Martin Whitman is the Chairman of the board of Third Avenue Funds. Here is what Ian Lapey, the manager of his Value Fund thinks of Applied Materials (source: Third Avenue 2012 second Quarter Shareholder Letter):
In March, I attended the Applied Materials investor meeting in New York along with my colleague Yang Lie, who has followed Applied Materials and other technology
stocks since joining the firm in 1996. Applied Materials’ Chairman and CEO Mike Splinter, along with several other members of the senior management team, presented a compelling long-term investment case for the company, which is the leading global provider of semiconductor capital equipment, driven by increasing consumer demand for mobility. While it is difficult to predict who will produce the next top-selling consumer electronics gadget (although the odds appear to favor Apple at the moment), it seems to be a safe bet that the demand for equipment and services provided by Applied Materials should increase, given its market dominance in many areas of semiconductor equipment, as semiconductor chips become more ubiquitous and more complex, necessitating a greater number and more advanced tools.
This favorable longer-term outlook seems to have been lost on many, as the company’s modest reduction in 2012 earnings guidance triggered a 3% decline in the stock price that day and a subsequent 4% decline through quarter end. Specifically, owing primarily to weak demand for solar power capital equipment, the company projected fiscal 2012 earnings of $0.85 to $0.95 per share, compared to the previous Wall Street consensus forecast of $0.96 per share. As a result, we added to our position in Applied Common at very attractive multiples of about 9 and 13 times 2011 and expected 2012 earnings, respectively. Importantly, we believe that earnings are likely to exceed recent peak 2011 earnings of $1.30 per share in the next few years, driven by the favorable dynamics noted above, as well as an increase in addressable market from the recent acquisition of Varian Semiconductor. Although Applied Materials paid a rich price for Varian ($4.2 billion; 18 times earnings), the transaction was financed with excess cash and very low cost debt and should be accretive next year. Varian is the market leader in the ion implant market, a critical step in semiconductor chip manufacturing, which enables the manufacturing of high performance chips, e.g., for applications requiring faster speeds and longer battery lives. Even after the Varian acquisition, Applied Materials has a very strong financial position, with about $3 billion of cash and $2 billion of debt consisting of senior unsecured notes due from 2016 to 2041 at rates ranging from 2.7% to 7.1%. Applied Common accounted for 1.3% of the Fund’s net assets at quarter end, and we have been increasing our position on further share price weakness this quarter.
I also read the investor presentation and saw its webcast. I was deeply impressed by it. Mostly due to its comprehensibility and above all because I agreed with the idea that whoever wins on the new computing gadgets race (be it Apple, Intel, ARM, Microsoft, Google, Nokia, Blackberry… ?), Amat will keep on selling their machines to build semiconductors. It seems to offers a safe way to invest in the mobility and computing trend without betting for the winner.
I liked to read about someone who basically invested in Applied Materials for exactly the same reasons as I did.
Besides the top quality of their machines and technological moat I would also highlight their strong free cash flows and point out the reduction in shares as well as the stability of it’s dividend as signs of shareholder friendliness.
While Applied Materials had worse earnings than expected in 2012 Ian Lapey had the conviction and seized the opportunity to keep on substantially increasing his positions both in the 3rd and 4th quarters of 2012. Applied Materials’ worse earnings were mostly due to the low capital expenditures from their clients as well as a write down in their solar business. Capital expenditures in the semiconductor industry is generally hard to predict and is very lumpy. This makes Applied Materials earnings very unstable. Personally I do not care about that, on the contrary, that generates volatility on the stock, which makes it ideal for long term holders to build a position at good entry points. It might explain why Ian Lapey kept on adding.