Company: CyberOptics Corporation
Ticker: NASDAQ:CYBE
Market Cap: $296M
CyberOptics (NASDAQ:CYBE) is an excellent picks and shovels play on the continued growth of the semiconductor industry. The chip shortage that is still ongoing shed a light on major supply chain issues and accelerated developments like the passing of the US CHIPS Act, which includes $52 billion in subsidies to encourage chip manufacturers to build out semiconductor fabrication plants in the US. In this article I'll share my investment thesis for CyberOptics, why the company is growing faster than its respective market, its high margin products are part of nearly every semiconductor fab and why there is hidden value in CyberOptics' connection to Apple inc (NASDAQ:AAPL) that will likely be unlocked in Q4 2022.
Structure
History
Products
Competition
Business model
Share structure
Valuation
Risks
When I bought an engagement ring for my now fiancee (she said yes :) ) this spring, I came across the topic of synthetic diamonds. I decided for a natural diamond, but the topic raised my interest enough to research it. When running some screens for companies to research, I came across multiple CVD companies. I knew the CVD industry already through my graphene research from 2020. CVD companies currently are not of interest to me, but one thing led to the other and one of the screens also included non-CVD companies, one of them being CyberOptics.
Those that follow my blog because of the commodities companies I have covered might wonder, why I am covering a high tech company in this article? First, my interests are very diverse and I am always looking for opportunities in various industries. Second, while CYBE might be a high tech stock, it is important to understand that semiconductors are the raw material that is the basis for a diverse set of microchips. CyberOptics' technology is actually an important component in the production process of semiconductors and microchips. Let's start with the basics of semiconductors/SMT and then cover the market dynamics & key drivers for growth, before deep diving into CyberOptics.
Semiconductor & Surface-mount technology (SMT) intro
Sand is the simple raw material that is the basis for all (micro)chips, as sand is primarily made up of silicon dioxide. In order to produce an extremely pure mono crystalline silicon ingot called a blank (only one impurity atom for every 10 million silicon atoms), complex chemical and physical processes are required to convert silica sand to silicon. Silicon blanks are fabricated in a range of different diameters the most common sizes are 150, 200 and 300 millimeters wafers. The extremely thin wafers (one millimeter thick) are then cut from the silicon blanks using a special sawing technique. In microelectronics, photovoltaics and microsystems technology these wafers are usually used as a substrate (base plate) for electronic components, including integrated circuits (IC, "chip"). Silicon is a semiconductor. This means it can conduct electricity and also act as an insulator. These wafers are the basic building blocks for subsequent chip production.
Source: YouTube Infineon
Silicon wafers have to be fabricated in a dust-free environment with stable temperature and humidity levels: They have to be made in a cleanroom. A cleanroom is a room in which no more than one particle of dust larger than 0.5 micrometers is permitted in around 10 litres of air. This is even cleaner than the air in an operating room.
Once the wafers are created, in order to produce microchips the layout and design phase starts. Highly complex chips are made up of billions of integrated and connected transistors enabling sophisticated circuits such as microcontrollers to be built on a semiconductor surface measuring just a few square millimeters in size. The sheer number of components calls for an in-depth design process this entails defining the chips functions simulating its technical and physical properties, testing its
functionality and working out the individual transistor connections.
In this video the whole process from sand to finished microchip is explained very well.
Source: Infineon
The other industry CyberOptics is active in is the electronics industry, specifically SMT. Surface-mount technology (SMT) is a method in which the electrical components are mounted directly onto the surface of a printed circuit board (PCB). An electrical component mounted in this manner is referred to as a surface-mount device (SMD). In the industry this approach has largely replaced the through-hole technology construction method of fitting components, in large part because SMT allows for increased manufacturing automation which reduces cost and improves quality. It also allows for more components to fit on a given area of substrate.
The semiconductor & SMT industries are converging due to the growing use of automation as part of the production process. An example of the convergence is Lights-Out Manufacturing: A way to operate factories without humans. See a complete explanation in this short video.
Source: YouTube - MSC Industrial Supply Co.
Inspection technology is needed to enable this level of automation.
