4.4 Growth Rate Analysis
4.4.2 Analysis of the companies
Table 4-6 and 4-7 records the NOPAT growth rate of Lam Research and Applied Materials.
Table 4-6: NOPAT growth rate of Lam Research
FY 06 05 04 03 02
New Invested Capital 741.96 285.227 -138.551 -411.504 NA Increase in NOPAT -1.48 296.21 143.43 -0.78 NA
IR 138% 53% -57% -416% NA
IROIC -1% -214% -35% NA NA
WACC 15% 16% 16% 15% 13%
IROIC-WACC -16% -230% -51% NA NA
Growth Rate on NOPAT (gt= IRt-1 x IROICt) 0% 122% 145% -1% NA
Source: from this study
Table 4-7: NOPAT growth rate of Applied Materials
FY 06 05 04 03 02
New Invested Capital -1902.633 -499.625 1418.601 -350.571 NA Increase in NOPAT 575.75 -330.08 1862.55 -1001.96 NA
IR -78% -27% 64% -104% NA
IROIC -115% -23% -531% NA NA
WACC 12.9% 13.0% 13.1% 13.4% 12.6%
IROIC-WACC -128% -36% -544% NA NA
Growth Rate on NOPAT (gt= IRt-1 x IROICt) 31% -15% 551% -75% NA
Source: from this study
Growth Rate of NOPAT
Figure 4-13: Growth Rate of NOPAT comparison between Lam and Applied
Put them together for comparison in Figure 4-13 shows that both companies do not show clear trends except that Applied Material did have bigger fluctuation from year to year. By examining their CAGR (compound annual growth rate), we can found that Lam Research grows at an surprising high rate of 52% per year (NOPAT increases from 99.6 M in 2002 to 537.0 M in 2006) while Applied grows at an rate of 16% per year (NOPAT increases from 1339.9 M in 2002 to 2446.1 M in 2006)
This can also explain the strategy of Lam Research is to launch new products including 2300 Bevel Clean system, our 2300 Motif patterning system, and Deep Silicon Etch MEMS offering. This is trying to attack more segments of the whole WFE markets from current 13% to 25 to 26% by year 2010.
By decomposing g into IROIC and IR further and put them into Figure 4-14 and Figure 4-15 respectively, it is found that IROIC for both companies are not performing that well, actually all numbers for all years are negative. This may be attributed to the fact that typically in WFE industry, it takes more than 3 years to see the return of a specific investment. It simply takes that long from an alpha product (prototype product) to beta site testing (introducing to limited selected customer sites
IROIC
Figure 4-14: Return on Incremental Invested Capital comparison between Lam and Applied
As for Investment Rate comparison, it is found that Lam is doing more and more aggressive re-investment compared while Applied Materials seems to be the opposite.
This may related to the fact that these two companies are at two different positions of the market and stages of their lifecycles and thus they have different behaviors. As stated earlier, Lam decides to attack more market segment than Etch and Clean and is launching several new products to capture the 150 Billion opportunity from 2007 to 2010. (Martin Anstice, Steve Newberry, 2007)
Investment Rate
Figure 4-15: Investment Rate comparison between Lam and Applied
4.4 Summary of this chapter 4.5 Summary of this chapter
Put all the performance indexes discussed above into Table 4-8 and summarized as below:
Table 4-8: Performance index comparison between Lam and Applied
Performance Index Lam Research Applied Materials ROIC-WACC Spread Upward trend
Much higher
Upward trend Lower Standardized EVA Upward trend Upward trend
Lower Profit Margin Upward trend
Higher
Flat Lower Gross Margin Upward trend
Higher
Upward trend Lower Net income as a percentage of
Revenue
Significant improvement over
years Upward trend Net non-operating income as a
percentage of Revenue
Significantly reduced over years
Significantly reduced over years
Invested Capital Turnover Upward trend Much higher
Upward trend Lower Total Asset Turnover Days Improvement over years
Lower
Improvement over years Higher
Fixed Asset Turnover Days No obvious trend Lower
No obvious trend Higher
Average Collection Period Upward trend Flat
Average Inventory Period Improvement over years Lower
Improvement over years Higher
Growth Rate of NOPAT Upward trend Higher
Upward trend Lower Investment Rate Upward trend Flat
IROIC No obvious trend Big fluctuation
No obvious trend Big fluctuation
Source: from this study
showed better performance than those of Applied Materials except for the Average Collection Period. Out of all of these, actually the (ROIC-WACC) Spread and Invested Capital Turnover are the most important measures of performance. It shows that both Lam Research and Applied Materials meet the criteria of having good businesses and good managers, the two most essential ingredients of a successful business since these two important measures are already good are showing good trend.
