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ATMI's Beginning to Benefit From New Growth Opportunities

But we think the market has failed to recognize the potential.

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 ATMI (ATMI) is a leading supplier of materials and consumables that are used during the semiconductor fabrication process. We believe the firm has two key opportunities to drive revenue growth in the upcoming years: its high productivity development, or HPD, platform and the life sciences segment.  We think that the market is mispricing the firm's growth opportunities and that ATMI's shares offer a favorable risk/reward for investors.

Our thesis has been based primarily on two growth opportunities that ATMI has been investing heavily in over the past several years, and which appear to be on track. The first is the HPD platform, which allows the firm to create customized materials tailored to specific customer needs for their chip fabrication processes. As chip performance continues to increase, ATMI's HPD capability is now coming into play, as chipmakers need new materials to be developed to help them migrate to next-generation manufacturing processes.

ATMI has begun to benefit from a ramp-up in revenue from materials developed using its HPD platform. It saw steady growth for HPD-related revenue throughout 2011, with sales from HPD materials rising from $1 million in the first quarter to what is expected to be $7 million-$8 million in the fourth quarter.

Overall manufacturing activity in the chip industry has softened in recent quarters, particularly at the older fabrication processes, which has slowed demand for ATMI's traditional products. However, production activity levels at the cutting-edge nodes have remained healthy, allowing ATMI to see the rise in HPD-related revenue. We expect continued momentum in the HPD opportunity, as foundries ramp up their next-generation 28-nanometer semiconductor manufacturing processes.

The firm is also seeing growth in its life sciences segment, with revenue rising 26% in the first nine months of 2011 versus the year-ago period. ATMI's growth opportunities in this business are in consumables products, such as single-use bioreactors, mixers, and storage systems, used for pharmaceuticals manufacturing. Drugmakers are starting to shift toward single-use systems over traditional stainless steel-based manufacturing processes for certain pharmaceuticals products, such as vaccines. While customers have mostly been going through process qualifications in the past couple of years, some pharmaceutical firms are now beginning to move some lines to volume manufacturing using single-use systems. As this trend continues in the upcoming quarters, we expect ATMI to see further top-line growth in the life sciences business. Management has said it believes the unit is capable of expanding around 25% over the next few years.

ATMI recently took full control of distribution and manufacturing of its flagship Safe Delivery Source product line from partner Matheson. SDS, which typically accounts for around 20%-25% of sales, is widely considered the standard ion implant gas storage system for semiconductor manufacturing.

By completely taking control of SDS, ATMI can capture more of the profits on the product, as they will no longer have to be shared with Matheson. Management expects to see incremental quarterly contributions of $7 million-$8 million to revenue and $0.08-$0.09 to earnings per share beginning in the second quarter. However, ATMI had to pay $95 million to terminate its agreement with Matheson. Management expects that revenue in the fourth and first quarters will be depressed by reversals of previously recognized product shipments into the Matheson distribution channels and by inventory burns in the channel, until ATMI is in a position to fully take over the business. The drag on the top line is forecast to total up to $16 million during the two quarters. Matheson has agreed to manufacture SDS products for up to two years and provide distribution support for ATMI over a transitional period. In addition, Taiyo Nippon Sanso, Matheson's parent, will continue to be ATMI's SDS distributor in Japan, where distribution tends to be much more complex than in other countries.

We think the SDS transaction was a good strategic decision by ATMI. By bringing SDS distribution and manufacturing in house, the firm will have greater opportunity to leverage its entire product portfolio to directly interact with chipmakers and better serve their technology needs. In addition, ATMI today has the infrastructure to engage with customers on a global scale, unlike in the past, thereby allowing it to end its dependence on Matheson.

Finally, management should have better visibility into its near-term business outlook as a result. In the past, ATMI would periodically suffer from inventory overbuilds in the SDS distribution channels, which would sometimes unexpectedly hurt revenue and earnings and cause volatility in ATMI's stock price after quarterly earnings results. Now the firm will have better insight into the supply chain and be positioned to better manage SDS inventory levels.

Risk/Reward Remains Favorable for ATMI Investors
We believe the market continues to misprice the HPD and life sciences opportunities. Our bear-case scenario analysis, which results in a fair value estimate of $19 per share, is based on the far-fetched assumptions that HPD, despite being successful so far, eventually ends up failing and that revenue from this opportunity eventually goes down to zero. In addition, we project minimal growth in the life sciences segment over our forecast period. Such a lack of success in these opportunities would mean that ATMI would be unable to offset pricing pressure for its older products with new materials from HPD and consumables products from the life sciences business, which would result in a drag on gross margins. In such a scenario, we estimate that the firm's long-term operating margins will eventually run around 12% over time.

ATMI is clearly making progress in the HPD opportunity and appears on track for growth in the life sciences segment. However, the market appears to continue to ignore these opportunities, which presents a buying opportunity for the stock.

Because the market's time horizon for most chip and chip supplier stocks tends to go out for only several quarters, as most investors try to play the industry cycles, we believe the ATMI story is underappreciated. The chip industry has been hampered by a cyclical downturn, which has put pressure on semiconductor-related stocks in general. As a result, the stock market does not appear to be giving credit to the favorable long-term growth prospects at ATMI. Although the industry downturn has caused a slowdown in overall semiconductor manufacturing activity, manufacturing activity levels at the cutting-edge chip fabrication processes remain high. This, combined with the volume increases that are now occurring for next-generation process nodes (such as the 28-nanometer process at the leading foundry chipmakers), should drive demand for new HPD-related materials from ATMI in the upcoming quarters. We believe revenue growth from HPD and the life sciences business should allow the firm to outperform most other similar-size firms tied to the semiconductor industry in the near term and over the long run.

ATMI's shares offer a favorable risk/reward for investors, in our view. A bearish outlook on the firm's growth prospects appears to be priced into the stock, which should offer some downside protection. As the firm reaps the benefits from the HPD and life sciences opportunities down the road, we think the stock market will eventually appreciate the story and handsomely reward investors who are willing to buy now.

Andy Ng does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.