ASML’s Latest Chapter in the Semiconductor Story

In this podcast, Motley Fool analyst Jason Moser and host Mary Long discuss the semiconductor supply chain, ASML‘s earnings, and what’s ailing the pharmacy industry.

Then, Motley Fool contributor Brian Orelli joins for a look at how genetic testing company 23andMe went from a $6 billion valuation to a penny stock in a mere three years…and where the company (and its data) might go from here.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our beginner’s guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 16, 2024.

Mary Long: Today, we got chips and we got scripts. You’re listening to Motley Fool Money. I’m Mary Long, joined today by Jason Moser. Jamo great to have you. Thanks for hanging out with me this morning.

Jason Moser: Mary, thanks for having me. Always, a pleasure.

Mary Long: Before we talk numbers, before we started recording, you had to exit to go check on your dogs. They were barking.

Jason Moser: I was saying, they have just this sixth sense that whenever I’m get ready to start doing anything media-related, man, they come out in full force. I had to reel them back inside here for a bit to quiet things down.

Mary Long: Were they barking about anything in particular or were they really just trying to bother you?

Jason Moser: Probably the latter, but we live in a pretty wooded area, our neighborhood, so there’s all wildlife running around and they’re always barking at something.

Mary Long: Could have been a rogue deer. Who knows?

Jason Moser: Could have been.

Mary Long: ASML earnings came out a day early and $1, perhaps a few dollar short, the semiconductor equipment maker suffered its biggest single-day drop since 1998 yesterday. Results were released a day early due to a technical error, and the news within those results sent nearly all semiconductor stocks sinking. Before we take a closer look at that news, maybe you can give us a refresher on where exactly ASML sits within this broader semiconductor landscape.

Jason Moser: ASML is a crucial link, I would say, and perhaps one of the most complex supply chains out there. But the company, so they make the machines that ultimately make the semiconductor chips that are powering everything that we do in our lives from smartphones, computers, data centers. You may have heard of this thing called AI that is making some progress and they play a big role in that as well. It’s an interesting company because what separates them? Ultimately, they make these machines, they’re called lithography machines and they’re two different kinds.

There’s this deep ultraviolet lithography machine and that’s something that a number of companies out there make. I guess you could consider that a lower tier chip producing machine. But when you start talking about these higher-tier bleeding edge technology, chips, they’re using what is called EUV extreme ultraviolet lithography. ASML is the only player in that space. They’re the only game in town and that technology it’s necessary to manufacture all of these chips. They hold a very strong competitive position just by virtue of what they build.

Mary Long: News from this latest quarter came out yesterday, as we said. Some key takeaways from that, just to start us off. Revenue and earnings per share, both up compared to the last quarter. We saw a slight increase in the number of those lithography systems that were sold. Here’s what’s getting all the attention in the press. Net bookings for the quarter were down far below analyst estimates. Came out to about 2.6 billion euros. That’s up year over year, but again, far below analyst estimates, which were closer to 5.5 billion euros. Gross profit margin right on track at just over 50%. What in all of this is most interesting to you?

Jason Moser: While we say it, often, investing is all about the future. For me, it really is the bookings Number 1, just the significance, that disparity there. But it also, I think those booking numbers reflect the number of challenges in the market from the state of its customers, companies like Intel and Samsung, to the political landscape, US restrictions on exports of its manufacturing tools to China. I think all in all, it’s just that look forward. That bookings number tell us what the future looks like, at least in the near term and that to me is what stands out the most.

Mary Long: Help me understand why we’re seeing this pullback in the bookings numbers because demand for AI is booming. AI needs semiconductors. ASML plays as you said, crucial part in the semiconductor supply chain. Why aren’t we seeing that AI demand come through in these net booking numbers that ASML is posting?

Jason Moser: Well, so I think part of that is they called it out. They actually called this out in the earnings call, and they mentioned that their low order intake is a reflection of what they call the slow recovery in their traditional end markets as their customers, these big companies, they remain cautious in this current environment. It’s something that rhymes with a lot of what we’ve seen throughout the last several quarters. With a lot of these big enterprise companies and enterprise customers is that they’re just spending a bit more frugally, I guess, but they’re a little bit more cautious in the current environment and, you add that to the ongoing issues in regards to China. China is something where I believe last year China was around 30% of revenue and next year, it’s forecast to be around 20%, and so all of that put together. Then finally, I mean, these are big purchases.