Lam Research does show better performance than Applied’s, one big turn around from its past years prior to 2002. Theses two indexes show that Lam catches up with Applied starting from 2003 to 2004 and surpassed it by a large magnitude in 2005 and 2006.
Besides that, since both companies’ growth rate on NOPAT (CAGR, Lam 52%
and Applied 16%) are still significant, it is recommend that they should both adopt the strategy of expansion and increase invested capital to gain more NOPAT, and lead to maximization of shareholders’ wealth. There is in lined with Lam’s practice for the past four years. It is not as clear why Applied was not practicing it since the IR was quite flat for the past four years. It is speculated that it is more difficult for Applied Materials to decide what the right areas to fund giving the following two facts:
1. It does not enjoy as high ROIC-WACC spread and Invested Capital Turnover for the markets that they are already engaged. So the strategy for these markets should be targeted at enhancing these performances in stead of increasing Investment Rate.
2. Applied has already set foot in quite some arenas including Flat Panel, Solar Photovoltaic Cell, Flexible Electronics and Energy Efficient Glass. It needs to consider its internal resources and capability before further attacking more markets.
Chapter Five: Business Valuation
In this chapter, we will start to compute the values of the companies. Before that, we will first explain the regression model and the method to do forecasting for the parameters.
5.1 Introduction to regression method used
Since we need NOPAT and Invested Capital for EVA’s calculation, then we need to find a way to forecast these values for future years. Usually the procedure to get this done is as the following:
1. Firstly we consider the past years’ data and come out regression models 2. Choose the best model that has highest R squared value
3. Use the chosen model to do forecasting
But for the purpose of simplicity, we choose liner regression model for our study.
5.2 Some commonly used methods for business valuation
From Gordon Growth Model, we can derive the following two methods:
1. Price Earning Multiple
PERatio= P0/EPS0= (PayoutRatiox(1+g))/(r-g) Where P0= Stock Price at term zero
DPS1: predicted dividend per share in term one EPS0: Earning per share in term zero
PayoutRatio: DPS/ EPS r: cost of equity
g: growth rate of dividend 2. Price Book Value Multiple
PBVRatio= P0/BV= ROE x PayoutRatio x(1+g)/(r-g)
The drawback of these methods is that usually EPS or BV can get impacted easily by corporate accounting decisions and having a fixed payout ratio is not common for all companies.
5.3 Model of business valuation
Remember that in Chapter two, we have that Company Value
= Invested Capital + Present Value of EVA During Explicit Forecast Period + Present Value after Explicit Forecast Period.
= Invested Capital + +Continuing Value
Where Continuing Value=
(EVAt+1/WACC)+ (NOPATt+1 ( IROIC-WACC) g)/ (( WACC (WACC-g) IROIC)) And EVAt
= NOPATt-WACC x Invested Capitalt-1
5.4 Computation of Lam’s value 5.4.1 NOPAT forecasting
By using linear regression, we can get the estimated NOPAT from year 2007 to 2012. See Table 5-1 for the calculated value.
Table 5-1: NOPAT Forecasting for Lam Research
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 NOPAT(Actual) 100 99 242 538 537 NOPAT(estimated) 128 260 392 524 655 787 919 1051 1183
Source: from this study
5.4.2 Invested Capital forecasting
By using linear regression, we can get the estimated Invested Capital from year 2007 to 2012. See Table 5-2 for the calculated value.
