ASML: One of a Kind Monopoly
A deep dive into the most important company in the world
Dear reader,
Welcome back to another deep dive into a wonderful company.
Today, discover the story of ASML, from its origins in the Dutch town of Veldhoven to its rise as a critical player in the semiconductor industry. Explore the world of semiconductors, understand why ASML's technology is indispensable, and learn about the company's current prospects. ASML's significance cannot be overstated—without them, the production of the most advanced semiconductor chips would be impossible, making ASML arguably the most important company in the world today.
Advanced Semiconductor Materials Lithography, or ASML, a Dutch-based company and Europe's largest technology firm, designs and manufactures the lithography machines essential for chip production. These machines, each costing hundreds of millions of dollars, are vital to the semiconductor industry—a cornerstone of modern technology. Semiconductors are the building blocks of nearly all contemporary devices, powering everything from computers and smartphones to automobiles, electronics, military systems, and medical equipment. In this article, we'll explore whether investing in ASML is wise.
Table of Contents
1. Chips
1.1 What are Chips?
1.2 The Semiconductor Industry
2. ASML’s History
2.1 Philips’ Spin-Off
2.2 IPO and EUV
2.3 The Making of a Monopoly
3. ASML’s Business
3.1 Lithography Machines
3.2 ASML’s Moat
3.3 Key Financials
3.4 Into The Future
3.5 Management
3.6 Risks
4. Conclusion
1. Chips
1.1 What are Chips?
In my typical deep dives, I’d go straight into the history of the company we’re analyzing. However, to fully grasp ASML’s significance and its impact on the chip industry, it's essential to first understand what chips are, their functions, and how they are manufactured. Additionally, a broad understanding of the chip industry’s dynamics is crucial.
A chip, also known as a microchip, semiconductor, or integrated circuit, is a compact piece of silicon—an abundant metal with conductive properties—embedded with millions or even billions of tiny electronic components called transistors. These transistors act as miniature electrical switches that control the flow of electricity. For instance, when you click a button on your phone or keyboard, an electrical current is sent to the chip, initiating its processing functions.
Chips process information in binary form, using 1s and 0s. Each transistor can either be in an "on" state (representing a 1) or an "off" state (representing a 0). By switching millions or billions of transistors on and off in complex patterns, chips can perform calculations, store data, and execute instructions. The more transistors, the more complex tasks the chip can perform—resulting in higher computing power.
Chip designers and manufacturers constantly seek ways to enhance chip performance by packing more transistors onto a chip. Smaller transistors allow for more to fit on the same-sized chip. The more transistors fit on a chip, the more power the chip has. But why don't companies simply make larger chips to fit more transistors?
Larger chips pose several challenges: longer distances for electrical signals slow down processing speed, they are more expensive to produce, consume more power, and are less practical for compact devices.
That's why chip companies are constantly striving to make chips smaller while simultaneously fitting more transistors onto them.
The creation of a microchip is a complex, multi-step process that takes several months from design to mass production. The main steps of the manufacturing process include:
Deposition: The process starts with a thin, round slice of silicon called a wafer. During deposition, various materials are layered onto the wafer, similar to adding layers to a sandwich but on a much smaller scale. Each layer serves a specific function—some conduct electricity, others insulate, and some create connections between different parts.
Photoresist Coating: To prepare the wafer for the next step, it is coated with a light-sensitive material called photoresist. This coating acts like a protective film that will react to light exposure.
Lithography: This critical step involves using ASML’s advanced machines to project deep ultraviolet (DUV) or extreme ultraviolet (EUV) light onto the wafer. This light, invisible to the human eye, has wavelengths anywhere from 365 nanometers (one nanometer equals one millionth of a millimeter) to 13.5 nanometers, which is used to produce extremely fine details.
The light passes through a reticle, which contains the blueprint of the chip’s pattern. When the light hits the photoresist, it causes a chemical reaction that transfers the pattern onto the wafer.
Etching: Following lithography, the wafer undergoes etching to remove the unprotected material not part of the final design. This can be accomplished through dry etching using gases or wet etching using chemical baths.
