{"id":8423,"date":"2021-09-17T10:00:00","date_gmt":"2021-09-17T07:00:00","guid":{"rendered":"https:\/\/sifterfund.com\/disco-corporation-a-japanese-leader-in-a-niche\/"},"modified":"2022-06-16T11:08:00","modified_gmt":"2022-06-16T08:08:00","slug":"disco-corporation-a-japanese-leader-in-a-niche","status":"publish","type":"post","link":"https:\/\/sifterfund.com\/en\/disco-corporation-a-japanese-leader-in-a-niche\/","title":{"rendered":"Disco Corporation \u2013 A Japanese leader in a niche"},"content":{"rendered":"\n<p class=\"lead-p\">The making of processors and memory chips is often associated with near-scifi sounding technology. In contrast, the role of Disco Corporation\u2019s products sounds charmingly modest, primarily involving sawing.<\/p>\n\n\n\n<p><strong>However, the company is surprisingly critical to its customers<\/strong> and may contribute to the extension of chip performance as Moore\u2019s law gradually approaches its limits. The company has also other special characteristics, such as an internal currency system, which encourages entrepreneurship and increases flexibility. <\/p>\n\n\n<style>.elementor-8494 .elementor-element.elementor-element-121da7b .elementor-wrapper{--video-aspect-ratio:1.77777;}<\/style>\t\t<div data-elementor-type=\"section\" data-elementor-id=\"8494\" class=\"elementor elementor-8494\" data-elementor-post-type=\"elementor_library\">\n\t\t\t\t\t<section class=\"elementor-section elementor-top-section elementor-element elementor-element-0c0ccfd elementor-section-full_width ang-section-padding-initial elementor-section-height-default elementor-section-height-default elementor-repeater-item-none elementor-repeater-item-none_hover\" data-id=\"0c0ccfd\" data-element_type=\"section\" data-e-type=\"section\">\n\t\t\t\t\t\t<div class=\"elementor-container elementor-column-gap-no\">\n\t\t\t\t\t<div class=\"elementor-column elementor-col-100 elementor-top-column elementor-element elementor-element-2ca4683 elementor-repeater-item-none elementor-repeater-item-none_hover\" data-id=\"2ca4683\" data-element_type=\"column\" data-e-type=\"column\">\n\t\t\t<div class=\"elementor-widget-wrap elementor-element-populated\">\n\t\t\t\t\t\t<div class=\"elementor-element elementor-element-121da7b elementor-repeater-item-none elementor-repeater-item-none_hover elementor-widget elementor-widget-video\" data-id=\"121da7b\" data-element_type=\"widget\" data-e-type=\"widget\" data-settings=\"{&quot;youtube_url&quot;:&quot;https:\\\/\\\/www.youtube.com\\\/watch?v=rBbcMo7U-ao&quot;,&quot;lazy_load&quot;:&quot;yes&quot;,&quot;video_type&quot;:&quot;youtube&quot;,&quot;controls&quot;:&quot;yes&quot;}\" data-widget_type=\"video.default\">\n\t\t\t\t<div class=\"elementor-widget-container\">\n\t\t\t\t\t\t\t<div class=\"elementor-wrapper elementor-open-inline\">\n\t\t\t<div class=\"elementor-video\"><\/div>\t\t<\/div>\n\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/section>\n\t\t\t\t<\/div>\n\t\t\n\n\n<p><\/p>\n\n\n\n<h2 class=\"wp-block-heading\">What does Disco do?<\/h2>\n\n\n\n<p><strong>Disco is a Japanese company that manufactures and sells equipment which are critical in the manufacturing of chips.<\/strong> Those chips power our everyday electronic devices, such as smartphones and computers. The chips are mainly manufactured on round discs of silicon called \u201cwafers\u201d. The role of Disco\u2019s equipment is to thin, polish and cut such wafers. <\/p>\n\n\n\n<blockquote class=\"wp-block-quote is-layout-flow wp-block-quote-is-layout-flow\"><p>In this field, Disco is a giant, with most market estimates implying well over 60% market share in the sale of machines that cut and grind silicon wafers.<\/p><\/blockquote>\n\n\n\n<h2 class=\"wp-block-heading\">Why did we invest in Disco?<\/h2>\n\n\n\n<p><strong>Sifter originally invested in Disco in April 2019<\/strong>. At the time of writing (8.9.2021), the share had appreciated <strong>86%<\/strong> in euros since the initial investment and offered ca. <strong>2%<\/strong> annual dividend yield. Over the same period, the global equity index, MSCI ACWI, generated just <strong>43%<\/strong> return in euros.<\/p>\n\n\n\n<figure class=\"wp-block-image size-large is-resized graafi\"><img fetchpriority=\"high\" decoding=\"async\" src=\"https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price-1024x609.png\" alt=\"\" class=\"wp-image-8513\" width=\"840\" height=\"499\" srcset=\"https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price-1024x609.png 1024w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price-500x297.png 500w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price-768x457.png 768w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price-1536x913.png 1536w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-stock-price.png 1800w\" sizes=\"(max-width: 840px) 100vw, 840px\" \/><figcaption>Disco Corporation stock price since investment (4\/2019\u20139\/2021).<\/figcaption><\/figure>\n\n\n\n<p> At Sifter, we see that Disco fulfills our quantitative and qualitative criteria for a quality company.