Table 5-2: Invested Capital Forecasting for Lam Research
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Invested Capital(Actual) 1691 1280 1141 1426 2168 Invested Capital(estimated) 1020 1108 1195 1283 1370 1458 1545 1633 1720 1808 1895
Source: from this study
5.4.3 Forecasting of WACC and stock price
Using the average value of Lam Research’s past 5 years’ WACC 14.85%, we can get the calculated stock price 46.05 USD in Table 5-3. Please refer to the computation details in Table 5-4.
Table 5-3: Assumptions made for stock price calculation for Lam Research
Timing of evaluation 2006.12
Method to forecast NOPAT Linear regression Method to forecast Invested Capital Linear regression
Assumed WACC 14.85%
Stage one duration 5 years
Stage two will start from 2012
Assumption of Continuing Value computation IROIC = WACC
Stock Price Per share 46.05
Source: from this study
Lam’s annual report was filed on 8/17/2006. The stock price 10 days later was around 42.0 USD. This is about -8.8% different from the forecasted 46.05 USD. It seems that Lam’s stock was undervalues at that time. But since then, the stock price has been going strong and reached 50 USD two months later.
Table 5-4: Computation Process of Lam Research’s stock price
EVA Valuation Forecast Stage one Stage two
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 after 2011
Invested Capital 1691.117 1279.613 1141.062 1426.289 2168.249 1457.682 1545.208 1632.734 1720.26 1807.786 1895.312
NOPAT 99.618137 98.83 242.27 538.48 537.00 523.6 655.4 787.2 919 1050.8 1182.6
ROIC NA 5.84% 18.93% 47.19% 37.65% 24.15% 44.96% 50.94% 56.29% 61.08% 65.42%
WACC 12.51% 14.70% 16.06% 15.90% 15.07% 14.85% 14.85% 14.85% 14.85% 14.85% 14.85%
EVA per year NA -149.75 36.71 357.00 322.09 201.62 438.93 557.74 676.54 795.34 914.14
Continuing Value 2682.27
EVA -149.75 36.71 357.00 322.09 201.62 438.93 557.74 676.54 795.34
Present Value of EVA 175.55 332.76 368.16 388.84 398.01
Sum: PV of Total EVA 4345.59
Plus: Invested Capital 2168.249
Company Value 6513.84
Less: Total Interest baring Debts 608.28
Value for Common Equity 5905.56
Number of Outstanding shares 128.253
Value per share 46.05
Source: from this study
5.5 Computation of Applied’s value 5.5.1 NOPAT forecasting
By using linear regression, we can get the estimated NOPAT from year 2007 to 2012. See Table 5-5 for the calculated value.
Table 5-5: NOPAT Forecasting for Applied Materials
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 NOPAT(Actual) 1340 338 2200 1870 2446 NOPAT(estimated) -25 376 777 1179 1580 1981 2382 2783 3184 3585 3986
Source: from this study
5.5.2 Invested Capital forecasting
By using linear regression, we can get the estimated Invested Capital from year 2007 to 2012. See Table 5-6 for the calculated value.
Table 5-6: Invested Capital Forecasting for Applied Materials
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Invested Capital(Actual) 10527 10176 11595 11095 9193 Invested Capital(estimated) 9253 9009 8765 8522 8278 8034 7791 7547 7303 7060 6816
Source: from this study
5.5.3 Forecasting of WACC and stock price
Using the average value of Applied Materials’ past 5 years’ WACC 13.01%, we can get the calculated stock price 17.77 USD in Table 5-7. Please refer to the computation details in Table 5-8.
Applied’s annual report was filed on 12/14/2006. The stock price 10 days later was around 18.45 USD. This is quite close to the forecasted 17.77 USD, only around +3.7% difference.