Market dynamics
CyberOptics' President and CEO Dr. Subodh Kulkarni during the Q2 earnings call mentioned that "latest reports suggest that the overall semiconductor and electronics capital market will grow somewhere in the 5% to 10% rate this calendar year 2022". Due to microchips being needed for nearly everything in daily life today, the demand for semiconductors has stayed at elevated levels. This growth is likely supported by government initiatives that originated out of the experiences many nations & companies faced during the pandemic induced "chip shortage" and the lessons learnt from that. Add to that the urge to de-globalise the semiconductor supply chain. In an effort to increase their "Digital sovereignty" the EU has announced the "European chips act" on 2/8/2022 stating: "The EU Chips Act will build on Europe's strengths – world-leading research and technology organisations and networks as well as host of pioneering equipment manufacturers – and address outstanding weaknesses. It will bring about a thriving semiconductor sector from research to production and a resilient supply chain. It will mobilise more than €43 billion euros of public and private investments and set measures to prevent, prepare, anticipate and swiftly respond to any future supply chains disruption. It will enable the EU to reach its ambition to double its current market share to 20% in 2030."
The United States is working on a similar initiative to be more independent from Asian semiconductor fabs. "On 7/28/2022 the House passed the $280 billion CHIPS and Science Act to strengthen US science and technology innovation. The bill, a Biden administration priority, includes $52 billion in subsidies to encourage chip manufacturers to build out semiconductor fabrication plants, or “fabs,” in the US".
Even before this bill was passed, in 2021 TSMC started the construction of their first US based fab in Arizona. This fab is expected to produce 20K wafers per month starting in 2024. Intel broke ground on two new fabs in Arizona as well last year. 72 new fabs will come online by 2024. CyberOptics' products play an important role as part of the fab equipment. I will cover this in detail later.
Source: CNBC YouTube
Even in the light of a technical recession in the US, the organic growth prospects of the sector fueled by government initiatives makes semiconductors a compelling industry to invest in. Readers of my blog already know I prefer the picks and shovels play approach instead of picking out stocks with direct Semiconductor exposure. This is will likely be important in this scenario as well, as due to the technical recession in the US, some of the semiconductor stocks will be seen as having growth problems and their multiples will be compressed, However, especially in a recession companies will want to be more efficient and cut costs. Using automated inspection increases yield and decreases cost -> All the aspects that CyberOprics' products offer. According to Dr Kulkarni, there are multiple growth factors at play across CyberOptics' two target markets: Semiconductor and SMT.
Many exciting developments are currently occurring in the SMT market driven by the smartphone industry, but also by cloud and AI deployment. SMT industry parts are getting smaller and circuits are getting denser. This creates unique opportunities for inspection and metrology companies like CyberOptics: Things that didn't need to be inspected five years and certainly ten years ago now need to be inspected. The demand is very high and continues to grow as more complex products are developed and launched.
The semiconductor industry is going through an exciting growth phase. Demand for chips is incredibly high right now partly driven by the pandemic situation and supply chain issues. The "chip shortage" is still ongoing as chip capacity takes a long time to build up. Capacity is increasing, but it's still not catching up with the demand.
Semiconductor inspection and SMT inspection are merging right now forming a whole new type of "demand". Your latest smartphone for example doesn't have a conventional pcb anymore. It has multiple advanced packages that are strung together, that creates a grey zone between semi and SMT inspection. A lot of it gets created because of the third dimension that has been invoked in the semiconductor industry. Historically semiconductor just shrank the chip in two dimensions now they are beginning to put the third dimension in place. Chips are getting stacked on top of each other and heterogeneous inter interconnections are being developed in advance packaging area where you are bringing not only the chips but also passive components together in vertical dimensions and that is creating complex packages. The great advantage is you are getting tremendous improvement in speed, processing and cost, but it does create complex structures which is good for inspection companies like CyberOptics, because the situations where customers need to inspect 100 % of what they are stacking are increasing.