Ion implantation: In this step, the silicon wafer is bombarded with ions—tiny charged particles—that modify the silicon’s electrical properties, allowing precise control over electrical flow. Since silicon alone isn’t a perfect conductor, this step is essential.
Packaging: Finally, the wafer, which now contains numerous chips, is sliced into individual chips. These chips are then packaged carefully for integration into electronic devices.
1.2 The Semiconductor Industry
In the modern world, semiconductor chips are the new oil. These tiny components power virtually every electronic device, from smartphones and computers to cars, airplanes, and military systems. The significance of chips has led to intense political and economic competition, particularly between the United States and China.
To understand the geopolitical tensions, it's essential to grasp how chips are made and to know the key players in the semiconductor industry.
There are different types of companies in the semiconductor industry:
Integrated Device Manufacturers (IDMs): Examples are Intel and Samsung. These companies both design and manufacture chips, handling the entire production process in-house.
Foundries: These companies focus solely on manufacturing chips for other companies. For instance, TSMC produces chips designed by Apple. TSMC doesn’t design any chips itself.
Fabless Companies: Examples are Nvidia, AMD, and Qualcomm, who focus only on chip design. They rely on foundries to manufacture their designs.
Suppliers: These companies provide the necessary tools and materials for chip production. Their roles include supplying design software, semiconductor intellectual property (IP), chemicals, silicon wafers, and manufacturing equipment. Well-known examples are Synopsys (software supplier), ARM Holdings (licenses IP), Applied Materials (manufacturing equipment supplier), and ASML (manufacturing equipment supplier).
The semiconductor industry's value chain is a global network of specialized companies and regions, each playing a distinct role. No single country or company controls the entire production process, from design to manufacturing. Instead, the value chain is marked by intricate interdependencies, a high degree of specialization, and close collaboration across the production process. Even ASML itself has about 5,000 suppliers with which the company works together closely.
You should know now the basics of the semiconductor chip industry, which will be crucial in understanding ASML’s business.
2. ASML’s History
2.1 Philips’ Spin-Off
In the 1970s and 1980s, Dutch electronics conglomerate Philips was a dominant player in various industries, producing everything from TVs and radios to medical equipment, household appliances, and lighting. Philips manufactured everything in-house, including the chips used to control their products, making the company the second-largest chip producer globally. However, by the early 1970s, Philips faced challenges with its latest chips, which were too slow and yielded too many unstable units. To address this, scientists at Philips' NatLab, the company’s innovation hub, began developing what would later be known as the Silicon Repeater—a superior machine compared to conventional lithography systems. This prototype would eventually become the PAS 2000.
Philips, like many large conglomerates at the time, was a slow-moving and bureaucratic organization. Innovation required extensive consultation and strategizing, and financial struggles led Philips to consider divesting non-core parts of its business. The Science & Industry (S&I) department, responsible for commercializing the PAS 2000, was one such non-core business. Philips decided to spin off the PAS 2000 through a joint venture, eventually selling its stake over time. In 1984, Philips partnered with ASM International, a semiconductor equipment company, to launch ASM Lithography, which would later be known as ASML. Although most of the 47 S&I employees who transferred to ASML were reluctant to leave Philips due to its exceptional employee benefits, the move was necessary for the new venture.
ASML’s first office was in Eindhoven, where Philips was headquartered, but the company soon relocated to nearby Veldhoven as it expanded.
The early years of ASML were primarily financed by Philips, ASM International, and even the Dutch government, which recognized the company's strategic importance.
In 1986, ASML introduced its first truly competitive lithography system, the PAS 2500, which featured lenses from Zeiss, a key supplier that remains integral to ASML’s extensive network of 5,000 suppliers. The following year, Philips was approached by Morris Chang, founder of Taiwan Semiconductor Manufacturing Company (TSMC), who needed a partner to help launch his company. Philips agreed, which allowed ASML to place its machines in TSMC’s factories. This relationship remains vital, as ASML continues to be a critical supplier to TSMC.