Table 5-7: Assumptions made for stock price calculation for Applied Materials
Timing of evaluation 2006.12
Method to forecast NOPAT Linear regression Method to forecast Invested Capital Linear regression
Assumed WACC 13.01%
Stage one duration 5 years
Stage two will start from 2012
Assumption of Continuing Value computation IROIC = WACC
Stock Price Per share 17.77
Source: from this study
Table 5-8: Computation Process of Applied Materials’ stock price
EVA Valuation Forecast Stage one Stage two
FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 After 2012
Invested Capital 10526.794 10176.223 11594.824 11095.199 9192.566 8034.38 7790.72 7547.06 7303.4 7059.74 6816.08
NOPAT 1339.8559 337.90036 2200.4513 1870.3723 2446.1272 1980.7 2381.8 2782.9 3184 3585.1 3986.2
ROIC NA 3.21% 21.62% 16.13% 22.05% 21.55% 29.65% 35.72% 42.19% 49.09% 56.46%
5.6 Simple PE ratio multiple method
As discussed earlier in section 5.2, usually companies do not have a fixed payout ratio. An alternative simpler approach is used below. The historical EPS data is used for liner regression analysis. Both companies’ 2007 FY EPS values are forecasted shown in Table 5-9 below.
Table 5-9: FY 2007 EPS forecasting by using linear regression method
FY 2006 2005 2004 2003 2002 2007
(forecasted)
LRCX 2.34 2.1 0.59 -0.06 -0.71 3.28
AMAT 0.97 0.73 0.78 -0.09 0.16 1.24
Source: from this study
Since the exact PE multiple for these two companies is unknown due to the lack of payout ratio information, we use 14.35 since it gives same AMAT stock forecasted price as the EVA method so that we do comparison between PE Ratio method and EVA method. The result is given in Table 5-10. EVA gives a slightly smaller difference from actual stock price than PE Ratio method does.
This result matches the EVA theory’s claim that it is superior to traditional earning method to predict company’ value.
Table 5-10: Forecasted stock price comparison between PE Ratio method and EVA Valuation
5.7 Summary of this chapter
From this chapter’s analysis, the stock price of Lam Research was higher than that
of Applied Materials at the end of 2006. This result is consistent with what we have been discussed in Chapter Four. That is to say, with better profitability and growth indexes, Lam’s stock value is higher than Applied’s.
Also by comparing to the market price, our forecasted prices are within +/- 10%
range. EVA gives a slightly smaller difference from actual stock price than PE Ratio method does. But from both methods, LRCX seems to be undervalued at that time.
The later on (two months later) stock price rise seems to support our valuation result.
Chapter Six: Conclusion and Recommendations
In this chapter, we will examine the result we derived in this study. We will also present our recommendations for these two companies’ future development. At the last, we will discuss the limitation of this study and also recommendations for future study.
6.1 Conclusion and Recommendations toward companies in this case
Let us present this section by having a review of the goals set in Chapter One.
1. To analyze the operation efficiency and business valuation of these two companies through the EVA method.
Operation efficiency has been discussed in Chapter Four. We get to understand the operation of these two companies from the EVA point of view. Since Applied Materials accounts for quite a big chunk of the whole WFE business, so it is suitable to be used for benchmarking purpose; while Lam Research on the other hand, has clearly set a higher bar for both indexes (ROIC-WACC spread and Invested Capital Turnover) in this industry.
Business valuation has been covered in Chapter Five. The valuation result is compared to the market price and is confirmed to be within +/- 10% difference. This may be due to that these two companies are traced regularly by many analysts. It has been briefly discussed that Lam’s stock price seems to be undervalued by -8.8 % in August, 2006 and was later recovered and even surpassed by +8.7% within two months.
2. Come out an analysis of how Lam Research went through the past five years and achieved the changes.
For Lam Research, we have seen a continuous upward trend for both ROIC-WACC spread and also Invested Capital Turnover starting from
2003. Part of it is seems to be a natural result of the revenue increase due to economies of scale effect, but clearly the company has managed to keep the pace of invested capital growth slower than the revenue growth in order to get this achieved. We believe the following reasons are the foundation of these changes:
Strong engineering and service team: The revenue growth is mostly attributed to the success of Lam’s Dielectric etcher product. Although relatively late to the market in the 300 mm arena, its intrinsic superiority in technology and productivity supported by the continuous improvement projects has proven to address customer’s needs. This is the fruitful result of long term investment in technology development and joint development relationships. Combined with the original well performed Conductor etch product, Lam was pushed to the etch market share leader for the past 5 years.
