ACM Research (NASDAQ:ACMR) is projected to grow impressively, the stock is trading at valuations that price this is in. Will the value of Class A shares reflect this growth? Will Class A shareholders end up funding ACM Research (Shanghai) with no upside? The company’s market cap in October could be a key determinant.

Background

ACM Research, Inc. is a semiconductor equipment manufacturer. It was incorporated in California in 1998 and initially developed tools for wafer processing steps involving the integration of copper and ultralow dielectric materials. It started focusing on its current line – tools for wet cleaning of single wafers, after moving its operational center to Shanghai in 2006. Three customers accounted for 73.8% of the company’s revenue in 2019. Two customers based in China (PRC) accounted for 54% of the revenue, Korea-based SK Hynix accounted for 19.8%. The company has a TTM revenue of $111.4M.

The company’s sole US operations – “ACM Research (CA)” (see org structure shown below) consists of 5 employees, occupying a 3,000 sq. ft. office and warehouse space in Fremont, California. The function of this entity is to provide procurement services on behalf of ACM Shanghai. Substantially, all of the company’s product development, manufacturing, support and services are in the PRC. 28 of the company’s 361 full-time employees are located in Korea, and the rest are in China and Taiwan. All the company’s sales in 2018 and 2019 were made to customers outside the United States. The company currently has one demo tool in the US – a megasonic technology-based wafer wet cleaning tool (SAPS II) at an undisclosed US R&D lab.

The company’s key suppliers are Product Systems, Inc. (US), Ninebell Co., Ltd. (Korea), and Advanced Electric Co. Inc. (Japan). ProSys is the sole supplier of megasonic transducers, Ninebell is the principal supplier of robotic delivery system subassemblies, and Advanced Electric Co. is a key supplier of valves. These subassemblies are used in the ACM’s single wafer cleaning equipment.

Share Classes and Corporate Structure

ACM Research Common Stock has a dual class structure, with 16,272,306 Class A shares and 1,802,606 Class B shares outstanding as of Aug. 4, 2020. Each Class A share is entitled to one vote, whereas each Class B share is entitled to 20 votes. Class B shares are exclusively owned by executive officers and directors of the company and are not listed or traded on any stock exchange. The buyer of ACM Research shares, thus, has no control over the company’s actions as long as Class B common stock represents at least 4.8% of all outstanding shares of Class A and Class B common stock.

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This brings us to a very interesting clause regarding the automatic conversion of Class B shares to Class A found on Pg.5 of the Prospectus (dated February 12th, 2019) in the 424B5 filed on August 13th, 2019.

“on or after the date of this prospectus, all outstanding shares of Class B common stock will convert automatically into shares of Class A common stock, on a one for one basis, upon a) the election of the holders of a majority of the then outstanding shares of Class B common stock or b) on the first December 31 that occurs more than five years after the date of this prospectus if the October Market Cap with respect to the month of October immediately preceding such December 31 exceeds $1.0 billion, provided that the conversion provided by this clause b) shall not apply and no automatic conversion of Class B common stock into Class A common stock will ever occur pursuant to this clause b) if the October Market Cap for the month of October immediately preceding a December 31 exceeds $1.0 billion prior to the fifth anniversary of the date of this prospectus.”

October Market Cap is defined as the volume weighted average trading price of Class A common stock for each day in any October multiplied by the number of shares of common stock outstanding on the last day of that October. Based on my understanding of the above, this clause implies that, if the shares trade at an average price of about $65 for the month of October 2020, Class B shares will never convert to Class A, unless a majority of the holders of Class B common stock elect to do so. With the stock trading at ~ $71, the company currently has a market cap of ~ $1.2B. Interestingly enough, Needham & Company and Stifel (organizations that recently pronounced opposing opinions on the stock) are listed as Joint Bookrunning Managers on this 424B5. The clause regarding conversion appears again in the S-1 filed on May 26th, 2020, which has since been withdrawn. (August 11th, 2020)

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The company’s corporate structure is complex, ostensibly as a result of preparation for STAR listing and STAR IPO. STAR is China’s domestic version of Nasdaq. The slide below attempts to capture the company’s structure gleaned from information in the 10-Q dated June 30, 2020. The key takeaway is that all operating subsidiaries are wholly owned by ACM Shanghai. As a result of actions taken in connection with the STAR listing, ACM Research will no longer wholly own ACM Shanghai. As of June 30, 2020, ACM Research had a 91.7% interest in ACM Shanghai.

After the STAR IPO, ACM Research will retain majority ownership of ACM Shanghai, but ACM Shanghai will be managed by a separate board of directors and officers. The 2019 10-K states that these officers may act contrary to the best interests of ACM Research. It is also pertinent to note that the CEO and President of ACM Shanghai, Jian Wang and David H. Wang, the President and CEO of ACM Research, are brothers.

The company will be the first US-traded company to list a PRC-based subsidiary on the STAR market. The company also states that the proceeds from the STAR IPO will be reserved to repay current PRC investors and will not be available to fund operations in the PRC. In the interim, ACM Shanghai may require additional funding from ACM Research. ACM Shanghai could also issue share-based compensation to its directors, officers and employees or engage in capital raising activities that could further dilute ACM Research’s ownership interest in ACM Shanghai.

This has serious implications for current (Class A) shareholders of ACM Research. In addition to the lack of voting control, a situation that will continue, if the company’s share price remains in its current range in October; ACM Research shareholders could end up funding the operations of ACM Shanghai with little if any upside once the STAR IPO goes through. The company is currently an “emerging growth company” and thus has reduced disclosure requirements.

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Valuation

The company’s nosebleed valuation is evident when compared (Table 1) to a couple of its peers LAM Research Corporation (NASDAQ:LRCX) (TTM Revenue, $10.0B) and Ultra Clean Holdings Inc. (NASDAQ:UCTT) (TTM Revenue, $1.2B). LAM Research is a developer of equipment for semiconductor wafer deposition, etch, and clean. ACM Research lists LAM as one of its competitors. Ultra Clean is a leading developer and supplier of critical subsystems, ultra-high purity cleaning and analytical services primarily for the semiconductor industry. Neither LAM Research nor Ultra Clean Holdings have a dual class stock structure.

P/Earnings (TTM)

P/Sales (TTM)

P/Cash Flow

LRCX

20.43x

4.48x

17.85x

UCTT

38.61x

0.66x

11.71x

ACMR

74.4x

11.58x

70.89x

Market data and information provided by Morningstar (obtained from TD Ameritrade)

Table 1.

ACM Research claims that its tools could potentially address 80% of $3.0B wafer cleaning market, giving it a TAM of $2.4B. A few points must be kept in mind by those justifying these valuations for ACM Research, based on its potential growth prospects. The industry that ACM Research operates in is capital intensive and characterized by long lead times between tool evaluation and final order placement. Unlike companies operating in the software space, rapid growth in a few months is unlikely. Since the company operates primarily in China, its growth (at least within China) could be faster than it would otherwise have been. However, this is not a given.

Takeaway

ACM Research is a Chinese manufacturer of semiconductor processing equipment. It currently sports a valuation that is more typical of asset-light companies during these heady times. Given the risks inherent in its corporate structure, dual class stock structure, and upcoming STAR market listing, investors should not be buying ACM Research Class A common at current prices.

Disclosure: I am/we are long UCTT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Short ACMR.



Via SeekingAlpha.com