Today we’re looking into a teaser pitch from Karim Rahemtulla for his Trade of the Day Plus service at Monument Traders ($99 for the first year) — he’s been pitching Rolls Royce for a couple years now as both a nuclear and jet engine powerhouse, but he has now moved on to a new theme in his ads for this newsletter… it’s all about protecting yourself from the catastrophe that could come if China actually invades Taiwan and cuts the rest of the world off from its semiconductor exports.

That’s a real issue, of course, and was the reason that Warren Buffett, despite being attracted to the excellent fundamentals at Taiwan Semiconductor (TSM) last year, sold his shares almost as quickly as he bought them. Fear of what could happen if Taiwan’s chipmaking industry gets cut off from the world is pretty rampant… and has led to the big investments that other countries are making in helping their own semiconductor companies to “catch up” and build advanced factories to produce chips in the US, Europe and elsewhere outside of China’s borders (or future aspirational borders, depending who you ask).

The big picture argument is pretty clear: The rest of the world is investing aggressively in building up their semiconductor capacity, which we’ve all seen (last year’s CHIPS Act is one of the more aggressive industrial promotion moves by the US government in a long time, and one of the most bipartisan — everybody can agree on “we gotta fight China”), and therefore investing in the companies who are needed to increase chip production will lead to profits. We’ve seen plenty of semiconductor capital equipment companies benefit from that, and apparently Rahemtulla has one particular stock in mind.

Here’s how the teasing begins:

“One Small, Under-the-Radar Company Is Crucial to This Entire Project to Save the American Chip Industry

“You see… the advanced chips that have become the lifeblood of the American economy are some of the most impressive and complex technological innovations known to mankind.

“A single chip can hold billions of transistors… each one 166,000 times smaller than a single grain of sand.

“We’re talking so tiny that you’d need an electron microscope, which can cost upward of $10 million, to see them.

“Now, as you can imagine, these are not easily built.

“They require extreme precision…

“And beyond that, an extreme level of purity that is almost unimaginable.

“A single speck of dust can ruin millions upon millions of chips.

“In fact, something like that recently happened at one of Taiwan’s factories.

“An entire batch of microchips was destroyed… and it cost the company $550 million….

“That is a chipmaker’s worst nightmare!

“And it’s one of the reasons chip production was never scaled up here in America.

“The facilities are incredibly expensive to build, and they must be run with extreme attention to detail.”

It’s not really true that chip production “never scaled up” in America, there are hundreds of semiconductor fabs in the US that were built in the 1960s-1980s and led the world in production of chips, and several major US companies still make their chips in the US… but it is true that we generally and slowly outsourced almost all chip production to Taiwan, especially the high-end chips designed by folks like NVIDIA, for the same reason that almost all iPhones are assembled in China and almost all manufacturing has been outsourced to other countries: IT’S CHEAPER.

Companies tend to prioritize profits over all else, and globalization was a massive boon to companies who were willing to move production to cheaper countries overseas, benefitting from friendlier or absent regulators, government subsidies, cheap labor, and, as manufacturing scaled up in various areas, amazing economies of scale. Having all the world’s blenders made in China certainly means that they’ll be a lot cheaper than if Germany made its own blenders, and the US made its own blenders, and Mexico made its own blenders. Globalization has been great for consumers, and deflationary, but it has also led to supply chains that are often very fragile, dependent on just one or two suppliers (even for simple stuff — like when the automakers suddenly realized last year that almost all new cars were using wiring harnesses that were made in Ukraine… thankfully, building a factory to assemble wiring harnesses doesn’t cost $10 billion and take four years, like a new semiconductor fab, but the same issues are impacting all kinds of industries and supply chains).

More from Rahemtulla:

“American tech companies decided it was just cheaper to allow Taiwan to build the facilities and produce the chips… and we’d simply buy them from there.

“However, if China were to take over that chip production, simply buying them from Asia would no longer be an option.

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“It’s why we are seeing chipmakers like Intel, IBM, Micron and others rushing to build plants in the U.S.”

That has indeed been a major theme over the past couple years… but what, then, should we buy?

From the ad:

“While each of those American chip companies is a solid investment bet right now… there is another company that I believe is going to be crucial to virtually every new chip factory around the world.

