Comments
Amkor Technology, Inc. is not shy about asking for
money from the public. It wants $402.5 million. Of
this amount, $240 million will go to pay down a
portion of a heavy debt load. Precisely how the
remaining $162.5 million will be used is unclear at
this time (10/14/97). The investor should note that a
percentage of it, at least several million and
perhaps considerably more, will bypass the company
altogether and end up in the pockets of the selling
stockholders, namely Mr. James Kim and his three
children. Mr. Kim is the founder of the Company; he
holds 35% of the 85 million shares outstanding. Three
trusts, one for each child, have almost all the
remaining shares. If we assume an opening price of
$15 per share, then 26.8 million shares will move
into the NASDAQ market. Four million shares of that
amount, if it came from the selling stockholders, the
Kim family, would net them a nifty $60 million with
hardly a la di dah.
Their self aggrandizement
will be inconsequential, however, if they’ve
created a company with a foundation of substance,
capable of exploiting opportunity, showing an income,
and able to hold steady against the buffeting of a
global economy, that is, a company in which investors
can share in some serious growth. Certainly, their
claim to being the biggest packager of semiconductors
in the world with an income statement sporting a
billion dollars in revenue is a good start. But that
claim has to be looked at carefully.
The
Upside Of Independent Packaging
There are 3 major stages to the production of a
semiconductor. First is wafer fabrication. Second is
assembly of the die into a finished device; this step
is called packaging. And third, is testing of the
finished device. All three require a high level of
engineering and manufacturing sophistication. The
Company focuses mainly on the last two stages.
Traditionally, all the major
semiconductor companies performed these functions
in-house. However, over the last number of years
there’s been a trend to outsource this work to
independent packagers. A number of reasons can be
cited for this.
- Companies shorten their
time to market for new products by using both
their own resources and at the same time
those of the independent packaging companies.
- Packaging has evolved
into a highly challenging technical area of
its own. Independent packagers often are more
advanced in their capabilities than the
companies using them.
- Packaging and testing
is a highly complex process to do in volume.
It requires a substantial capital
expenditure, as much as a billion dollar for
a wafer manufacturing plant, which can be
avoided by outsourcing to companies with the
funds and expertise to develop this kind of
capacity.
- There’s a growing
trend toward "fabless"
semiconductor companies. They sidestep all
the complexities and headaches of
manufacturing by subcontracting that work and
instead focus strictly on the design and
marketing of semiconductors.
The other good news is that
"packaging and testing" as a market segment
is not highly fragmented among many players. There
aren’t more than 50 serious competitors in the
world and among those are only 15 doing over $100
million in revenue. It means Amkor may bring to bear
the facilities, the technical and management
expertise, the manufacturing experience, and their
existing relationships to continue attracting the
larger semiconductor companies with the high-volume
jobs. Any new competitor in this field would have to
overcome significant financial and technological
barriers if they were to enter the market
successfully.
These reasons form part of a
compelling argument that can be made for 20%
compounded annual growth in the independent packaging
segment of the industry; the segment realized $5
billion in ’96 and may grow to $12 billion by
the year 2001.
Positioning
For Growth
If indeed such growth occurs, the Company seems well
enough positioned to rake in a share of the work.
They already have some serious customers, such as
Intel and Texas Instruments (TI) who supply the
Company a great deal of its business. Intel has
recently announced a new generation of processor
chip, code named Merced, to enter production in 1999.
Merced replaces the x86-based architecture of the
last 20 years with significant performance
improvements. The chip will be introduced into the
market showing clock speeds of 600 MHz and within a
year will get ramped up to 1000 MHz. In contrast, the
current maximum for the Pentium II is 300 MHz. Also,
Merced will allow multiple processors to be
configured together, the combined power of which
could essentially create desktop supercomputers. The
chip first will be promoted into the engineering
community where speed is essential, but shortly
thereafter, as Intel brings its manufacturing costs
below $100 per chip, it will enter the consumer
market as a replacement for the Pentium. Merced
should continue to propel high-paced growth in the
computer industry for several years after its entry.