Last but not least, one of the areas that CyberOptics got involved in a few years ago that is a big driver of their current business is mini-LED back lights for display screens. The inspection of reflective parts is important for mini-LED and companies like Apple & Samsung work with companies like LG Display for these displays. LG Display in turn uses CyberOptics' MRS sensors as OEM (as far as I know). "LCD panels use LEDs, or light-emitting diodes inside for backlighting purposes to light up the display. Mini-LEDs, as the name suggests, are smaller diodes that are less than 0.2mm. A device like a TV features an LCD panel with LEDs for backlighting, with the panel used to control where light is displayed on the screen. Depending on what's on the display, the LEDs are lit up fully or dimmed down for dark scenes". According to my research, the Mini-LED display naming convention at Apple is "Liquid Retina XDR-Display". Apple analyst Ming-Chi Kuo has said "that Apple's transition to mini-LED will allow for thinner and lighter product designs that offer a lot of the same benefits as OLED. Mini-LEDs are close to the deep blacks and better HDR provided by OLED, but without the burn-in or degradation issues. LED-backlit LCDs are much more power efficient than the cold cathode fluorescent lighting used for LCD panels in the past, and mini-LED LCDs will have additional power efficiency gains".
Currently the biggest consumption of power of your smartphone is caused by the display. Technology like mini-LED could enable phones to not have to be charged for a few days.
"Apple is working on multiple iPads and MacBooks that use mini-LED technology. Mini-LED technology deployed in the next year or two are 16-inch MacBook Pro, 14.1-inch MacBook Pro and 12.9-inch iPad Pro. Based on rumors, it sounds like Apple's ultimate plan is to transition much of its iPad and Mac lineup to mini-LED display technology. The first mini-LED products came out in 2021, and Apple is expected to continue using mini-LED technology throughout 2022 and 2023". Apple's focus on mini-LED is a massive growth driver for CyberOptics and its one of a kind sensors that are key to the production process of these displays.
In conclusion, there are multiple market dynamics at play that offer tailwind for CyberOptics future growth. When asked about the market outlook during the Q2 2022 earnings call CEO Dr Kulkarni answered:
"At a high level, both the semiconductor and electronics CapEx market seems to be slowing down, but still growing. So the growth rate has come down from last year, but it’s a positive and healthy growth rate. I think the latest reports we are seeing still seem to suggest that the overall semiconductor and electronics capital market will grow somewhere in the 5 % to 10 % rate this calendar year 2022. So that’s at a broader macro level. Within that, obviously, in the first half of 2022, our sales grew 21 %. Clearly we seem to be outperforming the market that will indicate our market share gain where we compete or better market penetration in products like WaferSense where we don’t compete with anyone effectively. So we feel pretty good about our numbers. As you can see, the backlog is at a record level. Orders continue to be very healthy."
Next, let's deep dive into this interesting company, which is growing faster than the market it is active in.
CyberOptics overview
History
CyberOptics Corporation is a leading global developer and manufacturer of high-precision 3D sensing technology solutions. It can be categorized as part of the semiconductor & electronics equipment industry. CyberOptics was founded in 1984 by Steven K. Case, a professor of optics and physics at the University of Minnesota. The company went public in 1987 and was originally focused on lasers and 2D optical sensors for SMT applications. Later the company shifted its focus to 3D. A significant improvement of their customers' manufacturing yields and productivity is achieved by the usage of CyberOptics' products in the SMT and semiconductor industries. Proprietary technologies such as lasers, optics and machine vision are combined with software, electronics and mechanical design as part of CyberOptics products. The value proposition of these products to manufacturers is providing them with key information relating to their manufacturing processes, which allows them to improve production volumes, yields and product quality. CyberOptics is a market leader and its customers include companies like TSMC, Samsung & Micron.
Source: CyberOptics
The company's strong focus and continued investment in R&D led to an extensive patent portfolio of more than 70 patents. More than 70 % of CyberOptics revenues are generated in Asia, as most high-speed manufacturing happens there. For a complete overview of the company, please find this introduction by Dr Kulkarni.
Source: CyberOptics YouTube
CyberOptics founder Steven K. Case unfortunately died in a plane crash in 2009. Case served as the company’s president until 1998 and became the company’s chairman in 1995, a title he retained until his death. Dr. Subodh Kulkarni had been a director of CyberOptics since 2009 and became President and Chief Executive Officer in February 2014. He held various positions with Imation Corporation (“Imation”), including Chief Technology Officer and Senior Vice President, OEM/Emerging Business and Vice President, Global Commercial Business, R&D and Manufacturing. Prior to his employment with Imation, Dr. Kulkarni held various research management positions with 3M Corporation and IBM. Dr. Kulkarni received his B.S. in chemical engineering from IIT—Bombay, India (where he was first in his class), and went on to obtain a Masters Degree and a Ph.D. in Chemical Engineering from the Massachusetts Institute of Technology, where he did his thesis work on disilane surface decomposition, which is used in the manufacture of semiconductors. He has won a number of awards for commercializing technologies he and others have developed in the electronics industry.