“This one small company is just a fraction of the size of Intel, IBM and Micron…

“But it has a stranglehold on the industry that very few outsiders know about…

“It owns 128 patents on products including…

“Innovative components that allow chipmakers to keep their equipment clear of any contaminants…

“And chemical delivery modules that deliver precise amounts of gas and chemicals throughout the chipmaking process.

“Without these components, it would be impossible to produce any chips.

“And top chipmakers around the world have tasked this company with ensuring that no major accidents shut down operations in their facilities.”

And he implies that this company is particularly essential, used by every chipmaker…

“This small company indirectly touches virtually every one of the trillions of chips produced on this planet every year.

“The more chip factories that are built… the more this company can grow!

“And because of China’s sinister plot…

“American chipmakers like Intel are already lining up to work with this small company… so it can help them efficiently produce massive amounts of chips right here in America.”

The second part of this pitch is that not only are new fabs being built around the world… but that they are going to be even more sensitive and high-tech plants, moving up to the 2nm manufacturing scale (I guess I should say, down to that scale). That’s essentially the cutting edge of chip technology now — Taiwan Semiconductor and Samsung both say they expect to be making 2nm chips by 2025, and Intel has said (not everyone agrees with their claim) that they plan to beat TSM to the punch by a year, with IBM also piloting a 2nm chip a couple years ago. We’re a long way from that being the standard, of course, and Samsung is arguably leading in 3nm chips at the moment, but yes, chips continue to push the boundaries of physics, as the new electrical connections inside these chips are sometimes only a few atoms wide. Presumably there’s a limit, but if you had asked the experts a decade ago I’m sure that a lot of them would have said manufacturing chips on 2nm process, or even getting down to 1nm, which is obviously in the plans for the future, would be impossible.

But anyway, yes, I would imagine that more advanced chips need more precise testing and monitoring and deposition and environmental control equipment. Here’s how Rahemtulla puts it:

“These tiny chips will be more powerful than any chips the world has seen before.

“They’re called “2-nanometer chips.”

“And Intel is expected to be the first to mass-produce them.

“Most importantly… they’ll be produced right here in the United States years before they’re produced anywhere else in the world.

“The implications of this breakthrough development are massive.

“These new chips are expected to use 75% less power than the chips that are currently on the market.

“Dr. Mukesh Khare, a vice president of IBM, said this development is massive…

‘It will accelerate AI workloads for 5G and beyond. It will unlock edge computing gains to unforeseen levels, including in areas like space exploration. This new 2-nanometer chip technology will aid the discovery of new materials, new drugs, which requires very high performance computing to simulate molecular structures. And finally, this technology will also be very valuable… towards reduced power consumption.'”

Plenty of folks will start shouting that Intel is cheating, and the Santa Clara plant that they say will produce 2nm chips is actually more on the 5nm scale, just goosing the performance by other means, but yes, everyone’s pushing to make more advanced fabs… and in recent years, the push is certainly on to build those fabs in the US, including Intel and TSM’s major projects in Ohio, Arizona and elsewhere.

But Monument Traders Alliance says it can’t be done without this one little company…

“That’s why Intel and its partners are doing whatever they can to mass-produce these cutting-edge chips first.

“But here’s the thing.

“It simply CANNOT happen without this one small company and their patent-protected technology.”

That’s almost never true. There are very few real monopolies, where only one technology can support the most advanced products… but it does happen on occasion (like with ASML’s monopoly over extreme ultraviolet lithography).

What else do we learn about this little company?

“I believe their technology will be used not just by Intel… but by virtually every chipmaking company around the world.

“Without this small, $32 company…

“Chipmakers simply wouldn’t be able to bring chip manufacturing home to American shores…

“Which is why all the big blue chip tech firms are handing this company millions upon millions of dollars….

“This Company’s Revenue Could Increase by a Record $800 Million…

“Over the past few years, this little-known company is growing faster than the other chip equipment makers….”

And we get a chart that shows the company’s growth in revenue, from about $500-600 million in 2016 to $2 billion in 2021, and with operating margins that grew to 12.2% (from 5.4% in 2016).

And some other tidbits for the Thinkolator…

“In fact, Christian Schwab of Craig-Hallum Capital Group told Investor’s Business Daily that he projects this company could see an $800 million increase in revenue in the near future….