This is not something where companies just go buy these things like we go to the grocery store. The latest EUV machine runs up of $380 million. These require a lot of thought and a lot of planning and their customers right now are just spending a little bit more cautiously than they have in the past.

Mary Long: Let’s zoom in on that China piece for a moment because as you said, the restrictions that the US and the Netherlands have put on certain countries, China, in particular, when it comes to shipping advanced AI chips there, that has played a huge role in ASML’s pullback here. Bloomberg reported yesterday that the White House is mulling even more of these chip caps on other countries, so not just China. What’s their path forward? Where else can they turn to to make up for the losing and likely continuing to lose a large piece of that market?

Jason Moser: That’s a bit of a more difficult problem to solve. Again, looking at China and just looking at some of the numbers. Last year, they sourced 29% of their sales from China. In the second quarter of this year, there. They noted that they sourced about 49% of their sales from China. That is very significant and now, again, going into next year, they’re talking about that being closer to 20 and they can look to other markets where they don’t hold that they are not as reliant on today. A few that stand out, Japan. You’re talking about areas Middle East and Asia and potentially the US as we continue to invest in our own capabilities here, but make no mistake.

I mean, this is not an insignificant deal and I don’t think it’s something that’s just that they’re going to be able to figure out overnight. I think this certainly could turn into a bit of a longer-term drag on the business, but by the same token. I think it is something that ultimately it’ll ebb and flow, I think with the political landscape. We’ll see how that turns out and given their specialized nature, they’re still in a good position.

Mary Long: Management talks about this broader industry slowdown and you can think if this is an inventory issue, but it’s different than an inventory issue. It looks different than an inventory issue we might see with something like Target. That’s easier to conceptualize for me. Target has a lot for any consumer-facing company, if Target has too much inventory on its hands, it can have a back to school sale to offload some of that inventory onto its consumers. What ASML is dealing with here is a bit more complicated. Their clients hold too much of the inventory. They’re not buying as many new ASML products. You don’t solve that problem with a back to school sale. How do you solve it?

Jason Moser: No, it’s like iPhones keep getting better and better, so we don’t need to upgrade nearly as often as we do. Obviously, this is not a fair comparison, but you get the idea. They make really good equipment and what their customers can use that equipment for a long time. But as we know, particularly as it pertains to AI, tech moves very fast. I think on the one hand, we’re not going to see them resorting to fire sales to try to push product out. They know their equipment is special and necessary and they’ll stick with that. This may be something that in the near term at least is just more or less a bit out of their control. There are greater forces at play.

They may just need to be patient and let innovation run its course. I like to look at this as a little bit more of a timing thing than anything else. I think the buses the company is going to be just fine. This could be something that actually ends up opening up a window of opportunity for investors and we like to find great businesses that are dealing with some near term challenges. This may just fit that bill.

Mary Long: Talk about a window of opportunity. How do you value a company like this? Because we’ve seen a massive drop off in shares just today alone. But we know that this is a top dog in the space. That bodes well for the long-term story. But still, as we’ve discussed, its output is constrained. What do you make of that from a evaluation perspective? What do you do with that information?

Jason Moser: Well, you look at the stock today. It’s definitely cheaper than it was a couple of days ago. I’d say today, it’s valued around 38 times earnings. I think for folks who are looking for a bargain, you’d look at 38 times earnings and think, well, man, that’s still not cheap, but also remember. This is like you said, it’s a top dog. It’s always garnered a premium valuation because of its position in the market. Then when you consider where the stock is today, somewhere in the $600 change range. The 52 week high was just over $1,100 per share. This is clearly a special company with a tremendous competitive advantage. But that said, I think given the challenges that we’ve outlined, for folks who are interested and I think you’re right to be interested in a company like this, this is one I think just where investors will need to stay patient, and that goes back to those greater forces at play. That’s something that’s a little bit more out of the company’s control. But again, I think when you look further out, this company is just in such a strong competitive position there. You really have to like the long-term prospects.

