Besi: Initiate Coverage With Narrow Moat Rating; Revenue Tailwinds, but Shares Priced for Perfection

We are initiating coverage of BE Semiconductor Industries BESI with a narrow moat supported by intangible assets and switching costs, an Exemplary Morningstar Capital Allocation Rating, and an EUR 82 fair value estimate, with shares overvalued by 20% as of the last trading session. Its Capital Allocation Rating comes from accretive organic investments and research and development, cost discipline, appropriate dividends and buybacks, and a clean balance sheet.

Besi understands how to operate well in a cyclical industry like semiconductors. It runs a flexible business model by (1) multisourcing from different suppliers as well as rapidly adapting capacity to demand changes, (2) having 15% to 20% of its staff on flexible/temporary contracts, and (3) having 70% of its workers in Asia, mainly in assembly and production, where it can save personnel and logistics costs as more than 60% of revenue comes from China, Taiwan (TSMC), Korea (Samsung), and Malaysia. This strategy allows Besi to maintain leading gross margins of about 60% even in downcycle periods compared with peers ASMPT and Kulicke & Soffa, which are at 40% to 50%.

Besi’s strong share price appreciation (up 110% in the last 12 months) comes from the expected arrival of hybrid bonding machines. These machines will be needed over the next 10 to 15 years to assemble the most advanced chips and foundries still need them to build installed bases. In 2016 Besi saw the need for these machines, so it invested early and gained a lead. It is years ahead of its closest competitor ASMPT. Hybrid bonding machines are more critical than previous generations of machines, the average selling prices are two to five times higher, and they require more expertise, which will result in higher service attachment rates and hence higher margins. In future, we model revenue growing at midteens CAGR with strong operating margins in the range of high 30s to low 40s and a higher proportion of service revenue coming from hybrid bonding machines.