflationary spiral that hands over pricing control to the customer. One of the biggest customers is Intel... This master-slave relationship has allowed the Microsoft Windows/Intel PC architecture (also called "Wintel") to achieve a global monopoly...
Out of the box
The era of the Wintel PC may be drawing to a close. The PC is losing relevance in the age of the internet. You don't need to have a box to get computing power...
Elbit Ltd.'s Peach Networks (ELBTF-NASDAQ) subsidiary has created a technology for getting Internet access and Windows 95/98 capability over regular cable TV digital set top boxes. Java-powered multi-media devices (using SUNW-NASDAQ software) let you check email or use a spreadsheet without a computer.
Or what about computer games hardware? Every slackjawed suburbanite teenager is wasting precious chunks of life on making inane cartoon figures jump over burning tires. But what the kids lack in brains, the machine makes up for in power: Sony (SNE-NASDAQ) is launching the Playstation 2 in September 1999.
In fact, that same Playstation 2 will be more powerful than a Pentium III -- but it will only cost around US$400. With this kind of low-cost computing power, the Playstation 2 represents more than a vehicle for training your children for another trenchcoat mafia-style massacre. Taipan believes that the Playstation 2 represents a significant threat to the Wintel monopoly -- and it will drive an explosion in demand for fancy, value-added memory chips...
Curl up and die
Don't get me wrong. The PC won't die tomorrow. The sub-$1000 PC will flood the world, resulting in the final Wintel boom. Since 75% of all DRAM parts are used in PCs, the fortunes of the DRAM manufacturers and Wintel are still intimately intertwined.
But the birth of a post-PC era would trigger a revolution in consumer demand for electronics and value-added chips -- ending the boom-bust cycle in semiconductor capital equipment.
Outlook for DRAM
The Asian crisis was the best thing that could have happened to the DRAM industry. Demand dried up, forcing hard-currency-strapped producers to dump chips below cost. As a result, marginal players were removed from the market. Only a handful of major DRAM manufacturers with adequate economies of scale survived the shakeout.
 Capital budgets were slashed by an average 50% in 1998. The capex reduction eliminated or delayed planned expansion in capacity. A surprise acceleration in PC sales resulted in a supply/ demand imbalance. DRAM prices firmed up.
Recently, DRAM prices have slipped again as supply from Micron Technology (MU-NYSE) flooded the market during the seasonally weak late April-early May period. However, Taipan believes that DRAM prices will stabilize and recover following a post-Y2k IT spending boom (the Year 2000 problem is eating up most computer budgets; this will reverse next year).
Frog eat frog world
To counter Moore's Law, semiconductor manufacturers "leapfrog" each other to the next generation of technology. The key is chip shrinkage. If you can shrink a chip, you can get more chips out of one wafer. The DRAM companies also need to gear up for the migration to Rambus copper chips in 2000.
DRAM capex is still down 66% from 1995 levels.
The current level of capital spending is inadequate to meet the demands of migration to sub 0.20 micron technology. Given the high probability of stable to firm DRAM prices over the next six to twelve months, our sources believe that there will be sufficient cash generation to fund a dramatic ramp up in DRAM capex.
Ground floor opportunity
William Elder is a low-key Scotsman. Blame it on the perma-draft up the kilt, but I believe that the Scots are genetically fit to run businesses, since they tend to be both frugal -- and fiercely determined to cut the throats of the competition south of the border.
Elder founded Genus in 1982. Genus has grown into a thin film deposition powerhouse with a 20% lock on the market.
 To diversify the product mix, Genus bought a high-energy ion implant system company in 1988. This acquisition turned out to be a mistake. The new unprofitable product line drained Genus's liquidity. During the Asian crisis, semiconductor capital equipment orders dried up -- and Genus was eventually driven to the brink of a liquidity crisis.
Elder stepped aside in 1996 to let a new CEO run the company. Genus decided to dispose of the ion business to generate cash, pay down debt, and refocus on the core thin film business. Elder came back from his sabbatical in 1998 to turn Genus around.
Since exiting the ion business, Genus has grown the top line every quarter. Even though Genus has been operating at a small loss, the cash on the balance sheet has been maintained. Long-term debt remains zero.
Despite the sequential sales growth, Genus has retained a tight grip on inventories and receivables -- a sign of solid financial management.