Products
CyberOptics manufactures 3D and 2D optical sensors for use in their own proprietary inspection system products and for sale to original equipment manufacturers (OEMs), system integrators and end customers in the SMT and semiconductor capital equipment markets. The product lines can be divided into two hero categories: MRS-enabled systems and WaferSense sensors.
Source: CyberOptics
CyberOptics sensing portfolio is primarily designed to help our customers with yield and productivity and throughput. A complete product line overview can be found on this slide.
Source: CyberOptics
MRS technology (multi-reflection separation)
Multi-reflection separation (MRS) is suppressing different reflections of light reflecting from any shiny surfaces. Reflections otherwise would create problems during the inspection process, when the machine is using light to detect things. MRS does a very good job of suppressing the artificial noises and focusing on the signal of the device.
CyberOptics MRS sensors offer the combination of the best of both worlds:
With MRS they have been able to improve resolution, accuracy and speed concurrently. CyberOptics offers very high speed sensors which are low resolution and accuracy or very high accuracy resolution sensors but low in speed.
SQ3000+ currently is CyberOptics' key product that is driving financials. SQ3000+ Multi-Function System with Multi-Reflection Suppression™ (MRS™) sensor technology provides the ultimate combination of high resolution, high accuracy and high speed for inspection and metrology. It remains the only system on the market capable of performing AOI, SPI and CMM in-line.
Inspection of reflective parts is especially important & challenging in mini- and micro-LED production. As explained in the Rohinni case study. Micro LEDs developed using Rohinni’s technology can be deployed in consumer electronics devices, automotive applications and outdoor signage.
Wafersense - wireless measurement: Front end of the fab
The other key area CyberOptics has invested in besides their MRS technology
is WaferSense & ReticleSense: "The world’s most efficient and effective wireless measurement devices".
Most of WaferSense is sold to the front end fabs for applications like gap detection for etching or deposition, humidity detection in implant or litho, or various other applications.
Source: CyberOptics
By providing highly accurate measurements of critical process factors WaferSense supports with yield improvement and tool uptime in semiconductor wafer fabrication and flat panel display manufacturing. WaferSense is more accurate when compared to the various manual techniques historically used by semiconductor manufacturers to obtain critical wafer fabrication process measurements.
Continued growth of WaferSense was one of the highlights during the Q2 2022 earnings call: "Sales of semiconductor sensors principally the WaferSense line of products increased 35% year-over-year in the second quarter of 2022 to a record $7.4 million. Increasing customer awareness combined with global demand for semiconductors is driving the growth in WaferSense sales.
Within the last week, we received a new $1.3 million order for WaferSense products that is expected to ship in the fourth quarter. We expect WaferSense sales to remain strong throughout the balance of 2022."
For Q2 reported total sales were $27.6 million meaning Wafersense was 26% of total sales. This will be a massive growth driver going forward as "products like WaferSense where we don’t compete with anyone effectively". Sales of semiconductor sensors accounted for
21 % of revenues in 2020
26 % of revenues in 2021
27 % of revenues in H1 2022
Based on the above, it seems like WaferSense has become the gold standard in wireless measurement sensors. Many OEM standards require the use of the WaferSense and ReticleSense devices which have been adopted as the BKM (Best Known Method) due to the increased level of precision required with today’s ever smaller chip geometries.
Bringing it back to the government initiatives mentioned in the market dynamics section, the US CHIPS act for example includes $52 billion in subsidies to encourage chip manufacturers to build out semiconductor fabrications plants (fabs) in the US. Likely these fabs will have CyberOptics products in them. This is future revenue growth that Mr Market did not calculate into the current market price of CYBE yet.
Competition
CyberOptics competitive positioning is very favorable.
MRS sensors (OEM)
Competition includes internal sensors in backend semi, lower performing sensor technology. Although these competitors are slower in semiconductor applications and slower/less accurate in SMT applications than CyberOptics.
