ASML - The world's most important technology company

Well over a trillion chips, also known as semiconductors, are made every year, ending up in an enormous number of devices and machines, all over the world. Smartphones, cars, data centres, children’s toys, satellites, fridge-freezers and TVs are just a small number of the wide variety of products that rely on semiconductors to function, with the average home likely to contain more than ten thousand of them.

The production of semiconductors is highly complex and capitally intensive. The advanced technology used to produce them is at the cutting edge of scientific endeavour and has been developed by the entire industry over several decades. Leading mass manufacturers of semiconductors, such as TSMC and Samsung, collectively spend hundreds of billions of US dollars every year on their production.

The Dutch company ASML plays a vital role in the production of these semiconductors, thanks to its near total dominance in making highly innovative machines that are essential for their production. Its innovations have historically also been largely responsible for the progression of Moore’s Law (ie the notion that the number of transistors on a microchip will double every two years with production costs lowering at the same time).

ASML is the leading maker of photolithography machines that use light to print circuit designs onto silicon wafers and thus make semiconductors. In the most advanced cases, its machines fire laser beams within a vacuum at drops of molten tin moving at high speed, causing the tin to vaporise and, in so doing, produce extreme ultra violet light (EUV). It does this 50,000 times a second in order to produce a constant beam of this EUV light which is then projected by a series of ultra-smooth mirrors on to silicon wafers at an extremely small wavelength (eg 13.5 nanometres). This enables the production of the smallest, most powerful, yet most efficient semiconductors scientific endeavour can deliver. 

We have owned ASML in the Global Best Ideas Equity Fund since 2021.

Humble beginnings

ASML was formed via a joint venture between Phillips and ASM International in 1984.  At the time, the nascent market for photolithography was highly competitive and the development of the technology required huge upfront capital investment and came with a lot of execution risk.  ASML initially struggled to win customers for its early machines, resulting in ASM International pulling out of the venture in 1988.  Its survival therefore depended on the ongoing financial commitment of Phillips, whose commitment was finally rewarded in the 1990s when ASML launched a breakthrough machine, the PAS 5500, that won it key customers and market share.  These same customers remain to be its largest partners today.

Following this success, in 1995 ASML listed as a public company, and since then its stock has returned a remarkable average total return of 23% per annum.

ASML today is essentially a monopoly with 90% market share in the production and service of photolithography machines. Its only competition comes from Canon and Nikon, although this is at the least sophisticated, and least profitable end of the market, with machines that are now considered to be old technology.  It is the sole maker of the most advanced EUV machines (mentioned above) with currently zero competitive threat in that category.

Competitive edge

Two critical factors are responsible for ASML’s remarkable competitive position. The first is the sheer complexity of its machines. The technology is at the cutting edge of human scientific endeavour and has been developed collaboratively across the entire global chip ecosystem, from academic institutions to end-use customers. Both of its core customers, TSMC and Samsung, have historically held equity stakes in the company in order to ensure the success of these innovations and to ensure their top ranking in the pecking order for receiving the machines.

The second factor behind ASML’s competitive strength is the complexity of its supply chain, consisting of over 100 companies, all around the world, with many being equally as advanced in their capabilities as ASML.

For example, the mirrors used to reflect the light in the EUV machines (mentioned above) are made by Carl Zeiss in Germany. These mirrors need to be incredibly smooth in order to project the light pattern of the chip onto the wafer at an incredibly small scale. They are so smooth, in fact, that if they were to be increased to the size of Germany, the biggest ‘bump’ on them would only be a 10th of 1mm. Today, there is no other company capable of making these mirrors, and ASML is the only company it supplies (a position reinforced by ASML holding a 25% equity stake in the company).

Lifetime Service Sales

Every machine that ASML sells comes with a life-time of service, parts and upgrade revenues. This high margin offering generates over €6bn of predictable revenues for ASML every year. Yet again, it is the complexity of the machines and thus the advanced knowhow required to maintain them that makes this an almost impossible to replicate offering, aided by the need to use ASML made spare parts.