Mary Long: locationsLet’s turn to a far less technical part of the economy and talk drug stores. Walgreens announced during its earnings call the other day that it would be shuttering 1,200 stores, so that’s about one in seven locations and that would happen by 2027. Five hundred of those stores are going to be gone by the end of fiscal 2025. Despite its massive footprint, this is a company that lost $10 per share in the past fiscal year. They’re not the only player in this industry to resort to cost-cutting or that’s struggling. Rite Aid is in the process of closing 800 stores. They filed for Chapter 11 bankruptcy last October. CVS is slashing jobs left and right. They had an announcement about that earlier this month after having already cut 5,000 jobs last year. What is ailing the pharmacy business?

Jason Moser: Well, I think in a word, it’s digital. I think that’s probably the easiest way to put it out now to expand on that a little bit. Ultimately, it’s just shifting consumer trends. We, as consumers, were opting more for online solutions and that applies for prescriptions. You look at Walgreens and CBS, companies like that, they rely very heavily on the pharmacy side of the business. The other part of the business, when you go into those stores, they’re a different version of a grocery store almost. They carry a lot of stuff and so going back to your inventory point, the inventory in those places has got to be a nightmare keeping up with all of that.

Whether it’s pharmacy or whether it’s grocery or anything in between, you look at a company like Amazon, and clearly, they’ve been making a lot of inroads in the online pharmacy business and focusing more on digital health and I think that you put that all together. These are just businesses that were built out to this scale, this footprint in a different world, where those solutions weren’t necessarily as obvious at the time. What they’re faced with now is just exactly, as you described, they’re closing stores. They are having to whittle down the workforce and become leaner and that clearly has played out on the stock price over the last several years.

Mary Long: We like, make easy comparisons between CVS and Walgreens because as consumers. We really know them as very comparable companies. But they are different businesses. CVS. Their approach in recent years has been to vertically integrate and they’ve merged with an insurance company, Aetna. They have a middleman pharmacy benefits manager Caremark, that’s been their tactic. On the other hand, Walgreens, their new CEO, Tim Wentworth, his turnaround plan and shuttering stores as a part of this turnaround plan is to really focus on what the business does best. That is its retail pharmacy stores. Those are two different approaches. If you’re betting on a horse here, which do you think is the better path forward?

Jason Moser: Well, I’ll be clear. I don’t own shares in either. I don’t know that I’m really interested in owning shares in either. But I would have to give the nod to CBS right now and I think part of that stems from that Aetna acquisition. I also think another part of it and I think CBS has done a better job at this than Walgreens has is becoming turning those stores into healthcare centers, really, more or less. There are plenty of areas all throughout the country where access to healthcare is just not readily available. People have to drive a long way to get there. But there’s a CBS seemingly on every corner and so, giving that dynamic to that business, where they’re basically healthcare centers, along with the pharmacy, along with that Aetna dynamic, the insurance dynamic. To me, that makes more sense. It’s not to say Walgreens can’t get to that point, but they are far behind CBS in doing so and so consequently, right now they’re just have to playing a bit of defense.

Mary Long: Jamo has always, pleasure to talk to you and to have you on to the show. Thanks so much for joining us this Wednesday on Motley Fool Money.

Jason Moser: Thanks for having me.

Mary Long: Before we get to the next segment for today’s show, I come to you with a humble request. If you listened to the show over the past couple of weeks, you might have heard us mention that Motley Fool Money is currently a finalist for Signal’s Best Money and Finance podcast for 2024. We’re up against some big dogs at Barns, the Financial Times and Bloomberg. We are humbled and excited and honored to be a part of this group, but the winner is determined by your vote and tomorrow is the last day to vote. If you enjoy the show, all of us here at Motley Fool Money would really appreciate you taking a moment to cast your vote for us. There will be a link where you can do so in the show notes. You will have to share your email in order to prove that you’re a human, not a robot. We really appreciate you taking the time not only to listen, but to cast a vote for us if you choose to do so.