<\/p>\n\n\n\n<div class=\"wp-block-group box is-layout-flow wp-block-group-is-layout-flow\">\n<h3 class=\"wp-block-heading\">Numeric superiority factors<\/h3>\n\n\n\n<ul class=\"wp-block-list\"><li>Turnover grows steadily<\/li><li>Net profit is increasing and predictable<\/li><li>Gross and net margins are higher than among competitors<\/li><li>High return on invested capital (ROIC, over 15 %)<\/li><li>Healthy balance sheet, preferably a net debt-free company<\/li><\/ul>\n\n\n\n<h3 class=\"wp-block-heading\">Qualitative superiority factors<\/h3>\n\n\n\n<ul class=\"wp-block-list\"><li>The earnings model has a clear competitive edge<\/li><li>High barriers to market entry<\/li><li>The products and services are critical to customers<\/li><li>The product represents a minor share of the customer&#8217;s total costs<\/li><li>A large share of the revenue is recurring<\/li><li>The company&#8217;s products have pricing power<\/li><li>There is growth in the industry<\/li><li>Skilled management and strong company culture<\/li><\/ul>\n<\/div>\n\n\n\n<p class=\"text-cta\"><strong>Interested in long-term quality investing?<\/strong>&nbsp;Download our 20-page guide:&nbsp;<a href=\"https:\/\/sifterfund.com\/en\/long-term-quality-investing-guide\/\">Long-term quality investing.<\/a>&nbsp;Our guide explains how time and high-quality companies work in an investor\u2019s favor.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Disco\u2019s business has significant entry barriers<\/h2>\n\n\n\n<p><strong>For Disco\u2019s customers, the cost of failure is high<\/strong>. Disco\u2019s equipment are mainly used at a point where the silicon wafer\u2019s surface is already filled with precious integrated circuits. The wafer may have gone through months of processing \u2013 sometimes involving equipment that cost well <strong>over 100 million dollars each<\/strong>. <\/p>\n\n\n\n<p>At that stage, inaccurate cutting, grinding, or polishing could spoil the product. Given these risks, Disco\u2019s clients are unlikely to experiment with unproven equipment vendors. Meanwhile, <strong>Disco\u2019s equipment are astonishingly accurate. <\/strong><\/p>\n\n\n\n<blockquote class=\"wp-block-quote is-layout-flow wp-block-quote-is-layout-flow\"><p>The machines cut materials with up to a micrometer (1\/1000 of a mm) accuracy, which is comparable to cutting a human hair 30 times crosswise. <\/p><\/blockquote>\n\n\n\n<p>Disco\u2019s machines can also grind the backside of a wafers down to 5 micrometer thickness, reaching a point where the material is turning translucent. Over the past 10 years, <strong>Disco\u2019s has spent on average 10% of its revenue on R&amp;D<\/strong> to maintain its technological edge.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Disco has close customer relationships<\/h2>\n\n\n\n<p><strong>Disco\u2019s customer relationships are built on R&amp;D services.<\/strong> In practice, Disco&#8217;s engineers perform test cuts and determine the optimal combination of equipment, consumables, and processing methods for the client. <\/p>\n\n\n\n<p>This is no simple task, as Disco\u2019s selection of consumables, such as sawing blades and grinding\/polishing wheels, is counted in tens of thousands. <strong>The relationships are further strengthened by Disco\u2019s after sales services, such as maintenance and training.<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Disco operates in a niche market<\/h2>\n\n\n\n<p>According to the semiconductor industry association, <strong>SEMI<\/strong>, global investments in semiconductor manufacturing equipment will amount to <strong>95 billion USD<\/strong> in 2021. When we compare SEMI\u2019s estimates to Disco\u2019s modest USD 2 billion revenue and high market share, it seems clear that Disco operates in a niche. <\/p>\n\n\n\n<p><strong>Disco\u2019s small market size offers two advantages:<\/strong> First, it limits incentives for large players to enter Disco\u2019s territory, as the rewards would be relatively modest. Second, Disco\u2019s critical role and small-scale business reduce price pressure from clients\u2019 side, as the most effective cost savings are probably found somewhere else.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Disco\u2019s margins and returns reflect a healthy competitive position<\/h2>\n\n\n\n<p>In the latest fiscal year, <strong>Disco\u2019s gross margin amounted to 59%<\/strong> while the <strong>EBITDA margin was 33%<\/strong>. <strong>The average return on invested capital over the past 5 years amounts to 15%<\/strong>. &nbsp;Disco\u2019s closest competitor, Tokyo Seimitsu, generates about 1\/3 lower margins and returns.<\/p>\n\n\n\n<figure class=\"wp-block-image size-large graafi\"><a href=\"https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital.png\"><img decoding=\"async\" width=\"1024\" height=\"609\" src=\"https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital-1024x609.png\" alt=\"\" class=\"wp-image-8429\" srcset=\"https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital-1024x609.png 1024w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital-500x297.png 500w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital-768x457.png 768w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital-1536x913.png 1536w, https:\/\/sifterfund.com\/wp-content\/uploads\/disco-corporation-margins-and-return-on-invested-capital.png 1800w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/a><figcaption>Disco\u2019s margins and return on invested capital<\/figcaption><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\">Long-term outlook \u2013 Promising<\/h2>\n\n\n\n<p><strong>Global wafer volumes seem likely to increase further, as the number of smart devices increases.