Calls of Note Part 5

Thomas Weisel reduces their industry rating on the semiconductor capital equipment industry from Favorable to Neutral following recent industry analysis that suggests the outlook for equipment orders in 2Q07 and 2H07 will track well below levels implied by Street estimates. With their industry downgrade, they are lowering their ratings on both VSEA and ASML from Overweight to Market Weight. They are also reducing estimates on AMAT, ASML, LRCX, VSEA, FORM, NVLS, KLAC and CYMI. While they believe that a modest downturn in DRAM orders (45-50% of 4Q06 total) now expected for 2Q07 and 3Q07 is already reflected in current semi cap valuations, firm's analysis indicates that separate, compensating positive catalysts anticipated by many investors are unlikely to materialize. In the current environment, they favor technology-driven (rather than capacity-driven) stories with expanding addressable markets that are trading at attractive valuations, including VRGY, LRCX and AMAT.

Firm is reducing their 2007 capex growth estimate from an above-Street 10% y/y to a below-Street 0% y/y. Firm expects recent negative capex commentary to characterize 1Q07 earnings calls.

Bad news is bad news, for a change: In contrast to the stock behavior around prior semi cap equipment order cycles, firm does not expect cautious capex commentary or evidence of equipment delivery push outs to serve as positive catalysts for stocks in the group. Their discussions with investors suggest to us that at current valuations negative demand datapoints will dominate over the positive psychology historically associated with oversupply corrections.

Semi cap group fairly valued given lack of near-term catalysts: Semi cap equipment stocks trade at an average 2007E and 2008E P/E of 19x and 14x, respectively, versus the lower-risk reference points of the SPX, which are currently at a respective 16x and 15x for 2007E and 2008E.

Notablecalls: There are lots of calls on semiconductor capital equipment today (notably BofA raising AMAT rating, JP Morgan once again praising ASML, LRCX getting positive comments from CIBC), so it will be interesting to see how the stocks react. Fundamentally I would rather agree with Thomas Weisel, but I'm not sure if the mkt agrees today.