Amkor is probably preparing
itself to take advantage of this growth if and when
Intel seems inclined. There’s no certainty Intel
will parcel out any of this work to external sources.
However, they may do exactly that with their older
Pentium lines, which still will be under production
as Merced works its way into the various markets. At
the very least, the Company wants to ensure that its
capabilities track the needs of Intel on whom they
rely so greatly.
The
Downside Of Independent Packaging
Despite an optimistic survey of its future potential
a number of negative elements characterize the
semiconductor packaging segment.
- Small customer
base. The
customer base is exceedingly small. Besides
Intel and TI, it includes IBM, Rockwell,
Lucent Technologies, and others like these
who make the majority of the world’s
semiconductors. Consequently, many companies,
virtually all of which are in Asia, are
fighting for the same few customers. Although
Amkor claims 150 customers, it generates
nearly 40% of its revenue from just 5 of
them. This suggests that Amkor is at the
mercy of events very much out of its control.
A loss of any one of these important 5
customers would result in serious
consequences for the Company. Indeed, Amkor
depends on its Korean partner AICL, and AICL
depends on Intel and TI. A strategic error by
the management of any of these other three
companies could severely impact Amkor.
- Low gross
profit margins. Despite the high degree of
technical competence required to perform
these manufacturing functions in volume,
independent packagers remain at the low end
of the food chain with commodity level gross
profit margins. Net income usually is a small
percentage of revenue, probably somewhere in
the low single digits.
- High capital
expenditures.
Wafer manufacturing and packaging require
specially designed facilities and specialized
equipment. The technologies are changing so
quickly that some of the expensive equipment
tends to have short life cycles after which
it’s rendered obsolete. This forces a
constant level of significant capital
expenditures. Companies will find themselves
staying highly leveraged to keep up with the
changes. Amkor already has $678 million worth
of debt with promises of more to come. It
remains to be shown that they have the
capacity to support such an amount.
- Little
backlog. To
justify the high cost of business the
independents have to keep their facilities
running near capacity. Yet, they usually
operate with no backlog whatever. A small
customer base, easily skewed by alliances,
and the speed and erratic nature at which
products move into the marketplace can keep
their future speculative.
A
Family Affair
Although its products, manufacturing, and technical
expertise might be excellent, as a public company
Amkor is weakened by a tangled web of family ties and
a fog of interdependencies with a Korean company
called Anam Industrial Company, Ltd. (AICL). Any
analysis of Amkor necessarily devolves into an
analysis of the Kim family and AICL. They’ve
created a complex picture of relationships and
agreements and money flowing in different directions
and partial ownership of this and that, such that the
whole picture becomes a brew which Generally Accepted
Accounting Practices can only begin to sort out. It
should keep many investors sufficiently baffled for a
long time.
That the Company is a family
operation, run entrepreneurially, which the sale of
stock in a public arena will do little to change, is
clear. But between Amkor and AICL and knowing which
of the two companies is the dog, and which the tail,
is not clear. It should be unsettling that a billion
dollar operation with claims of public ownership
operates through a skein of family ties in a
cross-cultural context.
History
AICL was formed in 1956 by Mr. Kim’s father
Hyang-Soo Kim. Although AICL has since gone public in
Korea, the Kim family still owns 21%, the patriarch
remains an honorary Chairman, his son James Kim has
served as acting Chairman since 1992, and his
son-in-law is the president and a Representative
Director. James Kim is also the founder and CEO of
Amkor Technology.
AICL runs manufacturing
facilities in Korea covering 2.4 million square feet.
All their plants are ISO-9002 certified, which means
they measure up to the world’s gold standard in
manufacturing. With customers like Intel and Texas
Instruments there can be little doubt about the
quality of their products.