“Respect the data” spirit: Particularly, Lam has an important spirit that is intrinsic to its big engineering community and other organizations:
respecting the data. People are really concentrating on projects and make daily decisions based on the real engineering data. This nurtures the atmosphere of fantastic engineering environment and becomes the root of its engineering excellency. There is relatively less effort spent dealing with office politics. Combined with dedicated account structure to support its customers, Lam is able to provide speed to solutions.
Outsource non-core activities: Lam has outsourced several of the non-core activities like Legacy tool manufacturing, IT support function and also Spare parts management to save cost and boost efficiency.
Dedicated operation organization team: A dedicated CSBG (Customer
Satisfaction Business Group) organization has been formed to look at the operation efficiency of warranty tool performance. This kind of attention-to-details mindset helped to drive the best of breed FAST QUAL new tool installation and start-up and installation base performance. The weekly review includes both material and manpower resources allocation.
This of course in term helps to accomplish the ultimate performance of Invested Capital Turnover. Basically, you get what you monitor. Also there is dedicated personnel for service and spares business operation.
Back to about 5 years ago, Lam even bought a book “Lean Thinking” by James P. Womack for its middle managers trying to get this operation excellency rooted deep. I think this $26 dollar book is well paid off now.
Careful funding projects management: From strategic point of view, Lam has been cautious to pick up the most lucrative markets to attack.
Before making a decision, the ROI (Return-on-Investment) analysis is carefully evaluated down to project level even the project is only one or two employee’s effort. This is based on the understanding that any company resource is not only precious but also scarce. The power is so huge while this spirit cascades down to the engineers’ level.
3. Based on the business valuation view point, formulate the recommended strategies of these two companies’ future development.
For Lam Research:
Adjacent market engagement: Since Lam has gained a lot of momentum from the revenue growth and this is mostly a direct result of market share growth. With the existing high market share that it already achieved (around 50%); the room for further growth may be somewhat
can leverage the current Lam expertise and resources. Lam is actually already doing so. As put by Lam’s CFO Martin Anstice in F3Q07 (Qtr End 3/25/07) Earnings Call, “Lam's development of new products adjacent to the Etch market that provide the opportunity to double our served available market and potentially grow the company 2.5 times faster than the overall total growth in wafer fab equipment spending through 2010.” Considering our forecasting of CAGR 8% from 2005 to 2011 in Chapter 3, the prediction made by Mr. Anstice is suggesting a 20% revenue growth rate annually. This is greater than the 15% CAGR of Lam’s revenue from 2002 to 2006 already.
M&A: The other thing that may worth considering is the acquisition of other companies. With current management team experience, there may be chance that Lam can leverage the learning gained from the past several years and create another change. After all, the experience includes both improvements in ROIC-WACC spread and also invested capital turnover.
Both these may have chance to be duplicated in another similar companies that experiences similar situation as Lam did back before 2002.
Knowledge management and People retention: Trying to stay at our current position for our current business alone is not going to be easy.
Lam’s strongest competitors are the number one and number two players in the WFE industry: Applied Materials and Tokyo Electron. These two companies have great resources and capabilities that they have demonstrated repeatedly they can turn things around over the past 20 years.
So it is important for Lam to be able to hold on to everything that is already possessed and achieved. This includes getting patents for our precious technologies, keeping experienced people working for us still,
implement and leverage the knowledge acquired with hard work.
Optimize the capital structure: The other thing that we found in this analysis is that maybe Lam could lower down the WACC by having higher percentage of debts in stead of equities. WACC of Lam’s is almost 2%
higher than that of Applied’s and this has caused some impact to the company value. For example, if we can drop the WACC to something similar to that of Applied by doing so, Lam’s stock value can be boosted up from the original 46.05 to 53.97, a 17% gain!
For Applied Materials:
Be bold on expansion: Applied Materials is qualified to own good business and good managers. Being dominating at almost all major
Be bold on expansion: Applied Materials is qualified to own good business and good managers. Being dominating at almost all major