ASML Holding

World market leader in lithography systems

In my last article on FactSet Research, I already drew the comparison with the gold diggers and the shovel suppliers. In today's article I want to go one step further and present, so to speak, a supplier to the shovel makers. The Dutch company ASML Holding produces highly complex lithography systems. These are machines that play an enormously important role in the manufacture of integrated circuits. And those, in turn, are indispensable in our digitalized world. With a market share of almost 65 percent, ASML holds the absolute leading position here.

Since we're still in our infancy when it comes to digitalization, ASML's business should remain highly profitable for a long time. But of course, alongside the many opportunities there are also risks, which I'll go into in more detail further down. First, let's take a look at the company's history.

The history and business model of ASML Holding N.V.

The high-tech company ASML Holding has a history that goes back a long way. On October 9, 1858, Gerard Leonard Frederik Philips was born in Zaltbommel. His father Frederik was not only a well-known industrialist and banker, he was also a first cousin of Karl Marx. After finishing school, Gerard decided to study civil and structural engineering. Later, however, he switched to the faculty of mechanical engineering, where he also graduated in 1883. After a few smaller jobs at shipyards, he developed an interest in electrical engineering. Without further ado he took a course on electric light at the Glasgow College of Science. Thrilled by the many possibilities, he started working at the Anglo-American Brush Electric Light Corp., but gradually the desire grew in him to start his own business in his home country. With his father's capital, he finally founded his own company for manufacturing light bulbs in May 1891. Philips succeeded in producing carbon filament lamps in large quantities and the company grew rapidly. The profits were always put into further developing existing business areas and researching new ones. This is how Philips became a global electronics group that brought not only light bulbs to market, but also cassettes, X-ray machines, television sets, CDs and many other innovations.

In 1931, Arthur del Prado was born in the Dutch East Indies. During World War II, he had to spend several years in Japanese captivity. After the war he moved to the Netherlands and studied chemistry and economics there. In 1954 he moved to the USA to study at Harvard Business School. However, he left without a degree and moved to California. There he met Dean Knapic, who had previously worked at Shockley Semiconductor Laboratory, where the founders of Intel also started their careers. Knapic was researching the growing of semiconductor crystals and sparked the idea in Arthur del Prado of founding a semiconductor company in the Netherlands. In 1968 ASM International (short for: Advanced Semiconductor Materials) was created and he began manufacturing semiconductor process equipment. In 1984 he entered into a joint venture with Philips under the name ASML (ASM Lithography). Shortly afterwards, the first semiconductor exposure system, the PAS 2500, was brought to market. When the global chip industry came under pressure in 1988 and ASMI ran into financial difficulties as a result, it had to sell its stake in the company to Philips. That same year, ASML ventured into the Asian market, which gave the company a significant growth boost. In March 1995, Philips took ASML public as an independent company.

Computers and cell phones became more and more popular and the entire technology industry experienced a real boom. Until it burst in 2001. Intel withdrew a major order worth 100 million US dollars, and ASML then had to lay off 23 percent of its workforce. Nevertheless, in 2001 the company managed to take over the Silicon Valley Group and broaden its base that way. With the acquisition of Cymer Inc. in 2013, it paved the way for EUV lithography machines, which work much more efficiently and powerfully. Today ASML is indispensable in the semiconductor industry and by far the leader in its segment. The biggest and most important chipmakers are among the company's customers.

How do I assess the opportunities and risks of ASML Holding?

First, let's take another look at the business model. ASML Holding makes lithography systems that are urgently needed in chip manufacturing. One of these machines can cost up to 150 million US dollars and is delivered to the customer in 3 cargo planes. Just so you can get a rough idea of how big and valuable these systems are. Besides the pure sale of these machines, ASML also earns money from maintenance and repair costs.

Of course ASML's business isn't without risks, which is why I'd now like to go into them in more detail. First of all, it depends on its suppliers. If there are supply bottlenecks here, ASML will take a hit with its customers. However, the Dutch technology group works in close coordination with the two German companies Zeiss and Trumpf and surely factors in a reasonable buffer for such cases.

The second risk I'd like to mention is the small number of customers. According to some figures, around 80% of chipmakers are ASML customers, but if one of them were ever to drop out, it would definitely be felt. The company also depends on its customers' willingness to invest. After all, you don't buy a lithography system like that every day. The fact is, though, that demand is steadily rising and it's gaining new customers rather than losing them. Nonetheless, this is a risk investors should be aware of.

Last but not least, I'd like to address the high investment costs ASML incurs. To always keep its finger on the pulse in the future, it has to keep developing - everyone should be aware of that. Of course, though, there's no guarantee of success with this kind of research work. So the danger of burning money for years without showing any notable success is also there.

And what about the opportunities?

Well, as I've mentioned many times, digitalization is still in its infancy. Artificial intelligence, 5G, smart home and the Internet of Things are just a few of the topics that will accompany us in the coming years. And all of these topics require powerful semiconductors. That in turn keeps ASML's order books full. And I hardly need to get started on this company's strong moat, do I?

And what about the dividend?

ASML also took its time with the dividend for quite a while. In 2008 it gave its shareholders a share of the company's profits in the form of dividends for the first time. In the two following years, however, it had to scale it back somewhat before showing phenomenal dividend growth from 2010 onward. Over the last 10 years, the dividend growth rate is an impressive 29 percent. You read that right: 29 percent! For that, I'm happy to accept the low dividend yield of 0.8 percent. The payout ratio of 30.2 percent also leaves enough money in the company for future research and investments.

Conclusion:
Over the years, the Dutch ASML Holding has built up a strong monopoly position in its industry. The company's complex systems are urgently needed for a modern future, which is why I'm also confident that long-term investors will be happy here.