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This Industry's Smallest Player Has the Biggest Potential Upside

When chip equipment maker Applied Materials (NASDAQ: AMAT) surpassed $10 billion in annual revenue for the first time in fiscal 2011, its competitors could only sigh. The company's industry leadership was never in doubt, but a series of acquisitions gave it such a broad suite of offerings that rivals wondered if they could ever take market share again.

AMAT's massive market presence eventually led its two biggest rivals, Lam Research (NASDAQ: LRCX) and Novellus Systems to join forces in 2011, but even that combined entity has yet to crack the $5 billion annual revenue barrier. KLA-Tencor (NASDAQ: KLAC) is also in AMAT's rearview mirror, with only $3 billion in annual sales. And a handful of smaller companies bring up the rear, none of which have even $1 billion in annual revenue. (Note: Only U.S. companies have been considered here.)

Lost in the crowd is little-known Axcelis Technologies (NASDAQ: ACLS), which had $400 million to $500 million in annual sales a decade ago, but has slumped badly in recent years, with sales falling to just $200 million in 2012. 

Rivals such as AMAT used their financial firepower to acquire or develop the products that ACLS had been known for, taking whatever small market share the company had cultivated. Yet, ACLS may be emerging from the ashes, and the stage is set for a steadily improving outlook in the quarters ahead. Meanwhile, shares remain extremely cheap.

ACLS Stock Chart

Moving the Ions

ACLS makes expensive machines that stimulate ions in an electric field, which is a key process in the manufacture of wafer-based semiconductors. The ion implant equipment market has three areas of focus: "high current" machines (50% of industry sales), "medium current" (35%) and "high energy" (15%) implanters.

ACLS was the second-largest provider of such tools, behind only Varian Semiconductor. AMAT wanted a big piece of the ion implant market and bought Varian in 2011 for an eye-popping $4.9 billion. That worked out to be five times annual sales. As I'll note later, ACLS trades at a fraction of that multiple.

The R&D Payoff

Over the past three years, ACLS has spent more than $100 million developing a pair of new product lines that management thinks will put the company back in the leadership position it held in the last decade. They are:

Optima HDx: These machines, which are aimed at the high current segment of the market, use "cold implant" technology to more precisely deposit ions onto a wafer. The better the ion deposition, the less current that can leak out of a chip. Competitors still use a technology known as "ribbon beam," which is not as accurate, especially among smaller chip designs.

Purion M and Purion XE: These target the medium current and high energy niches of the market, respectively. The Purion XE in particular may be a game changer for the company. As its first high energy machine, it will allow ACLS to serve this market niche.

Customers have been visiting the company's Massachusetts headquarters for product demos, and the response to these new products has been quite positive, especially regarding the Purion XE line.

"All have been impressed with the product's outstanding performance and the improvement in their device results," noted CEO Mary Puma in a recent call with analysts. She added that customer interest is also growing in the new Purion M machines, which can "deliver very low energy implants at high levels of productivity, something previously unavailable to the industry and important as device features continue to shrink."

Of course, the real tangible measure of customer interest is in orders, and by this measure, ACLS has really turned the corner. Q3 system bookings of $26.4 million were up 60% from Q2 and up over 200% from Q1. That led to a book-to-bill ratio of 1.44, up from 0.97 in Q2. And system backlog, including deferred revenue, was $30.5 million for the quarter, an increase of 35% over Q2.

Puma said she believes that the early positive indications and growing backlog set the stage for a return to $90 million in quarterly revenues, which the company hasn't seen since 2007.

Wall Street analysts are looking for a 58% jump in sales next year to more than $312 million, and believe that ACLS will earn $0.25 a share. More importantly, the outlook into 2015 and beyond should strengthen as the Optima and Purion machines are expected to be tested by many new customers next year, with orders flowing after a six to nine month testing period.

Meanwhile, shares don't yet reflect any sort of revenue surge. ACLS has an enterprise value of around $226 million, which is well below the 2014 revenue projection of $312 million, equating to an EV/sales ratio of just 0.72. Recall that AMAT paid nearly five times sales for rival Varian.

As ACLS continues to build backlog over the next few quarters, investors will start to see how the company's projected revenue gains in 2014 can spread into 2015 and beyond. Investors should stop penalizing this recent laggard, and push shares up to a range of 1 to 1.5 times forward sales, on an enterprise value basis. In the next six to nine months, shares might pierce the $3 or even $4 level, equating to 30% to nearly 75% upside from recent prices.

Recommended Trade Setup:

-- Buy ACLS up to $2.60
-- Set stop-loss at $2
-- Set initial price target at $3.40 for a potential 31% gain in six months