MRS Systems (SQ, MX, WX)
Competition in SMT includes companies like Koh Young, TRI and Vitrox.
Competition in Inspection and Metrology Systems, WaferLevel and Advanced Packaging include companies like Camtek and Onto Innovations.
In mini/micro-LED CyberOptics has a clear Leadership position.
WaferSense
CyberOptics has near 100% market share in wireless, real time measurement sensors.
Competition are manual methods that are too slow, not very accurate, not conducted in real time and require the tool to be shut down.
Business model
CyberOptics manufactures 3D and 2D optical sensors. The go-to-market strategy includes selling via OEM & directly to end-users. On the one hand, the sensors are sold to original equipment manufacturers (OEMs) & system integrators. On the other hand, the sensors are used in CyberOptics own proprietary, complete inspection systems and metrology products which are sold directly to end customers in the SMT and semiconductor capital equipment markets.
In order to understand their business model better, I sent an email with questions to the investor relations team and received an informative reply by CFO Jefferey Bertelsen.
"A significant amount of business is from repeat customers. We sell our MRS sensors to customers on an OEM basis and make recurring sales of sensors to them each quarter. The universe of large semi fabs and major semi equipment suppliers is fairly small on a relative basis, and most of our semi sensor (WaferSense) sales are to this same group of customers each period.
The universe of potential buyers of our inspection and metrology system products is large. Usually once our customers purchase our system products, they standardize on our products. Relative to sales of our system products, a typical customer may purchase once or twice a year as they add capacity, other customers may purchase our system products and then may not buy for a year or two. We are continually prospecting and adding new customers for each of our product categories (2D/3D MRS OEM sensors, Semi sensors and inspection and metrology systems)."
CyberOptics is an asset lite business as they had elected not to make the capital investments necessary for complete internal manufacturing of our products. Most of their product manufacturing is performed by outside contractors. Our production personnel inspect incoming parts, perform final assembly, calibrate and perform final quality control testing of finished products.
Share structure
Only 7.4M shares outstanding which is uncommon for a company that went public 35 years ago. There have been three stock splits in the company's history. However, the last one was already 22 years ago.
Jun. 16, 2000 1.5:1
Mar. 16, 1992 1.5:1
Aug. 09, 1991 1.1:1
There has not been any significant dilution (I couldn't find any relevant dilution filings).
Insider ownership of 4.08 % is high for such an old company, especially taking into consideration that the founder is not part of the company anymore. There have not been any significant open market insider buys during the last years. Stock purchases were regularly executed via option conversion into common stock. With this tight share structure and the company growing revenue and earnings, I see no issues here.
Only 2.31M shares are in free float, pointing towards share price volatility into both directions based on market sentiment. Based on the strong fundamentals, I really like this share structure.
Source: SeekingAlpha
The all time monthly chart shows that CYBE is close to reaching a 22 year high.
Source: TradingView
Valuation
Capital Structure (8/3/2022 based on SeekingAlpha data):
Market Cap: $296.44M
Total Debt: $2.80M
Cash: $20.67M
Enterprise Value: $262.50M
Some relevant metrics pulled from SeekingAlpha (8/3/2022).
Valuation metrics:
P/E GAAP (TTM): 18.76 vs sector median: 25.61
P/E GAAP (FWD): 19.96 vs sector median: 22.66
PEG GAAP (TTM): 0.18 vs sector median: 0.49
Price / Sales (TTM): 2.89 vs sector median: 3.11
Price / Sales (FWD) 2.82 vs sector median: 2.98
Profitability metrics:
Net Income Margin (TTM): 15.92 % vs sector median:4.37 %
Net Income Per Employee (TTM): 85.6K vs sector median: 6.6K
Growth metrics:
Revenue Growth (YoY): 26.08 % vs sector median: 20.19 %
Revenue Growth (FWD): 18.44 % vs sector median: 14.52 %
EBIT Growth (FWD): 53.73 % vs sector median: 18.37 %
EPS Diluted Growth (YoY): 102.74 % vs sector median: 29.54 %
EPS Diluted Growth (FWD): 46.88 % vs sector median: 17.16 %
There has been consequent earnings per share growth since the June 2019 quarter from $0.06 EPS to $0.58 EPS. a 9.7 X earnings per share growth. Earnings were missed only once and that was in the midst of the corona pandemic. Likely effects from Q2 spilled over into the Q3 2020 earnings.