Up next. A DNA test can tell you a whole lot about your ancestry, but then what? Twenty three and Me has been trying to figure out the answer to that question for years. Now, its consistent unprofitability is catching up to the company. Up next, Motley Fool contributor Brian Orelli joins me to decode how the genetic testing company went from a $6 billion valuation three years ago to a penny stock today. Twenty three and Me, the at home DNA test company, it’s fair to say, on the struggle bus. At its peak, this company was worth $6 billion. Now it’s worth less than 150 million. Brian, take us back into the time machine because this is a company that definitely had its moments of virality. What was the original value proposition from 23andMe?

Brian Orelli: I think when it IPOed in 2021, the big three things were that they had tons of data. Eighty four percent of US customers consent to research. That allows them to use the patient’s data or the customers data. Then also those customers are giving them not only their DNA data, but also their patient data. They’re filling out surveys and whatever to say, what other issues am I having? Then that allowed the company in theory to link DNA markers to diseases and then therefore, find targets that could design drugs for. In 2021, they had a drug development deal with GSK, the European large pharmaceutical company and then they had just launched the year before a subscription service.

Mary Long: Twenty three and Me is at a pretty major breaking point right now. It’s at risk of being delisted from the Nasdaq. Every independent board member has signed leaving only the founder CEO and Anne Wojcicki last year, the company had a massive data breach that exposed all this trove of information that it has from its nearly seven million customers. Where that’s a lot of bad. Where exactly did 23andMe go wrong? Can you pin point an exact moment, or has it just been a snowball effect building up to this?

Brian Orelli: I think it’s the diversification that they went through. We talked about the GSK. They started off with just DNA testing and then they added DNA testing for ancestry and that makes sense because that’s going to be something that you’re going to want to continue to look at. Because you might have other ancestors that then get into the system and therefore, you can find them that way. But then they went into drug development, and they really had two options here. They could have gone with a, just a licensing deal and said, hey, GSK, and anybody else that wants to do it, maybe we do exclusivities for different diseases. But look at our data and we’ll give it to you as a package deal and maybe we take you develop the drugs.

We’ll take some milestone payments. We’ll take some, single digit, low royalties. They could have done that for the cost of whatever, the initial payment and they wouldn’t have any of these expenses. But instead, what they did was they went and did a co-development deal with GSK and so now the drugs that they’re developing, they were paying for half of the cost. Then that, created a lot of costs for them that they had almost no control over because GSK is the drug developer and they’re the ones that are making the decisions on how much to spend on the drug development side. They eventually decided that they didn’t really want to deal with GSK anymore and so in 2023, they took over development that allows them to control cost and decide exactly what they want to develop. But it also means that they’re paying for most of it at this point.

Mary Long: Just feels a crazy, complicated and expensive business to try to step into?

Brian Orelli: That’s the reason I never bought it. It is just because drug development is hard enough, you don’t need to be doing drug development plus something else.

Mary Long: Are there any therapeutics that 23andMe has, at some point in that process, made progress on? Is that segment still a potential lifeline for the company.

Brian Orelli: Absolutely. They have two drugs in the clinic. They have one an immuno-oncology antibody for cancer that’s in Phase 2 development. It’s already progressed all the way through Phase 1. That clinical trial started in 2022. Then they have another one 23andMe-17, a 1473, which is an effector enhanced antibody that activates NK cells again, for cancer and trying to get the immune cells to attack the cancer. That’s in Phase 1, and we’re waiting for data from that. Yes, they have promise, but we’re still many millions of dollars away and many years away from having a product on the market. Phase 3 trials is going to cost 10s of millions, if not,10s and 10s of millions of dollars. Maybe not 100 million, but a lot of money and so then we’ve got, and then it’s going to take a couple of years, and then you got to wait for the FDA and which which is another year. There are a long ways before these would be creating revenue for them.

Mary Long: The founder CEO Anne Wojcicki, for what it’s worth, she is still fighting for this thing. The company announced a one for 20 reverse stock split that goes into effect on October 16. Sometimes this can be an effective path for a company, I’ll flag that Booking Holdings did a one for six stock split after the Internet tech bust bottomed in late 2000 and is now up more than 6,000%. It’s not sometimes that can work out. That said it’s probably going to take more than a reverse stock split for 23andMe to ever see those returns. Brian, looking ahead. What is next for this company? Where do they go from here?