By 1988, ASM International withdrew from the joint venture, lacking the capital needed for ASML's next investment rounds, leading Philips to acquire ASM International’s shares. ASML continued its innovation streak, and in 1991, the company developed a prototype of the PAS 5500, ASML’s first lithography system which used deep ultraviolet (DUV) light, allowing the machines to make significantly more advanced chips. The PAS 5500 became one of ASML’s most important lithography machines, and even today, PAS 5500 machines are still in use in several factories.
2.2 IPO and EUV
ASML’s continued success led to its public offering in 1995, a pivotal moment after which its parent company, Philips, began rapidly reducing its stake—a decision that, in hindsight, proved costly. Today, ASML is worth north of €300 billion, while Philips' market cap is around €25 billion. Notably, Peter Wennink, a young accountant from Deloitte who assisted ASML with its IPO, would later rise to become the company's CEO.
Around the turn of the century, it became evident that DUV lithography systems were reaching their limits. The next logical step was extreme ultraviolet (EUV) light, which uses light with a wavelength between 10 and 100 nanometers—far smaller than DUV light. EUV can naturally be found in the sun’s corona, but it can also be generated using extremely sophisticated technology. This involves firing a laser at a tiny droplet of hot tin to create plasma, which produces EUV light at a wavelength of just 13.5 nanometers. The light is then directed with a mirror into a lithography machine to project chip patterns onto a wafer.
The problem with early EUV systems was they were much too expensive to produce, causing them to be left in the dust for some time. However, ASML’s acquisition of Silicon Valley Group (SVG) in 2001 played a crucial role in the advancement of EUV technology. SVG held crucial rights and licenses for EUV development, giving ASML a substantial edge and solidifying its dominance in the industry. As a result, competitors like Nikon and Canon eventually withdrew from the EUV race, leaving ASML as the primary leader.
In the meantime, with EUV not yet viable, ASML innovated with its first lithography immersion machines, introduced in 2004. These machines used DUV light, but by projecting the light through a thin layer of water, they achieved finer detail. The introduction of the TwinScan machine—a revolutionary ASML invention—further set the company apart from its Japanese competitors.
And the best was yet to come.
2.3 The Making of a Monopoly
The acquisition of SVG in 2001 provided ASML with a crucial edge over Canon and Nikon. SVG possessed advanced EUV technology, licenses, and patents, which were essential for developing EUV lithography. Without access to these critical assets, the Japanese companies were unable to advance.
Over the years, ASML faced many technological hurdles in further developing EUV. To overcome these obstacles, the company formed strategic partnerships and acquired key companies, such as Cymer, a San Diego-based firm specializing in lasers for lithography machines.
Early prototypes of EUV systems emerged throughout the 2000s, but it wasn’t until 2017 that ASML introduced its first commercially viable EUV lithography machine, the NXE:3400. Prior to this, however, ASML shipped a pre-production EUV system—the NXE:3100—to a major customer in 2010. The first production model, the NXE:3300, was delivered in 2013. These milestones established ASML as the sole provider of advanced EUV lithography equipment, solidifying its virtual monopoly in the field. Since then, ASML has continuously refined its EUV systems, improving their reliability, efficiency, and throughput.
3. ASML’s Business
3.1 Lithography Machines
Today, ASML generates revenue through the manufacturing, refurbishing, and maintenance of lithography systems. Lithography is a crucial step in chip manufacturing, making ASML’s machines essential equipment in semiconductor fabrication.
ASML’s systems are categorized into three main types:
Extreme Ultraviolet (EUV) Lithography Systems: These are ASML’s most advanced machines, and the company is the sole provider of this technology. EUV systems use light with a wavelength of 13.5 nanometers to print the smallest features on microchips with the highest density. They are used for the most intricate and critical layers of advanced microchips. The first EUV machine was introduced in 2010, and the EXE platform, the next-generation EUV system, began shipping for R&D purposes in 2023. While the NXE platform was the initial EUV series, the EXE machines are expected to be sold in high volumes soon.
In 2023, ASML sold 53 EUV machines, generating €9.1 billion in revenue, averaging €172 million per machine.
Deep Ultraviolet (DUV) Lithography systems: These systems handle the majority of layers in microchips—ASML considers them as the industry workhorses. The company offers various versions of DUV machines, which use wavelengths of 193 nanometers, 248 nanometers, and 365 nanometers. Despite being less advanced than EUV systems, DUV machines remain crucial for chip production.
