The Business Of
Semiconductors | ASML | What Do They Do With Their Profits?
Morning All!
Yesterday we put together ASML’s costs with their revenues. And we’ve covered a fair amount this week. So let’s have a quick recap…
Monopoly: We’ve seen previously that Nvidia and TSMC both operated in duopolies. But ASML is a rare beast. In the EUV lithography machines market - they are a monopoly. Because no one else even sells these machines!
TSMC & Samsung: Whilst ASML have an incredibly low number of customers. Their concentration of customers is super high. With just 2 customers - TSMC and Samsung - making up over 50% of their revenues!
EBIT Margin: Despite the incredibly complex EUV technology they’ve pioneered. And the monopoly they have. ASML’s 2022 EBIT margin of 31% is far less than what we saw at TSMC. Who had an EBIT margin of ~50%.
Now, 31% is nothing to scoff at! It’s still a pretty amazing operating margin for a business to have. And in fact, as we include ASML in our TBO EBIT Margin Tracker below. We can see that aside from their semiconductor friends. It’s only Ninety One in the high-margin asset management industry that has a higher margin than ASML!
We’ll really look at this margin differential between ASML and TSMC in more detail tomorrow. Because on the face of it, it doesn’t appear to make sense! if ASML is a monopoly. And the worry with monopolies is that they can use their control to exploit customers. It does beg the question why ASML don’t charge their customers even higher prices for their machines. And get themselves a higher margin!
But for now, let’s crack on. Because, with ~€21bn in revenues. And a 31% margin. It means ASML still made a handsome ~€6bn EBIT in 2022. And the question we’ll be answering today is - where does all that profit/cash go?!
Capex… What Capex?
Well, to kick us off, let’s start with how ASML reinvests cash back into their business. Last week, we saw that capex was a huge part of how TSMC used their profits. In fact, a whopping 64% of the cash TSMC made from 2003-2022 was used for capex. And for TSMC this capex meant building fabs, buying equipment, etc.
However, we also saw that capex was a much more limited part of how Nvidia spent their cash. With the company only dedicating 14% of their cash to capex. So, quite a variety there - 64% and 14% - what might it look like for ASML?
Well, for ASML, it’s much more towards Nvidia’s end with only 17% of the cash they made from 2003-2022 spent on capex. And this capex is mainly investments into equipment and machinery that ASML use for their EUV production. Remember we said yesterday, that the company sources a lot of their parts from suppliers. Well, ASML need a lot of equipment/machinery to put all those parts together and to create prototypes for customers. And this equipment/machinery is defined as capex!
But let’s spend some time on this. Because some of you may be wondering, why is capex such a higher proportion of spend for TSMC vs ASML and Nvidia? And it’s a great question. And the answer can be found by really understanding how important capex is for their respective businesses.
So, the main purpose of reinvesting cash back into the business is to grow revenues and profits. And to start off, let’s see what drives this for TSMC…
Well, how does TSMC make money? By manufacturing chips for Nvidia, Apple, AMD.
And how do they grow their revenues? By manufacturing more chips!
And how can they manufacture more chips? If they have more capacity.
And how do they get more capacity? By building more fabs/buying more equipment!
Ahhh! So, this is why TSMC spend so much of their cash on capex! By building more fabs, and buying more lithography machines. TSMC can sell more chips to their chip designer customers. And grow their revenues. In fact, because TSMC is a manufacturer, and capacity is the name of the game. Capex is one of the biggest, if not the biggest driver of their revenues!
Okay, so that’s TSMC. We’ve seen that because they’re a manufacturer. Increasing capacity is fairly correlated with revenue growth. And so capex is a huge priority for them. But what about ASML? Because they’re not manufacturers. As we saw yesterday, ASML don’t manufacture much of their lithography machines. They outsource a lot of that production. So how important is capex to their business? And are their revenues directly correlated with capex?
Well, how does ASML make money? By selling lithography machines.
And how do they grow their revenues? By selling more lithography machines.
And how do they sell more machines? If their customers buy more!
This might seem obvious. But the point I’m trying to make is that ASML’s main driver of revenue isn’t their own capex. But actually the capex of their customers! And the headline below was from a recent article. Which showed how ASML’s stock price fell when TSMC said they were going to cut their capex plans. Because what happens if TSMC (ASML’s #1 customer) spends less on capex? Less lithography machine sales!
And so, it’s this less direct correlation between capex and revenue growth. Why ASML spend far less on capex than TSMC. ASML is far more asset-light. Now, ASML is no tech company like Facebook or Twitter. They’re much more asset-heavy than those tech companies. But relative to TSMC, ASML is much more asset-light!
More Buybacks… Errr Great?
So, that’s clear. Unlike TSMC, capex isn’t the highest priority for ASML. And hence the company doesn’t spend too much of their cash on capex. But then, where do they spend their cash? Well, as the chart below shows. The Dutch giant actually spends most of their time returning cash back to their shareholders. 21% of the cash the company’s made over the last 2 decades has been spent on dividends. And a huge 46% has been used for buying back shares.
Now, share buybacks are an interesting case. When you hear buybacks, most people think - great, that’s good for shareholders! Because it increases their returns (this article helps explain how that works)! And the world’s most famous investor, Warren Buffett, has been a long-time fan of buybacks. Saying that if a company thinks their shares are ‘undervalued’, it makes complete sense for them to buy their shares. And see a return on this investment.
But there are actually plenty of scenarios where a company buying back their shares really isn’t actually what’s best for shareholders. Some companies buy back shares to pump up their EPS growth or to offset excessive stock-based compensation. And in the US, politicians have actually introduced a tax on buybacks. Believing that, instead of inflating shareholder returns, companies like ASML should be using their excess cash to reinvest into their business. Or increase employees’ wages.
But Warren Buffett hasn’t been easily swayed. Back in Feb, he wrote that people who thought that buybacks were always bad were either ‘economic illiterates’ or ‘silver-tongued demagogues’. Take it easy Warren!
18th May 2023
Alrighty, that’s a wrap for today! I said I’d save the comparisons between ASML, TSMC and Nvidia for tomorrow. But I hope that comparison on capex was useful. And helped you understand why certain companies in the same industry spend so much more on capex than others. Tomorrow, we’ll close out The Business Of Semiconductors series with a cracking summary of the whole industry!
Have a great day!
The Business Of Team