Axcelis Technologies Inc (NASDAQ:ACLS) is a new addition to the Greenbackd Portfolio at its $0.60 closing price yesterday. ACLS is an undervalued asset play with an activist investor, Sterling Capital Management, holding 10.7% of its outstanding stock. At $0.60, the company has a market capitalization of $61.8M. We estimate that its liquidating value is more than 110% higher at $134.9M, or $1.31 per share. The caveat? The company is making substantial operating losses that have widened over the last five quarters, prompting Sterling Capital Management to detail to ACLS management an aggressive restructuring strategy to salvage for stockholders what value remains.
About ACLS
ACLS designs, manufactures and services ion implantation, dry strip and other processing equipment used in the fabrication of semiconductor chips. In addition to equipment, ACLS provides aftermarket service and support, including spare parts, equipment upgrades, maintenance services and customer training. The company owns 50% of SEN Corporation (SEN), a producer of ion implantation equipment in Japan. SEN licenses technology from ACLS for certain ion implantation products and has exclusive rights to market the licensed products in Japan. The investor relations website is here.
The value proposition
The last five quarters have not been kind to ACLS, with the company generating substantial and increasing operating losses in each, reaching a $22.8M nadir for the September quarter (see the Q3 10Q here). At present, some value remains on the balance sheet (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):
ACLS’s liquidating value is predominantly carried in its $177M in inventory, which we’ve written down by a third to $119M or $1.15 per share, and its long term investment in $136M SEN, which we’ve written down by 80% to $20.4M or $0.20 per share. The company has around $49.7M or $0.48 per share in cash and a further $12.6M or $0.12 per share in restricted cash. The company also has around $36.6M in receivables, which we’ve discounted by a fifth to $29.3M or $0.28 per share. Deducting the $1.38 per share in liabilities (including $0.80 per share in debt) leaves a value in liquidation of around $134.9M or $1.31 per share.
The catalyst
Sterling Capital Management has been in regular contact with ACLS since acquiring its original stake in October 2007. They began communicating with ACLS in November of that year, “[encouraging] management and the board of directors to move forward on several actions designed to enhance shareholder value” including “[hiring] an investment banking firm to solicit interest for a minority, majority, or strategic investment in [ACLS].” (See the full text of Sterling Capital Management’s first letter to ACLS here.)
In February 2008, Sterling Capital Management again pushed ACLS to “immediately hire an advisor and fully explore strategic alternatives.” When Sumitomo Heavy Industries (SHI), ACLS’s SEN joint venture partner, offered to acquire ACLS for $5.20 per share, Sterling Capital Management wrote:
We strongly encourage [ACLS]’s Board to fully engage SHI and work to determine if a combination is appropriate. Further, we also would expect the Board and its advisors to solicit interest from other parties that might have a desire in partnering with [ACLS].
In a subsequent February 2008 letter, Sterling Capital Management argued that the initial bid of $5.20 per share for ACLS was “clearly too low,” writing:
Even with strong industry headwinds and lack of traction to-date, it is appropriate to value [ACLS] assuming some modest level of Optima success. Our analysis would indicate that a fair price for [ACLS] under this scenario would approximate $7.00 to $7.50 per share.
When SHI increased its offer to $6.00 per share, Sterling Capital Management wrote in March 2008:
[It] would appear that we are no closer to achieving an open dialogue between Axcelis and SHI.
…
We are concerned that the Board and its advisors are utilizing overly optimistic assumptions regarding Optima’s ultimate market share gains and consequently embracing an intrinsic value which is not achievable.
Sterling Capital Management argued in a May 2008 letter that the failure of nominated directors at ACL’s Annual Meeting of Stockholders to receive a majority of the shareholder vote in support of their re-election demonstrated shareholders’ “discontent with the failure of the Board to fully engage SHI in negotiations that could ultimately lead to a transaction that fairly values our company.” Clearly growing frustrated with ACLS, Sterling Capital Management wrote:
Rather than battling your shareholder base, we encourage you and the Board to embrace the steps necessary to drive shareholder value via a transaction with SHI.
In Sterling Capital Management’s most recent 13D filing they write:
We believe that [ACLS] management is making good progress in addressing the company’s short term financing issues. Further, the recently announced restructuring effort should assist the company in weathering an environment of continued weak spending However, given the highly cyclical nature of the semiconductor capital equipment market, it is imperative that management actively explore all opportunities to better position [ACLS] for long term success and creation of shareholder value. As such, Sterling Capital has communicated to management of [ACLS] a concept of separating its systems business from the more stable aftermarket business. In addition to separating cyclical from non-cyclical businesses, this initiative would allow for efficient utilization of the cash currently residing on SEN’s balance sheet and the tax benefits associated with extensive NOLs at [ACLS].