Four Pillars of Quality 

ASML is one of the highest-quality companies we own. Its unrivalled market position and critical role in the evolution and production of semiconductors, combined with consistently high-quality management has resulted in the company delivering excellent financial performance.

• Sustainable growth
  • A lack of competition and structural growth in end-market demand affords ASML strong pricing power with consistent volume growth over time. This has led to a historic revenue CAGR of 15%.
  • Whilst quarterly results can be volatile due to the timing of customer orders, a backlog of orders in excess of a year’s sales, and the growing contribution of its service revenues helps to smooth out any cyclicality.
• Quality management
  • The company’s pioneering innovations enable ASML to attract the top talent from the world of physics and engineering.
  • Its collaboration with the semiconductor ecosystem has been critical to its success.
  • Strong financial discipline, with a level-headed Dutch culture has led to disciplined capital allocation and shareholder friendly policies.
• Operational efficiency
  • ASML’s gross margin is >50% and growing, its return on invested capital is >40% and also expanding, and its balance sheet has been in a net-cash position since 2002.
• Cash generation
  • Today ASML generates close to €10bn of free cashflow a year, despite the need to make capital investment to support its own growth and that of its suppliers. It also gets some payments from customers upfront, enabling it to convert >100% of its earnings into free cashflow.
  • ASML’s shareholder-friendly policies see us benefit from a dividend that has grown for the last 15 years and material share buybacks reducing the share count by >1% per annum over the past 10 years.

Geopolitics – Risk or Opportunity?

ASML’s critical position role in the production of semiconductors globally has placed it under substantial political pressure. Rising strategic conflict between the US and China has resulted in the former compelling the Dutch government to place export restrictions on ASML’s most advanced equipment to the latter. Even with this restriction in place, China typically accounts for about 20% of ASML’s revenues, and this could still be at threat from further US administration restrictions.

ASML argues that these restrictions do not, however, impact the end market demand for semiconductors and that any lost unit sales to China would rather be taken up by its customers in other countries in order to meet that demand. It has yet to be tested on whether this will indeed be the case.

Whilst tension between the US and China may appear to be a headwind for ASML, it is in fact resulting in a tremendous growth opportunity for the company. In response to growing geopolitical risks, many countries are looking to re-shore chip production. This is further reinforced by concerns of the impact of a possible invasion of Taiwan by China, which is home to TSMC, by far the world’s largest producer of advanced logic chips. The US, Japan, South Korea and EU are all currently building multiple new advanced semiconductor production facilities (also known colloquially as ‘fabs’), many supported by state subsidies. It is estimated that the total global investment to 2030 will be >$600bn. The largest recipient of this capital investment will be ASML whose machines will fill these new fabs.

The Outlook for Investors

The long-term outlook for ASML has always been constructive but the emergence of Generative AI and the need for material compute power to support it has provided a substantial boost to its long-term growth potential. The company projects that by 2030 its annual revenues will be between €44-€60bn compared to €28bn in 2024 (a CAGR of 8%-14%). The broad spread in the projection is largely down to the currently uncertain potential for AI chip demand. This growth is further supported by the on-shoring of semiconductor production mentioned above.

ASML’s profit margins should also expand healthily in the years ahead. Its most advanced machines can cost >€300m each and come with a material boost to the group margin mix. As unit volume sales of these machines increases, so too should ASML’s profitability, thus the company is projecting its gross margin will increase from 51% in 2024 to between 56%-60% in 2030. This would result in strong double-digit earnings and cashflow growth from which shareholders should benefit greatly.

“ASML, Changing the World, One Nanometer at a Time”

ASML is a unique and special company with an incredibly strong competitive edge. Its innovations have been developed by the industry, for the industry, and are intended to meet the ever-growing end-market demand for semiconductors that is transforming the world in which we all live today.

1 Average annualised return from 1995 to 2024.  Source: Bloomberg
2 Source: ASML 2024 Annual Results.
3 Source: ASML annual reports and Bloomberg. 10-year data to 31/12/2024. CAGR = compound annual growth rate.
4 Source: ASML and Bloomberg, as at 31/12/2024
5 Source: ASML 2024 Annual Report
6 Data to 31/12/2024, source ASML and Bloomberg