On Oct. 21, 2015, Lam Research announced it would acquire KLA-Tencor for $67.02 per share. The deal was valued at $10 billion. The combined company would have about $8.7 billion in revenue and was expected to realize $250 million in annualized cost synergies within 18 to 24 months of the deal's close. By 2020, it was estimated the combined company would generate $600 million in incremental revenue.
But after multiple inquiries by the U.S. Department of Justice, Lam Research decided to call the deal off.
Investors really liked this deal because it would have combined two of the best-managed semiconductor equipment companies in the world. KLAC is the world leader in yield monitoring and process control systems, while Lam is the leader in etch. In 2011, Lam acquired Novellus and really built a powerhouse semiconductor etch business.
As semiconductor dimensions continue to get impossibly small, with some customers moving to leading-edge 10-nanometer line widths, the merger would have created one company that could supply two of the most critically important technologies to semiconductor makers. After a wafer is etched with Lam's CVD (chemical vapor deposition) process, it is inspected for defects with KLAC's inspection equipment. The combined company would have given Applied Materials (AMAT) a real run for its money.
KLAC reported fiscal 2016 revenue of $2.9 billion, up 6%. Sales are expected to grow just 4% in 2017.
On July 28, management guided first-quarter fiscal 2017 revenue to a range of $1.55 billion to $1.70 billion versus the consensus of $1.59 billion. The company sees earnings per share of $1.67 to $1.87 and a non-GAAP operating margin of 23.2%.
Without the Lam acquisition, KLAC can continue to successfully trudge along by itself in the semi equipment business. Right now, analysts are projecting operating earnings of $4.94 for 2017 and $5.22 for next year. The company pays a 3% dividend. Historically, KLAC trades between 14x and 17x forward estimates.
I think KLAC will trade in the middle of its historical range because revenue is growing in the middle of the company's long-term range of 5% to 7%. With about 52% market share, it's hard to see KLAC taking any meaningful market share from Applied Materials or Hitachi without Lam. Last year, the company said it took 1% of share from the rest of the industry.
While KLAC has started ramping up its Gen 5 broadband plasma defect inspection equipment, I think most of the new orders will come at the back half of the year. We should see non-GAAP gross margins increase more than 61% as the company ships more of the Gen 5 equipment. Because KLA's equipment is so critical to the semi industry, the company is able to generate margins substantially (20 points) higher than the industry.
Once investors get over the disappointment of the Lam deal, I think the stock can drift toward the mid- $70s as it trades within its historic range.