Sterling Capital Management also attached their most recent letter to ACLS (reproduced below):
Ms. Mary Puma
Chairman and CEO
Axcelis Technologies, Inc.
108 Cherry Hill Drive
Beverly, MA 01915-1053
Dear Mary,
These are certainly unprecedented times which we all are trying to navigate through. We appreciate the focus and effort the entire team at Axcelis has demonstrated during the current environment. However, given the challenges facing the company, we would strongly encourage Axcelis to embrace an altered strategy which would produce both immediate and long term value for all constituents.
The initiative described below attempts to utilize all of the many resources and assets that Axcelis claims which clearly are not being recognized by the public markets. Further, we believe that the ultimate corporate structure it defines provides a more appropriate division between
cyclical and stable businesses.
Please consider:
o In March of 2008 SHI made an offer to purchase all of Axcelis’ outstanding shares for $6 per share or approximately $618 million dollars. Combined with debt on the balance sheet of Axcelis the total offer equated to $700 million. Through direct conversations with SHI and public documents it was clear that the motive behind this transaction was to consolidate the ion implant business of both Axcelis and SEN. Such a combination would yield significant cost synergies as well as enhanced product offerings.
The plan outlined below would allow SHI to achieve their initial goal, resolve short and long term financial challenges at Axcelis, and importantly create significant value for shareholders.
o Axcelis sells its implant/ dry strip systems business along with its 50% interest in SEN to SHI for $136 million. This figure approximates the book value of the SEN investment on Axcelis’ balance sheet. Importantly, such a price tag would require minimal net cash outlays by SHI as this transaction would give them immediate access to the entire $140 million of net cash currently on the books at SEN. SHI would have the ability to merge these operations and garner the synergies available.
o Axcelis Corporation would become solely focused on the aftermarket business which would include exclusive rights for SEN/Axcelis legacy accounts. The aftermarket business generates approximately $120 million in annual revenue and claims gross margins in excess of 50%. If properly sized such a business should be able to produce operating margins near the 20% level.
o Axcelis would retain existing NOLs which total $150 million and could then be applied to the operating profits generated by the aftermarket business. These NOLs could be fully utilized as no change of control event would be triggered.
o After repayment of the $85 million of debt the newly restructured Axcelis would have net cash of approximately $100 million. Given the low capital intensity of the aftermarket business and its relative stability, at least $50 million of this cash could be used for share repurchases. Assuming an average repurchase price of $1.50 per share Axcelis could retire 33 million shares.
o The new Axcelis would have approximately 70 million shares outstanding (after repurchases) and be generating $0.30 in eps. Applying a 10X multiple on this business would equate to a stock price of $3 per share. Revenue and earnings could grow at the new Axcelis as the market rebounded and SEN proved successful expanding its market share.
o The new Axcelis would have additional assets including net cash of $50 million and an unencumbered headquarters/ property which was recently appraised at almost $60 million.
Clearly, the above scenario is very different than the outcome we had all hoped for just a few months ago. However, there is no question that the world has changed and that looking forward and embracing the altered landscape is a prerequisite for future success. We hope that the Board might give full consideration to our proposal and we look forward to continuing to work with you in moving Axcelis forward.
Sincerely,
STERLING CAPITAL MANAGEMENT LLC
Brian R. Walton, CFA
Managing Director
Conclusion
At its $0.60 closing price yesterday, ACLS is trading at less than half of our estimate of its $1.31 per share value in liquidation. Its substantial and widening operating losses over the last five quarters have led management to make some efforts to restructure, which Sterling Capital Management believes will help ACLS in “weathering an environment of continued weak spending.” The company has thus far resisted Sterling Capital Management’s efforts to have ACLS negotiate with SHI or another bidder. Sterling Capital Management appears tenacious and so we think they may be able to persuade ACLS to create significant value for stockholders. With a downside limited by its presently substantial value in liquidation, we think ACLS is worthy addition to the Greenbackd Portfolio.
ACLS closed yesterday at $0.60.
The S&P500 Index closed yesterday at 906.65.
[Disclosure: We don’t have a holding in ACLS. We have now acquired a holding in ACLS. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]
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This summary balance sheet assumes that the $133M to be received in March 2009 from the sale of SEN is used to pay off the notes first (approximately $85M) with the remainder added to cash. We have backed out a further $15M in termination payments from cash. This summary balance sheet also assumes that ACLS burns an additional $22M in cash in the current quarter. The company is still making substantial operating losses that have widened over the last five quarters, so these amounts are likely to be substantial on an ongoing basis.
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