Brian Orelli: The CEO Wojcicki, she wants to take the company private. She had already announced that. That was the reason why all the independent board members resigned. They did it literally all in the same, letter to her, basically, because she wasn’t they didn’t think she was negotiating in good faith. They’re supposed to be keeping the stockholders best interests at heart. Because they’re the independents and so if she’s trying to take it private, sure they have to see whether any company wants to buy it or take it private, or, an individual wants to take it private. They have to, entertain those ideas, but she wasn’t giving them any prices that they thought was fair for the shareholders and so that’s why she resigned. She still owns over 20% of the shares and she has 49% of the voting power.

It seems to me likely that she’s going to put in board members that’ll support her go private initiative. She probably get another percent or two of the rest of the voting stock to agree with her and then, what does she do next? If she’s able to get the company private? I think the most sense would be to just sell off the drugs and take the profits and then put them back into the genetic testing thing and also then do more licensing deals with their data that they do have. She could also try to sell off a large chunk of the business, raise additional capital to fund the drug development. I think they’re trading at about their cash on hand, which at the end of June was 170 million. That’s not going to last them very far since they burned in the quarter that ended June 30, 46 million. They don’t have very much cash left. They need a huge amount of influx of cash, but at a market cap of 150 million, if you do a secondary offering at that, let’s say you want raise $150 million. That means you’re diluting all your shareholders by half, and that’s going to cause the valuation to go down by half. Then it would definitely be trading under their cash. I think it’s probably easier as a private company for her to raise capital because there’s different terms that would be involved in a private equity raise versus a public equity raise.

Mary Long: What happens to all that personal data that 23 and Me has, especially considering how uncertain their future is?

Brian Orelli: Obviously, if it goes private, then she’s in charge of it and they will hopefully continue to use it for good, not evil. Hopefully, I think the issue, maybe if the worst case scenario is that the company goes bankrupt. Then the data is still valuable. Somebody’s going to buy that data and probably do the business and model that I say that they should have started with all along, which is taking this large amount of data and letting pharma and biotech, have at it and give us a percentage of the profits. If you’re ever able to develop anything, you take the risk, but we take a small percentage of the light if there’s a success, we take a small percentage of that total.

Mary Long: We’ve touched on various parts of the 23andMe story. It went public in 2021. Now, we’ve seen a steady and steep decline in its stock price and its potential since then. Are there any lessons that you think investors can take away from this story, whether it’s in regards to what you should be looking for when a company goes public, or even just what to keep an eye on when you’re trying to dabble in the personalized medicine and therapeutic space?

Brian Orelli: Money is key for every biotech developing company, small drug company. The idea is that you get it, you have enough money so that you can develop to your next inflection point that lowers the risk and increases the value of the company. Now you can raise more additional capital at higher valuation and so therefore, dilute your shareholders less than you would have if you’d done it the evaluation at the earlier evaluation. No company that I know of has ever gone from IPO to a drug on the market. They always have to do secondary offerings because you just can’t raise enough in an IPO. It’s too risky because it’s too early stage. You raise a small amount in the IPO, 100, 200, 300 million. You spend half of that hopefully and then you get to Phase 2 data, proof of concept data. We’re still years away from being approved that we raise more money. That allows us to run a Phase 3 clinical trial and we have enough money to get to that inflection point. Then hopefully, we get a positive, and then we raise more money to launch the drug and that cycle just keeps going until they eventually go to profitability. They didn’t have enough money.

That’s the main point here. If they’d had more money, this wouldn’t be a problem, or if their valuation hadn’t dropped so much, and they’d been able to get to the next inflection point that increased their valuation, then they would be able to raise more money. That’s the lesson here. Anytime you’re investing in a biotech company, the first thing you should be going to is looking at how much cash they have on hand. That’s always what I do. Before I even look at the pipeline, somebody mentions a company, you should look at this company. First thing I go to is how much cash did they have at the end of the last quarter.

Mary Long: You know what they say? Everybody wants money. That’s why they call it money. Brian Orelli, thanks so much for joining us on Motley Fool Money. Always a pleasure to have you and thanks for sharing your insight into this company with us.

Brian Orelli: No problem. Thanks for having me.

Mary Long: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against. Throw buyer, sell stocks based solely on what you hear. I’m Mary Long. Thanks for listening. We’ll see you tomorrow, Fools.