In 1970 James Kim
incorporated a company in the U.S. called AEI, whose
purpose, at least eventually, was "to design
semiconductor packages and provide semiconductor
packaging services through a supply relationship with
AICL." Apparently, AEI would find the customers,
and AICL would make the product. By 1996, $860
million of Amkor’s claimed $1.2 billion in
revenue was generated by the sale of products
manufactured at AICL and booked by AEI.
Over the years Mr. Kim and
the Kim Family Trusts acquired a controlling interest
in a number of companies in the industry,
collectively called the Amkor Companies, such as CIL
Limited for marketing in Europe and Asia, TL Limited
for manufacturing, AAP in the Philippines for
manufacturing, and others. Amkor Companies has now
gone through a reorganization to emerge as Amkor
Technology, Inc. Almost simultaneously it submitted
an S1 form to the SEC for an initial public offering
of $402.5 million. The Kim family is trading its
shares of interest in the other companies for shares
in the new Amkor. Likewise, AICL, which owns 40% of
AAP, will do the same. This is where the conceptual
simplicity ends.
The
AICL Connection
It’s disingenuous of Amkor to suggest, or
unrealistic for one to interpret, that Amkor has
nothing more than a common kind of supplier
relationship with AICL. Only in the loosest sense can
this be said. The two companies prepare their
business plans jointly, coordinate their products and
operations, have common R&D activities, and share
intellectual property rights. Amkor markets to the
U.S. customers and performs the purchasing of raw
materials. AICL expands its capacity based on the
forecasts of Amkor. And Amkor has taken loans from
AICL to the tune of $678 million. It’s not
difficult to conclude that both are simply two
different faces of the same company. Those who invest
in Amkor simultaneously must pay equal attention to
the general health of AICL.
Even so, each company gets
to log every sale as its own. In 1996 Amkor invoiced
the customers for $860 million in sales for product
supplied by AICL, and AICL invoiced Amkor for very
nearly the same amount. This can be seen in
Amkor’s gross profit margins, which for ‘96
were 12.7%, very nearly a pass-through of most of the
money to AICL. To most companies with staff,
manufacturing, marketing, and sales this low of a
figure would signal a severe loss. Only when a
company enjoys very low overhead by supporting little
staff with limited manufacturing and no costly
marketing can a 12.7% gross profit margin be enough
to sustain viability. Gross margins in the
25–40% range are more typical of large,
commodity-based manufacturers.
It’s not at all clear
to which company the customer should owe allegiance.
It appears TI has elected to align itself with AICL.
TI has made an agreement with AICL for the purchase
of a percentage of the product coming out of a new
AICL plant based around the so-called .25 micron
technology. It appears that AICL developed the plant
specifically for the TI work. The agreement calls for
TI’s purchase of 40% of the plant’s
capacity and in certain circumstances up to 70% of
its capacity. Even though the agreement is with AICL,
TI has agreed to be invoiced through Amkor, and Amkor
will show the revenue on its financial statements.
This certainly will make Amkor look stronger to the
critical American stock market and other potential
customers. But it is strength without much underlying
substance.
One is left to wonder then
how important Amkor is to AICL. Certainly AICL is
essential to Amkor. Its very existence as a company
would be threatened to its core without AICL in the
picture, since it derives most of its revenue through
AICL as well as the lion’s share of its loans.
This should give pause to an investor. Any financial
trouble at AICL puts the Company at risk.
The
Potential For Conflicts Of Interest
The formation of Amkor Technology now brings under
one umbrella all of the manufacturing capacity of the
Amkor companies in the Philippines, which constitutes
943,000 square feet, plus a new 106,000 square foot
packaging facility under construction in Chandler,
Arizona for operation in ‘98. The total extent
of manufacturing space reaches over 1 million square
feet. In ’96 the Philippines facilities
delivered 28% of the Company’s revenue with the
remaining 72% coming from AICL. All of this
manufacturing capacity has been gained through
acquisitions or has been developed through loans
mainly from AICL. AICL’s financing arm, called
Anam USA (or AUSA), since 1994 has made loans to
Amkor amounting to $507 million dollars. Of that
amount $492 million have been used for capital
expenditures. The AUSA channel has been an extremely
lucrative resource for Amkor, one which seems to have
been used often throughout the years and in many
different ways. Again, one wonders whether the AUSA
financial pipeline would be available were it not for
the father/son relationship. Of course, great
companies have been formed through the strength of
family ties; they survive over the long term by
transitioning away from them to more independent and
formalized management. We shall hope the Company is
staffing up with that in mind.