In 2023, ASML sold 397 DUV systems, generating €12.3 billion in revenue, with an average sale price of €31 million per machine.
Metrology and Inspections (M&I) Systems: These systems are used to measure and verify the patterns printed on wafers, ensuring they match the intended design. M&I systems help optimize lithography processes to achieve better yields and performance.
ASML sold 151 M&I systems in 2023, generating €536.1 million in revenue, with an average price of €3.55 million per machine.
While EUV systems are the most lucrative, DUV systems generate the most revenue overall. M&I systems, though less critical, complement the other systems. EUV systems are expected to become an increasingly significant part of ASML’s business as increasingly more computing power is demanded globally.
Additionally, ASML earns substantial revenue from maintaining, refurbishing, and upgrading its systems. This segment generated €5.6 billion in sales in 2023. ASML collaborates closely with its customers for delivery, installation, maintenance, and enhancements, ensuring the longevity and continual improvement of its systems. As ASML’s installed base of systems grows, so does its services revenue.
3.2 ASML’s Moat
Of the traditional five sources of moat—network effect, intangible assets, cost advantage, switching costs, and efficient scale—ASML primarily benefits from intangible assets and switching costs, though cost advantages also play a role.
ASML’s intangible assets include its cutting-edge technology, supported by nearly 17,500 patents, and a robust network of suppliers and partners. As the sole provider of EUV lithography systems and a leader in the DUV market, ASML’s technological superiority creates significant barriers to entry. This provides the company with considerable pricing power and a strong negotiating position.
Research into EUV technology began in 1997, with ASML joining the effort in 1999. A key turning point was ASML's 2001 acquisition of SVG, which held the most advanced EUV technology and licenses at the time. This move consolidated ASML's monopoly on EUV systems, leaving Canon and Nikon without the necessary patents and technology to develop their own systems.
Another critical asset of ASML is its network of suppliers, many of whom are long-term partners. These relationships are deeply collaborative, with joint innovation efforts creating components that are complex and difficult to replicate. This further strengthens ASML’s competitive position, as these suppliers are integral to the company's success and are not easily accessible to competitors.
ASML's ongoing investment in R&D ensures it remains years ahead of the competition. Coupled with strong patent protection and an integrated supply chain, ASML’s leadership in the semiconductor industry is well-defended.
In addition to intangible assets, ASML’s moat is defined by high switching costs. The advanced EUV machines are extremely expensive and their cost only increases as they evolve. These machines are often customized to meet specific customer needs, making integration both time-consuming and costly. For instance, transporting ASML’s most advanced systems to a chip factory requires seven Boeing 747s, illustrating the complexity and scale of the equipment.
To better understand the complexity of these daunting machines and ASML’s operations, I highly recommend watching the video below, which showcases ASML’s sophisticated cleanrooms.
Furthermore, competitors’ systems are generally less advanced and less profitable, highlighting the necessity of ASML’s superior technology. Since end consumers demand the highest quality products, which can only be achieved with ASML’s machines, switching to a supplier with inferior technology is inherently costly.
ASML’s machines also require specialized knowledge and training, adding to the switching costs. Transitioning to a different system necessitates additional training, a process that is supported by ASML’s extensive network of customer support sites and training centers. For example, over 1,600 ASML employees are dedicated to supporting customers in Taiwan, particularly TSMC, which is headquartered there.
These high switching costs contribute to ASML’s long-term customer relationships and reinforce its competitive advantage in the industry.
Finally, ASML benefits from cost advantages, driven by its monopoly position and scale. As the sole provider of EUV lithography systems globally, ASML wields substantial pricing power, reflected in its rising gross margins. The company projects these margins to further increase to 56-60% by 2030, indicating plans to leverage even more pricing power.
In addition, ASML's economies of scale provide further cost benefits. As the largest producer of lithography machines, ASML can spread fixed costs across a greater number of units. Its scale also enables substantial investments in R&D, reinforcing its technological edge and maintaining high barriers to entry for competitors.