The share price "only" increased 228 % during the same period = 3.3 X
Source: SeekingAlpha
During the Q2 earnings call two discussions topics point towards a higher than expected growth rate in Q4 2022. First, during Q2 record SQ sales were achieved without a significant contribution from mini-LED related applications, which have been pushed out to the second half of 2022. CyberOptics anticipates receiving new orders for mini-LED related SQ systems in Q4. Second, Analyst Eric Slade hinted at Apple being the customer that pushed their mini-LED order to Q4 "my understanding was a very large consumer company that I guess people could figure out, look to do a launch in June of this product, and because of the delays, now they talked October. [...] So really just thinking about this, the floodgates could open pretty big on this product, which is the big one in December or, excuse me, that’s -- the end of this year and also the first quarter next year"
Going forward share price growth can be achieved by
Revenue / earnings growth
Multiple expansion (once FED reverses)
Mini-LED sales in Q4 2022/Q1 2023
All of the above
Risks
Current geopolitical developments are the biggest risk factor for an investment in CyberOptics.
Taiwan/China conflict: On Aug 2nd 2022 speaker of the US house Nancy Pelosi visited Taiwan, which was not seen as favorable by China. As most of the semiconductor supply chain is based in China, an escalation of this conflict would have negative implications for CyberOptics' business.
From CYBE's latest 10-K: Global trade conflicts may negatively impact our sales and results of operations. Ongoing trade conflicts with other countries, particularly China, may impact our sales and results of operations. Concerns over the impact of the U.S. and China trade war on the global economy may cause our customers to refrain from making investments in capital equipment, which would negatively impact our sales. We or our suppliers source certain raw materials and components from China. If the United States were to increase existing tariff levels or impose new tariffs, our supply chain and costs would be negatively impacted, resulting in an increase in our cost structure and negatively impacting our operating profits.
At this point in time is is unclear how such a conflict would impact the CYBE stock. From a company perspective it is short to mid term bearish, as their earnings are impacted. From a stock perspective one could argue that traders will play the narrative of CHIPS act and US/EU building fabs that CyberOptics products are needed for, meaning big orders are coming in. It is tough to forecast which narrative will play out.
Severe recession: A severe recession would dampen capital cost investments into semi equipment of the factory. On the other hand in these times making investments to get higher yields could also happen. This might not be as bad for CYBE. In addition, a deep recession would lead to the US FED reversing their rate hikes, restart QE and that in turn would increase stock prices.
Conclusion
In conclusion, CyberOptics is a great picks and shovels play on the growth in the semiconductor industry and a true hidden champion. Its near 100 % market share in wireless real time wafer sensors will ensure continued growth and act as a major moat. The tight share structure likely accelerates the upward stock price movement, supported by the sound fundamentals.
A major catalyst for the stock price could be Mr Market waking up to the Apple mini-LED connection. The current situation reminds me of a story I read about German battery maker Varta's stock recently. The market had not realized that Varta produced batteries for Apple's AirPods. When (then at Commerzbank) Analyst Stephan Klepp through unconventional research uncovered the Apple connection, the Varta share price went to the moon. The reaction in CYBE's case might not be that extreme, but the important point is that there is additional growth coming later 2022/early 2023 that Mr market is not expecting.
Other catalysts are earnings growth, multiple expansion and big order announcements for WaferSense.
To sum up,
Hidden champion in sensor & inspection technology
Picks and shovels play on the semiconductor industry
Own near 100% market share of wireless real time wafer sensors
72 new semi fabs will come online by 2024
CHIPS Act and EU chip act beneficiary
Apple mini-LED revenue expected in Q4 2022
Chart points at breakout above 22 year high
Growing faster than its industry
Attractive valuation
FWD EPS Diluted Growth +46.9 %
Multi bagger potential
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Sources:
https://youtu.be/r2AkauUlpMQ
Disclaimer: This blog post is purely my personal opinion and is not financial advice. Please do your own research, before taking investment decisions. I am long CYBE. No payment or other incentives were received in exchange to write this article.