With Amkor taking on the
ability to do a considerable amount of manufacturing
by itself one might think that its dependence on AICL
would diminish, and this probably will be the case.
But given the tight integration of the two companies
it seems unlikely that Amkor also will not act except
in the best interest of AICL. As Amkor increases its
manufacturing presence the potential for a conflict
of interest is obvious in those areas where the two
companies overlap in capability. Here, under normal
circumstances, they would be competing for the same
limited number of customers. However, when any
conflict does arise we can be assured that market
forces between Amkor and AICL will be suspended.
Which company gains the advantage could well be a
family decision.
Debt
Capacity
Total debt owed by the Company to AUSA comes to $678
million against $45.5 million in stockholders’
equity. As of June 30, 1997 they had a working
capital deficit of $6.5 million. Virtually all the
debt emanates from Korean banks raised through the
borrowing power of AICL. It means that Amkor
Technology begins its existence as a highly leveraged
company and bound financially to AICL. Amkor is
putting investors on notice that considerably more
borrowing will take place in the following years.
Most of the money will be for capital expenditures in
getting a million square feet of manufacturing
facility up and running. Such efforts do not come
cheaply.
AICL itself supports $1.1
billion of debt against $2.1 billion in assets. We
can only assume that it has the capacity to
accommodate this amount of debt. However, Korean
banks, many of which are highly extended, are now
enforcing low lending caps with leveraged companies.
Any restriction in AICL’s borrowing ability will
reflect back on Amkor and doubtless have an impact on
further capital expenditures.
Outside the embracing
financial arms of AICL the Company most likely does
not have the wherewithal to command loans of hundreds
of millions of dollars. Under those circumstances we
can be assured of an increase in the rate of private
and public offerings in their search for funding. As
it is, we are warned that the $402.5 million of this
initial offering will at best last a measly 12 months
and probably not even that. The board of directors
has authorized 500 million shares of stock. It leaves
little doubt about the way they intend to raise vast
amounts of money. How much is needed or, for that
matter, where all of this is leading remains
something of a blur. The Company’s decision to
develop such sizable manufacturing capacity
apparently is based on the projections of industry
growth; it isn’t motivated by specific customer
contracts.
The risk may be justified,
but it won’t be without cost. The Company begins
with low potential net income, exacerbated further by
not insignificant amounts of interest on debt. Scores
of millions of shares then unleashed on the market
will undoubtedly weaken stock growth if not dampen it
altogether.
Will
The Company Show Net Income?
Amkor’s consolidated financial statement for the
years dating back to 1992 present a reasonably
healthy picture, but it’s a puzzle.
For the first half of 1997
the financials show interest expense to be 2.5% of
revenue. This figure seems low given the amount of
debt they hold. Although net income is 0.6% of
revenue ($3.9 million) for the half year, the income
tax percentage used in the calculation also was low
with respect to U.S. standards, 32% when in fact one
would expect it to be closer to 45%. Furthermore,
Selling and G&A expense is a remarkably low 7.1%
of revenue. This can only be achieved when there is
very little selling to do.
Amkor is near break-even. If
any one of the parameters mentioned above were to
increase substantially, it would put the Company into
a deficit. They may be able to improve their gross
profit margins as they take on more manufacturing and
reduce their reliance on AICL, but they admit this
will be a lengthy process.
It would not be a surprise
to see them show a loss in 1998.