“This company doesn’t just supply chipmakers…

“It supplies other equipment makers with their own virtual monopolies…

“Lam Research, Applied Materials and ASML also are adding hundreds of millions of dollars to this small company’s business…

“Simply put…

“This company has contracts with all of the major players involved with chipmaking.”

And it’s not just supplying one specific kind of equipment, it sounds like…

“It is involved in every stage of the chipmaking process…

“From factory construction… to equipment buildout… to ongoing production support across the entire new chip industry.

“This company indirectly touches almost every chip that is produced in the world…

“When a new chip factory is built anywhere in the United States… that should mean more revenue for this company in the short and long term.”

They’re also selling outside the US, we’re told:

“The threat of China taking control of the entire global supply of chips is forcing every country around the world to focus on building their own safe and secure supply of chips.

“And this American company could end up being involved in just about all of it.

“In fact, this company’s percentage of revenue produced outside of the U.S. has DOUBLED since 2015!”

And the dream, it sounds like, is that this could be the next Lam Research or ASML…

“Just look at past pick-and-shovel chip stocks that have had similar positions in the market…

“Their all-time gains are massive!

“ASML’s patented technology allows chipmakers to mass-produce patterns on silicon…

“Its stock is up 26,961% in 28 years….

“Which would you have rather been an early investor of?

“Chipmaker TSMC… which is up 1,289% over its lifetime…

“Or Applied Materials, which is up 41,577%?”

We even get a few clues about the management team…

“This Mission-Critical Company Is Poised to Be the Next Breakout Chip Stock…

“And if you look at their leadership team…

“It’s stacked with chip industry all-stars.

“The CEO is actually a former executive of Applied Materials… He’s responsible for part of its 41,577% gain…

“And several of its other top executives helped take Lam Research’s stock up 16,079%….”

And, of course, the promises…

“The ceiling for this stock is absolutely MASSIVE!

“This is the #1 place you’re going to want to have your money over the next two years.”

Though he does sandwich the “lawyers required this” warning in between the Scrooge McDuck daydreams…

“Now, it should go without saying that all investing carries risk, and you never want to invest more than you can stand to lose – even in an opportunity like this one.

“That being said, I wouldn’t be here pounding the table on this company if I didn’t fully believe it could easily soar 525% within the next couple of years…”

And he gets even more aggressive on the order form:

“This company’s equipment and services are critical to America’s plans to produce chips domestically…

“It’s at the center of the production of the latest bleeding-edge 2-nanometer chips, which will soon power the world’s most important technology…

“It’s crushing competitors, with 329% revenue growth since 2016…

“It holds 128 patents on the critically important equipment and services that it provides…

“And best of all, its stock is still dramatically undervalued…

“It’s an ABSOLUTE STEAL compared with similar pick-and-shovel chip stocks, which have surged as much as 41,577% over their lifetimes.

“In short…

“This under-the-radar stock is the ultimate way to grow your portfolio and protect it from China’s plot to destroy America…

“And I believe it can help you achieve a great retirement in the process.

“In fact, I’ve put my real money where my mouth is…

“I’ve personally loaded up on this exact stock!”

So… hoodat? Thinkolator sez this is Ultra Clean Holdings (UCTT), which is a very small supplier to the semiconductor capital equipment industry (so they sell parts and tools that go into the larger tools made by folks like ASML and Applied Materials, for the most part)… they cite companies like Ichor (ICHR), Jabil (JBL) and Sanmina (SANM) as competitors for different parts of their business. Here’s how they describe themselves:

“Ultra Clean Holdings, Inc. is a leading developer and supplier of critical subsystems, components and parts, and ultra-high purity cleaning and analytical services primarily for the semiconductor industry. Under its Products Division, UCT offers its customers an integrated outsourced solution for major subassemblies, improved design-to-delivery cycle times, design for manufacturability, prototyping, advanced flow control solutions, and high-precision manufacturing. Under its Services Division, UCT offers its customers tool chamber parts cleaning and coating, as well as micro-contamination analytical services. Ultra Clean is headquartered in Hayward, California.”

