Electro Scientific: At the Crossroads of Chip Equipment
By Matt Paolucci

In its mid-year forecast, the Semiconductor Industry Association (SIA) predicted an annual compound growth rate of 20 percent through 2003 for the semiconductor industry. The industry hasn't had such a rosy outlook since the 1993-1995 period.

Electro Scientific Industries (ESIO) plans to take full advantage of these good times.

The company makes equipment for the testing and sorting of high- end capacitors. Capacitors are the devices that store the electrical charges used in semiconductor circuits. In addition to the testing of capacitors, ESIO also manufactures the material that connects the capacitors to the semiconductor itself.

When semiconductor chips are found to be defective, Electro Scientific also plays a role. They provide the lasers systems that deactivate the defective circuits and create new circuits. This is all done during the manufacturing process, thus, greatly reducing the number of chips that could potentially be discarded. ESIO has an estimated 90 percent share of this $100 million market, expected to grow in excess of 20 percent per year.

Dominance in this niche of the semiconductor market (capacitors/ testing) puts Electro Scientific essentially in the cat-bird seat: As the demand for faster chips continues, companies will have to come to ESIO for the equipment to test their chips. And with the increase in demand from another area of the chip sector, wireless, ESIO will have its hands full filling the demands of that market as well.

The same capacitors that Electro manufactures and tests for PCs and laptops are also needed for the smaller and more-complex chips used in the cell phones and other wireless devices you see everyone and their brother walking around with these days. ESIO makes what are called multi-chip modules. These modules are able to increase functionality while maintaining or decreasing the size of the actual. More functions, smaller size. I'm sure you remember the days when cell phones were about as large as your phone at home. Now, some are small enough to pop in a front shirt pocket.

Over the next four years, according to the SIA, expectations are for 31 percent growth in 2000, with revenues of $195 billion, expanding an additional 25 percent to $244 billion in 2001. From there, the market is expected to continue its momentum in 2002 with sales of $279 billion, a 14 percent increase, and ending the year 2003 with $312 billion of sales, an increase of 12 percent.

The Company is growing at a breakneck pace. For the third quarter ending February 26, 2000, ESIO reported record sales of $82.1 million versus $66.9 in the second quarter, and $51.5 million in the prior year period. Earnings per share were 43 cents, up from 26 cents in the second quarter, and 12 in the third quarter of 1999. Gross margins increased from 54.2 percent to 55.9 percent.

Wall Street seems to be a big advocate of Electro-Scientific. Of the nine analysts who cover shares of ESIO, eight of them rate the stock either Strong Buy or Buy. ESIO beat second quarter estimates of 39 cents per share by 4 cents.

Shares look quite compelling, trading for just 33 times fiscal 2000 estimates (ending May) of $1.42 per share, and even cheaper at 20 times fiscal 2001 estimates of $2.35 per share.

Shares currently trade for around $48 per share.