Applied Materials (AMAT) produces semiconductor fabrication equipment, including products used in deposition, etching, ion implantation, metrology, wafer inspection and mask-makings, notes Jim Kelleher, CFA, of Argus Research.

The global pandemic is acting as an accelerator for key technology inflections that were already underway. Work- and learn-at-home, e-commerce, and explosive growth in streaming and social media are driving investments in cloud data centers and communications infrastructure. Companies are hardening their business-continuity capacity, further driving technology demand.

The emerging workloads supporting these trends require domain-specific approaches, new system architectures, and new types of semiconductor devices.

Leading-edge node transitions are driving demand. These include 3D for memory, logic and other areas; the 5G revolution; and ongoing die shrinks that enable customers to pack more power into tinier and more power thrifty devices.

The company has increased its offer price and extended the time to deal close for Kokusai Electric Corp. AMAT has now agreed to pay $3.5 billion for Kokusai, compared with the original mutually agreed-upon price of $2.2 billion. The higher bid price, according to Applied, reflects higher valuations for participants in the semiconductor capital equipment industry.

The two parties have also agreed to a new closing deadline of 3/19/21. At the time of the original announcement in July 2019, deal terms allowed for three extensions, and this would be the third. We see the third extension as a final effort to receive a regulatory sign-off from China.

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The addition of Kokusai would provide AMAT with high-productivity batch-processing systems and other technology, would add key customers, and would expand AMAT’s regional reach. Even at the higher bid, the deal price is reasonable. At this point, geopolitics alone stands in the way of deal close.

On a stand-alone basis, AMAT is the revenue and market share leader in the semiconductor capital equipment space. As the global economy begins to recover from the pandemic during calendar 2021, digital transformation of companies, industries, and global economies should continue to drive demand.

AMAT trades at a discount to peers on absolute and relative P/E, price/sales, and EV/EBITDA; peer indicated value is in the low $100’s range, on the rise and above current prices. Our discounted free cash flow analysis suggests a value in the $150s, in a rising trend and well above current prices.

Our blended valuation estimate is now in the $130 area, in a now steadily rising trend. Including the current dividend yield of about 1.1%, appreciation to our 12-month target price of $110 (raised from $90) implies a risk-adjusted total return greater than our forecast return for the broad market and is thus consistent with a "buy" rating.

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