Overall, ASML possesses an exceptionally wide moat, reinforced by its technological expertise, extensive patent portfolio, robust supplier network, substantial customer switching costs, and cost advantages derived from economies of scale and pricing power.
3.3 Key Financials
While ASML has experienced high growth, 2024 is projected to be a period of stagnation, seen as a "transition" year with preparatory investments for future growth. A temporary pause in revenue growth is acceptable considering past growth and as long as long-term sustainability is maintained. ASML’s management anticipates a strong rebound in 2025, indicating that 2024 is expected to be a one-off year.
ASML’s return on invested capital (ROIC) is exceptionally high, seeing a consistent rise over the past years. This increase is due to higher operating income while invested capital has remained relatively stable. ASML’s continuously rising ROIC underscored the strength of its economic moat.
The company generates significant free cash flow, although it was notably lower in 2023 compared to previous years. This decline is attributed to unfavorable changes in working capital, particularly in contract assets and liabilities, and is not expected to be a recurring issue. As shown in the exhibit, ASML’s net income remains consistent.
ASML’s CFO provided important context for the 2023 free cash flow performance:
“Free cash flow was low compared to previous years by design. In a challenging economic climate, we took the decision to help our customers navigate their liquidity issues by offering extended payment terms, while continuing to support our supply chain. Understanding and balancing the interests of all our stakeholders is one of our most important responsibilities, and in this instance helping our ecosystem partners through difficult times was the right thing to do. However, this inevitably meant delayed payments and therefore reduced cash flow.”
To me, this signals a long-term focus, showing that ASML prioritizes strategic investments over short-term Wall Street expectations.
Finally, as of the latest quarter, ASML’s balance sheet is strong, with €4.8 billion in cash and equivalents compared to €4.6 billion in debt, resulting in a negative net debt position. Additionally, with an interest expense of €152.7 million and an operating income exceeding €9 billion in 2023, ASML’s interest cover ratio stands at 59, indicating that interest expenses are well-managed and not burdensome.
3.4 Into The Future
Investing is about anticipating the future, so it's crucial for a company to be aligned with secular trends that drive sustained revenue growth over the long term. Additionally, a company should have sufficient optionality and the ability to innovate, enabling it to discover new revenue streams.
ASML’s management has laid out medium-term targets for revenue. As previously mentioned, management expects 2024 revenue to be broadly in-line with revenue of 2023.
“We view 2024 to be a transition year in preparation for the expected strong demand in 2025. We continue to make investments this year both in capacity ramp and technology to be ready for the turn in the cycle.” —ASML 2023 Annual Report
At ASML’s 2022 Investor Day, management laid out targets for 2025 and 2030. For 2025, the company expects revenue between €30 billion and €40 billion, while the company believes it can achieve revenue between €44 billion and €60 billion by 2030. Management also expects gross margins to increase to 56-60% in 2030, from around 50% today.
ASML plans to update this medium-term guidance during its next Investor Day on November 14, 2024.
Obviously, management didn’t pluck these numbers out of thin air. The semiconductor industry is expected to grow significantly in the coming years, thanks to increasing demand for semiconductors across various sectors, such as automotive, data centers, 5G, artificial intelligence, consumer electronics, renewable energy. Anything that runs on electricity requires chips and, as those sectors grow, so does the semiconductor industry.
ASML is poised to benefit as they manufacture the most advanced machines and as they keep allocating capital towards R&D.
3.5 Management
ASML recently saw the retirement of its CEO, Peter Wennink, and CTO, Martin van den Brink, both of whom were pivotal to the company’s success. ASML has long operated with two president-directors, with Van den Brink setting the technological roadmap and Wennink steering the company. Their contributions were instrumental, but they have now stepped down.
Van den Brink joined ASML during its founding in 1984, where played a key role in product development, progressing from an engineer to Chief Technology Officer. He’s been one of the driving forces behind ASML’s technological advancements.
Peter Wennink joined ASML in 1999, initially as a Deloitte employee, where he led ASML's initial public offering (IPO) before joining the company. Starting as financial director, he became CEO in 2013, leading ASML through its most successful years.