Genus was a highflying stock during the semiconductor capex bubble in 1995, trading as high as $15. The 90% decline in the stock price from the 5-year peak reflects the catastrophic effect of the Asian crisis on semiconductor capex.
However, the current low price of the stock does not reflect Genus's successful transition to a fast-growing thin film company. The merits of Genus's technology will become apparent over the next few years as earnings explode and Wall Street returns to the stock.
Tungsten nitride rocks!
Genus's flagship product, the Lynx2, performs a small, but necessary, step in the semiconductor manufacturing process: "chemical vapor depositions" (CVD) of thin films. The thin films are needed to coat various parts of chips, including the "gate," the "capacitor electrode," and the "copper barrier."
 Genus has mastered the use of tungsten nitride (WN) as a thin film barrier. IBM is pushing tantalum, but tungsten nitride performs better as the scale gets smaller. Also, tungsten nitride can support the industry migration from aluminum to copper.
The competition for the thin film deposition market is fierce, but Genus has proven its ability to carve out a profitable niche business. The largest direct competitors are Tokyo Electron (8035-Tokyo Stock Exchange) and Applied Materials (AMAT-NASDAQ). Given Genus's superior tungsten nitride technology, high-powered sales/distribution force, and field-tested product line, the company's market position is rock solid.
Now, I'm not an engineer (I don't even play one on TV. I don't stand in line with a gaggle of 35-year old virgins and basement dwellers to get tickets for Star Wars. And I'd rather drill a hole in my hand and use it as a shot glass than get caught up in the painful intricacies of wafer production.)
But I'm telling you: it's hard not to get excited by the attractive earnings potential of the Lynx2.
Lynx to riches
The Lynx2 is currently a US$6 million per quarter product with 39% gross margins. But the geniuses at Genus have figured out how to use the same machine to penetrate two new markets! Currently, the Lynx2 is used mostly in silicide metal film tools, which is a US$200 million market (Genus has a 20% market share). But Genus is entering the gate/capacitor film and barrier film tool market -- a US$2 billion market.
If Genus achieves its historical market penetration of 20%, the Lynx2 could generate over US$400 million in sales. However, Genus's current infrastructure can only support US$100 million in sales. Personally, I am not banking on a 20% market share penetration. 5%-10% is a more realistic projection.
Given the operating leverage that can be achieved by selling one product into three markets, Genus should be able to expand gross profit margins while keeping R&D costs under control. I expect Genus to achieve a 45% gross profit margin by early 2000. R&D as a percentage of sales should decline over the next few quarters to a sustainable 17%. The high fixed cost structure gives Genus tremendous leverage to ramp up profits.
Buy this stock now!
At current levels, Genus is trading at just over 1x book value and 1x annual sales. According to my estimates, Genus will earn $0.00 per share in 1999, US$0.15 per share in 2000, and US$0.28 per share in 2001. While Genus is currently operating at a slight loss, most of the big semiconductor capital equipment companies are also in the red.
The industry trades at an average price/earnings multiple of 17 on 2000 estimates. Genus's 40% discount to the industry average is excessive.
Genus is suffering from a total lack of Wall Street coverage. Merrill Lynch used to cover the stock, but the Genus analyst left the firm in 1998. The big brokerage houses don't generally permit their analysts to cover stocks under US$5. Furthermore, Genus's current sales level is too low to show up on most institutional radar screens.
While the stock is currently trapped in a tight technical range, I expect continued sequential top line growth and the broad recovery trend in the semiconductor capital equipment sector to support the stock at higher trading levels. Genus is the kind of company that will attract serious Wall Street coverage -- once sales exceed US$50 million. You can buy now when the share price is low or wait for mainstream investors to jump on the bandwagon.
Keep in mind that this is a small-cap stock. Liquidity is limited. While the stock has 500-1000% upside over the next three years, it will be volatile over the next three quarters. On the other hand, the low share price and low valuation limits your downside risk. Insiders have been buying stock -- a very bullish sign for the company's near-term prospects.
As a long-term play on semiconductors, I recommend Genus (GGNS-NASDAQ) as a Strong Buy under $3 with a one-year target of US$6 and a three-year target of $15.
For more information, contact Kim Murphy, Marketing Communications Specialist, Genus, Inc., 1139 Karlstad Dr., Sunnyvale, CA 94089, USA, tel. 408-747-7140 ext. 1407, fax: 408-747-7199, email: kmurphy@genus.com, or check out the company's website: www.genus.com.
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