The Business Of

Semiconductors | ASML | How Do They Make Money?

Morning All!

So yesterday, we started Part 3 of The Business Of Semiconductors. And our attention this week is on ASML. A company that provides chip manufacturers (like TSMC) with equipment to help them make their chips. The screenshot below reminds us of ASML’s most expensive product - the EUV lithography machine. And yes, it is as complex as it looks!

Today, we’re going to focus on how the largest company in the Netherlands makes its money. So, without further ado, let’s dive in!

Challenge: Find A Company That Makes More Money, With Less Customers

Ignore the heading for a moment. It’ll make sense in a second! But to kick us off here, and to really get an understanding of how ASML makes money - we’re going to go back to basics.

So, what do companies need to make revenue? They need customers. B2C (Business to Consumer) companies generally need a lot of customers to be successful. If Netflix only had 50 paying subscribers, they wouldn’t make much money! Fortunately for them, Netflix have 231 million subscribers. And similarly, if Tesco only had 50 customers, they wouldn’t have much revenue. Fortunately, they too have millions of customers!

Okay, but do all companies need millions of customers? Well, no. If we think back to last week and TSMC. We’ll remember that TSMC’s customers weren’t individual consumers. Their customers were businesses. And in 2022, TSMC only served 532 customers. Quite a bit below the 231 million that Netflix served!

What I’m really trying to get at here, is that companies whose customers are individual consumers (B2C), need millions of customers to be really successful. However, companies whose customers are businesses (B2B) don’t need quite so many…

And why is this? Well, to put it simply, a company is going to make less revenue from an individual consumer than a business! One UK customer on a Standard subscription plan pays Netflix £10.99/month, so ~£130 a year. Whereas we saw a couple of weeks ago that just one of Nvidia’s customers (Microsoft) paid Nvidia ~$100m for their datacenter chips!

Okay, so why am I saying all of this? And how on Earth does this relate to ASML? Well, because ASML takes what we’re talking about to an extreme. ASML don’t have millions of customer like Netflix. And ASML don’t even have hundreds of customers like TSMC. In fact, ASML have less than 50 customers!

This is pretty incredible. Because ASML made €21 billion in revenue in 2022. And I doubt you’ll find another company in the world who makes as much revenue. With as few customers…

… if you do find one, then please do let me know!!

Apple Needs EUV… Hence Apple Needs ASML

But you may be wondering, how on Earth can a company make €21 billion in revenues with less than 50 customers? And are ASML just selling that one product - the EUV lithography machine - to all their customers? Well, let’s answer the second question first. And the answer is no. ASML don’t just sell that huge EUV machine.

The terminology can be a bit technical here so we’ll try and keep it nice and simple! But ASML sell both EUV (extreme ultraviolet light) lithography machines. And also, DUV (deep ultraviolet light) lithography machines. Both the EUV and DUV lithography machines are used by chip manufacturers like TSMC to create the patterns on semiconductor chips. So then…

Well, the difference is the light used by these machines. More specifically the wavelength of the light. The wavelength of the light used in the DUV lithography machine is small enough for chip manufacturers to create patterns on most chip sizes. E.g. 28nm, 12nm. But the wavelength isn’t small enough to create patterns on the smallest, most advanced chip sizes (7nm, 5nm, 3nm).

So, for these most advanced chips, ASML developed the EUV lithography machine with EUV light. Which has an even smaller wavelength than DUV light. And allows TSMC, Samsung and Intel to make their most advanced, smallest chips. Without ASML’s machines, making those advanced chips would be impossible! And our phones wouldn’t be as advanced as they are now!

Okay, so now let’s go back to the first question of how ASML generates so much money. And the answer here is a lot simpler. These lithography machines cost a lot of money. And by a lot of money, I mean a LOT of money. ASML’s 2022 annual report shows us that the company sold 345 lithography machines last year. And made €15.4bn in revenue from these machine sales. This means that on average, each machine was sold for €45 million! (€15.4bn / 345).

But are DUV and EUV machines sold for the same price? No. The less advanced DUV machines are sold for ~€30 million each. Whilst the EUV machines are sold for upwards for €150 million each! I find it absolutely extraordinary that a company can sell only 345 products in a year. And still be the 35th biggest company in the world. Crazy.

Taking A Leaf From Rolls-Royce’s Book…

Okay, so we know ASML make lots of money selling their lithography machines. But are these machines their only source of revenue? Well, some of the sharp readers here will have noticed that earlier in the newsletter I said that ASML made €21bn in revenues in 2022. But just now I said that revenues from machine sales was €15.4bn. So where’s the other ~€5.6bn?

Well, as we can see from the chart below, ASML do have another revenue stream! And this stream is servicing. But what is this servicing revenue?

Well, when ASML sell one of their lithography machines to a customer. They don’t just say ‘thanks for the money, good luck operating the machine’! In fact, quite the opposite. These machines need a lot of care. And after a machine has been sold, an ASML employee will be based at the customer’s site to ensure the machines are running smoothly. The maintenance and upgrading of these machines clearly help the customer. But they also provide a strong revenue stream for ASML! With a significant 27% of revenues coming from this maintenance.

FYI, this is similar to what we see at other companies like Rolls-Royce. The British company manufactures and sells engines for planes. But over 50% of their revenues come for the maintenance of these engines!

Is $150 Million Per Machine Too Cheap?

Okay, so just before we finish up for today. I want to talk about pricing. Because with machines priced at $150 million each, surely ASML can’t raise the prices more can they?

Well, you may be surprised. Because yes, while $150 million is clearly a lot of money. One of the key determinants of whether ASML is able to lift prices is if their customers can afford it. And one way to evaluate whether customers could take on increased prices is by looking at their margins.

Last week, we saw that TSMC - who make up ~40% of ASML’s revenues - have the most extraordinary margins. With the Taiwanese giant boasting an EBIT margin of ~50%!

These high margins present an opportunity for ASML. Because if the Dutch company lifted the prices of their machines by 10% a year, it would make a relatively insignificant impact on TSMC’s business model. And TSMC could just pass the increased prices onto their customers. The chip designers, e.g. Nvidia, Apple, AMD. This seems to indicate that ASML would be able to grow revenues through price increases. And as this article tells us, ASML are thinking along the same lines! With the company soon to bring out a new machine in 2024 priced at over €300 million!

So that’s what is to come. And the chart below shows us how far ASML have come already. Over the last 20 years, the Dutch giant has only had 3 years of negative revenue growth. And topline have grown at a stellar 15% CAGR since 2003!

Like we saw with TSMC, ASML has an incredible market position. And later this week - tomorrow and Friday - we’ll talk more about how the company’s position has aided this strong revenue growth!

16th May 2023

Nigel Jacob CFA