Christophe Fouquet, formerly Chief Business Officer, assumed the role of CEO on April 24, 2024. Although a successor for the CTO position has not yet been announced, Fouquet's 15 years of experience at ASML equip him well to lead the company. In a joint interview with Wennink, Fouquet assured that he intends to maintain the company's current strategic direction.
Neither Wennink, Van den Brink, or Fouquet hold a significant amount of ASML shares. In 2023, Wennink and Van den Brink received total compensation of almost €6 million, while Fouquet earned €3.5 million, though he was not yet CEO at the time.
Regarding capital allocation, ASML dedicates approximately 15% of its revenue to R&D, a significant but necessary investment. The company also allocates substantial funds to capital expenditures to meet growing customer demand.
ASML occasionally acquires smaller companies to bolster its technological capabilities but often prefers partnerships over outright acquisitions. The company also pays a regular dividend, which has seen rapid growth in recent years, alongside consistent share buybacks.
3.6 Risks
ASML, as does every company, faces multiple risks. In my view, these three risks are the most important:
ASML faces significant risks due to geopolitical tensions, particularly those involving the US and China. The Dutch government, under US pressure, is considering limiting ASML's business in China as part of broader US efforts to restrict China's access to advanced chip technologies. The US fears that China's technological advancements could threaten national security and alter the global balance of power.
Another major geopolitical risk for ASML is the complex relationship between Taiwan and China. Taiwan, home to TSMC—one of ASML's largest customers—is viewed by China as a renegade province. A military move by China to block or invade Taiwan would disrupt TSMC's operations, leading to a severe global semiconductor shortage. However, China understands that a semiconductor shortage would lead to a global economic collapse and a Western boycott, so it’s unlikely for China to do something so radical.
ASML relies heavily on a few key customers, a fact highlighted in its annual report where it notes that two customers each contribute over 10% of its revenue. While ASML does not disclose which companies these are, my guess is TSMC and Samsung, with others like Intel, SMIC, Micron, and Texas Instruments also being important customers. Customer concentration to this extent poses a risk—if any of these key customers were to reduce or halt purchases, ASML's revenue could be significantly impacted. However, the reverse is also true: ASML's customers have few to no alternatives, particularly for EUV lithography systems.
Moreover, while ASML may not directly engage with end consumers, its influence extends far beyond its immediate customers. Companies like Apple, Samsung Electronics, Huawei, Tesla, Microsoft, Amazon, Google, and many others depend on the chips produced by ASML's machines. In this sense, virtually any company that relies on advanced semiconductors is indirectly an ASML customer. In my opinion, this risk is less significant than it may initially appear.
With the departure of Van den Brink and Wennink, ASML could face a leadership crisis. Van den Brink has been crucial in establishing ASML’s technological leadership, while Wennink has been extremely important in managing company relationships and navigating ASML through a complex geopolitical landscape. Although newly appointed CEO Fouquet has yet to prove himself, he has repeatedly emphasized his commitment to continuing their legacy, supported by ASML’s strong team of exceptional engineers and scientists.
4. Conclusion
ASML is truly one of a kind, boasting an exceptional moat as evidenced by its remarkably high returns on capital. The company has a solid track record of growth, with a bright outlook as semiconductor chips, the "oil" of the 21st century, continue to drive industry expansion. ASML holds a monopoly with its EUV lithography systems, and while it isn’t currently in the Summit Stocks portfolio, it could be a future addition. However, I approach the stock with caution due to the significant geopolitical risks, which are largely beyond ASML’s control. With a trailing twelve months free cash flow yield under 1%—don’t forget that free cash flow has been low by design—and a forward P/E ratio of around 40, I would prefer to buy the stock at a more attractive valuation, considering the geopolitical risk.
Thank you for reading. I hope you’ll have learned a ton about ASML. Don’t forget to subscribe for more deep dives into other wonderful companies!
Disclaimer: the information provided is for informational purposes only and should not be considered as financial advice. I am not a financial advisor, and nothing on this platform should be construed as personalized financial advice. All investment decisions should be made based on your own research.
Thanks for the write-up, I also have been waiting to start a position. It's getting more interesting.
Neat write-up!