UCTT has been working on cutting costs over the past year, and their last quarter was actually meaningfully worse than the year-ago quarter (revenue last quarter was down to $433 million, their worst revenue number in about two years), so they’re in a bit of a down year after a phenomenal 2022 — last year they had $2.4 billion in revenue and $3.98 in adjusted earnings per share, and this year they’re expected to have revenue of about $1.76 billion and earnings of about $1.10. That may not be a supremely accurate forecast, it’s the guess of just three analysts, but clearly they’re coming off of a peak and looking to start growing again next year.

It sounds like the problem recently has been the glut in memory chips and the falling prices in that area as the supply chain recovers, not the lack of investment in higher-end chips — competitors like Ichor (ICHR), who supplies Lam Research and some of the same equipment companies, who in turn supply equipment and services to Micron and other memory chip makers, have had similar bad quarters to start the year, and expect to see earnings drop from last year’s peak (and trade at somewhat similar valuations).

The share price is right around the most optimistic targets of analysts right now, so to forecast a massive gain here is certainly contrarian — the few analysts who follow the stock do mostly give it a “buy,” but their 12-month target is about $36-38, which is roughly 20X the estimated $1.90 that UCTT will earn per share in 2024.

It is, of course, very possible that the analysts are being too conservative — often it seems like the analysts are the last to realize that there’s a huge surge of business coming. UCTT does look like a fairly solid company, even though it’s not currently growing — they have enough cash on the books ($320 million or so) that their $600M or so in debt does not look worrisome, they are still actively investing in new production capacity, and the industry is certainly growing pretty rapidly right now, so maybe they’ll have a surge in orders over the next year or two, as Rahemtulla seems to believe.

But seeing the future is always the tough part — IBD was excited about UCTT’s recovery about 16 months ago, in February of 2022, when it was coming off the peak but still at just about $50 per share, and hadn’t yet released its 2021 fourth quarter results. That article is where we can find the quote Rahemtulla uses from analyst Christian Schwab about $800 million in new revenue… here’s an excerpt:

“Analysts See Growth On Horizon….

“… Christian Schwab of Craig Hallum Capital Group told Investor’s Business Daily that Ultra Clean is well positioned for growth. That’s due in large part to revenue gains stemming from its Malaysian facility.

‘When fully operational, it could add $800 million in incremental revenue,’ Schwab said.

“He also spoke of growth predominantly driven by market share gains in spending on wafer fabrication equipment, also known as WFE. He noted changes at chipmaking giant Taiwan Semiconductor Manufacturing (TSM)….

‘TSM’s recent raising of its (capital expenditure) expectation bodes well for WFE spending to be up in the midteens where prior expectations would have it in mid-to-high single digits,’ Schwab said. Schwab gave UCTT stock a buy rating with a target price of 73.”

The last couple quarters have been quite “meh” for UCTT, no big “beat and raise” announcements but no shockingly bad news, either… though the stock did surge 20% a couple weeks ago on the back of the excitement over AI chips for folks like Marvell and NVIDIA, when essentially the entire semiconductor index jumped higher all at once. We’re obviously far from seeing the kind of recovery and revenue boost and price movement that the Craig Hallum analyst was predicting back in early 2022… no surprise, then, that the same analyst reduced his price target to $32 and downgraded the stock back in January of this year. Things change, and in this sector it seems to be the company and the stock price that tell the analyst what’s his or her opinion should be, nobody seems to be great at predicting how the chip business will evolve these days.

And that’s about all I can tell you after a few minutes of skimming through UCTT’s materials — it’s in an interesting sector, it should get more business as more fabs are built, but I don’t know if they have any kind of proprietary hold on the industry… their current financials don’t indicate that they have any unique pricing power over competitors like Ichor, or over customers like Lam Research and Applied Materials, but maybe it’s there and I just haven’t seen it yet. The valuation is maybe not ludicrous at this point, but you would be paying a growth valuation for a company that’s not currently growing, so you’d probably need to read a little deeper into their business to be confident that the growth will emerge again someday soon. It’s pretty clear that Rahemtulla is convinced, but I’ll stay on the fence for now.

It’s your money, of course, so you get to make the call…. and many of you probably know this little subset of the semiconductor capital equipment industry better than I do — so, do you think Karim is right, that the boom in chip factories will lead to a surge in revenue and profits for UCTT? Think other providers in this business are in better shape to ride that wave of investment? Please let us know with a comment below. Thanks for reading!