KLA Leads the Process Control Section of the WFE Market and Merits a Wide Moat

Equity Analyst

William Kerwin

Associate Equity Analyst

Verushka Shetty

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KLA is one of the largest providers in the world of wafer fabrication equipment for semiconductors, specializing in process control, where we expect its unmatched breadth and depth to defend and increase its market share. We believe trends toward higher complexity in chips will drive increasing demand and strong pricing for KLA’s equipment, including artificial intelligence and new technologies like high-bandwidth memory. We particularly like that KLA boasts the highest profit margins out of any WFE firm under our coverage.

We assign a wide economic moat rating to KLA, resulting from strong design expertise and steep customer switching costs. KLA holds a majority share of the process control segment of the WFE market, wherein machines inspect semiconductor wafers during research and development and manufacturing for defects and verify precise measurements. KLA more than quadruples the sales of its nearest competitor, Applied Materials, in this segment. We believe this share is built on KLA’s research and development budget of over $1 billion annually, which has helped it develop a comprehensive process control portfolio that spans the cost, performance, and product spectrum for its customers. Once in a customer, the complexity of KLA’s equipment and its embedded services make it sticky. In our view, this proficiency also gives it unmatched pricing power, with industry-leading gross margins in the low 60% range and strong cash flow.

We expect KLA to be prone to cyclicality in the semiconductor industry, but to increase revenue over the long term. The firm’s sales are a function of global chip volumes and overall chip complexity, and while we see cyclicality in the former, we see durable growth for the latter. More-complex chips that use gate all-around transistors, 3D structures, and require advanced packaging should fuel growth for KLA, in our view. We monitor for geopolitical risk affecting KLA via export restrictions applied between the US and China, but see these controls primarily having an impact on lithography equipment and chip designers thus far. Finally, we like KLA's significant shareholder returns funded with its heady cash flow.

Business Strategy & Outlook

We assign KLA with a wide economic moat rating, on the basis of intangible assets and switching costs. KLA’s proficiency in semiconductor process control results from best-of-breed design expertise, in our view, and we think its embedded services business and long-term customer roadmaps are sticky. We also believe the sheer amount of investment required to remain at the forefront of leading chip development creates an immense barrier to entry to all except the largest and best-capitalized chip equipment manufacturers. We expect KLA to earn returns on invested capital well above its cost of capital, more likely than not, for the next 20 years.

We see KLA holding the most comprehensive portfolio of equipment for semiconductor process control in the world. KLA’s dozens of product lines run the gamut of chip manufacturing, able to serve logic and memory chipmakers alike with best-of-breed equipment, and offerings that span the cost and capability spectrum. Process control makes up just under 15% of the total wafer fabrication equipment market, and KLA dominates with a majority share, more than 4 times that of the nearest competitor. To us, this commanding share position is the result of the broadest and deepest portfolio for this corner of the market, continually fueled by a R&D budget of over $1 billion annually. This huge budget dwarfs all but the largest of WFE competitors and enables KLA to continue building its immense base of intangible assets. The strength of KLA’s offerings also results in stellar non-GAAP gross margins consistently in the low 60% range.

KLA’s portfolio strength helps it win customers, and we see it embedding in customers once installed. Chipmaking is extremely complicated and precise, with KLA’s machines inspecting roughly 8 trillion individual transistors, each as small as 5 nanometers wide, on a single 12-inch wide wafer. These inspections are calibrated to specific product lines, and chipmakers build workflows around their equipment with the singular goal of efficient production. KLA sends on-site service engineers to customer fabs to operate as an extension of the chipmakers engineering team. These service engineers help to calibrate equipment during R&D, tweak and fix bugs during production, and work with chipmakers on meeting manufacturing requirements. They also work on equipment upgrades or recalibration to repurpose equipment. The high complexity of KLA’s machines and the integration of its services engineers make it hard to replace, in our view. 

Beyond the cost of purchasing new equipment (to the tune of $1 million or more per machine), chipmakers would need to redesign manufacturing workflows and learn wholesale new hardware and software interfaces, as well as restart knowledge sharing with new services engineers. KLA's equipment can last in the field for multiple decades, which generates deep connections with customer engineering teams and augments this stickiness. KLA's deep customer relationships also entail forward-looking project roadmaps up to 10 years out, giving the firm an unmatched leg up in winning new placements as it can target new machines to exact customer requirements. Finally, we see a virtuous cycle with KLA’s defect database, wherein its large installed base provides it with more data, which in turn benefits its customers and locks them in.

The combination of KLA’s robust portfolio, sticky customer relationships, and large ongoing investment give us confidence in the durability of its competitive position and healthy profitability. We believe this will allow it to continue earning strong economic profits, more likely than not, for the next 20 years and result in a wide economic moat.

Wide

Economic Moat

KLA-Tencor

KLA Corp. engages in the supply of process control and yield management solutions for the semiconductor and related nano-electronics industries. The company operates through the following segments: Semiconductor Process Control, Specialty Semiconductor Process, PCB, Display & Component Inspection, and Other. The Semiconductor Process Control segment provides a comprehensive portfolio of inspection, metrology and data analytics products and related services. The Specialty Semiconductor Process segment develops and sells advanced vacuum deposition and etching process tools. The PCB, Display and Component Inspection segment enables electronic device manufacturers to inspect, test and measure PCBs, flat panel displays and ICs to verify their quality. Its products include manufactured chips, reticle, packaging, surface profilers, nanochemical testers, KT pro equipment, and compound semiconductors. The company was founded in April 1997 and is headquartered in Milpitas, CA.

Earnings data Q1 2021

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Earnings data Q4 2024

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KLA Corp. engages in the supply of process control and yield management solutions for the semiconductor and related nano-electronics industries. The company operates through the following segments: Semiconductor Process Control, Specialty Semiconductor Process, and PCB, Display and Component Inspection. The Semiconductor Process Control segment provides a comprehensive portfolio of inspection, metrology and data analytics products and related services. The Specialty Semiconductor Process segment develops and sells advanced vacuum deposition and etching process tools. The PCB, Display and Component Inspection segment enables electronic device manufacturers to inspect, test and measure PCBs, flat panel displays and ICs to verify their quality. Its products include manufactured chips, reticle, packaging, surface profilers, nanochemical testers, KT pro equipment, and compound semiconductors. The company was founded in April 1997 and is headquartered in Milpitas, CA.

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