<\/strong><\/p>\n\n\n\n<p>Historically, <strong>Disco\u2019s annual (calendar year) revenue has correlated strongly with the global wafer shipment volumes<\/strong>. In 2010-2020, the correlation coefficient was 0.95. Going forward, the wafer volumes seem to have further upside. <\/p>\n\n\n\n<p><strong>For example, 5G networks<\/strong> will better support a network of connected devices (also known as Internet of Things), by facilitating a larger number of devices, while offering lower latency and faster data speeds. This is good news for Disco, as a larger number of smart devices should result in a larger number of wafers to grind, saw and polish.<\/p>\n\n\n\n<figure class=\"wp-block-image size-large graafi\"><a href=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments.png\"><img decoding=\"async\" width=\"1024\" height=\"609\" src=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments-1024x609.png\" alt=\"\" class=\"wp-image-8432\" srcset=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments-1024x609.png 1024w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments-500x297.png 500w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments-768x457.png 768w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments-1536x913.png 1536w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-and-global-silicon-wafer-shipments.png 1800w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/a><figcaption>Disco&#8217;s revenue and global silicon wafer shipments.<\/figcaption><\/figure>\n\n\n\n<h3 class=\"wp-block-heading\">The physical limits to transistor size could offer further upside for Disco<\/h3>\n\n\n\n<p>Historically, chip performance has been increased by cramming a larger number of ever smaller transistors into the same chip. The number of transistors has increased at a predictable pace, reflecting the so-called Moore\u2019s law.&nbsp;However, the process has become increasingly costly and should eventually slow down, restricted by the laws of physics. As a result, chip manufacturers will have to increasingly turn to other methods to achieve performance improvements. <\/p>\n\n\n\n<p>One such method is <strong>3D packaging<\/strong>, where several chips are stacked on top of each other. Disco is optimistic regarding this trend and sees that it could drive higher margins and revenue. We see that 3D packaging could increase the demand for thin chips and boost the use of Disco\u2019s equipment.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Short-term outlook \u2013 <strong>Disco\u2019s main source of revenue is<\/strong> volatile, but balanced by several strengths<\/h2>\n\n\n\n<p><strong>Some 52% of Disco\u2019s revenue <\/strong>originates from the sale of precision equipment which are essentially a capital expenditure for Disco\u2019s clients. The semiconductor industry\u2019s capex has been volatile through the years, and this has reflected on Disco\u2019s equipment sales. <\/p>\n\n\n\n<p><strong>Currently, the short-term outlook is positive<\/strong>. The semiconductor industry association, SEMI, forecasted in July that <strong>the global sales of semiconductor manufacturing equipment will soar by 34% in 2021 and grow by 6% in 2022.<\/strong><\/p>\n\n\n\n<figure class=\"wp-block-image size-large graafi\"><a href=\"https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1.png\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"609\" src=\"https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1-1024x609.png\" alt=\"Semiconductor industry capital expenditures\" class=\"wp-image-8488\" srcset=\"https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1-1024x609.png 1024w, https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1-500x297.png 500w, https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1-768x457.png 768w, https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1-1536x913.png 1536w, https:\/\/sifterfund.com\/wp-content\/uploads\/semiconductor-industry-capital-expenditures-1.png 1800w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/a><figcaption>Semiconductor industry capital expenditures.<\/figcaption><\/figure>\n\n\n\n<h3 class=\"wp-block-heading\">Disco\u2019s Japan-centric operations expose the company to fluctuations in exchange rates and tariffs.<\/h3>\n\n\n\n<p>Some 80% of Disco\u2019s workforce and 100% of manufacturing operations are located on the Japanese soil, while <strong>86% of the revenue originates outside Japan, primarily in Asia<\/strong>. &nbsp;As a result, appreciating yen and higher tariffs would add to Disco\u2019s costs and put pressure on Disco\u2019s profitability.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\">Disco\u2019s financial resilience helps it to manage short-term shocks<\/h3>\n\n\n\n<p><strong>Disco\u2019s financial resilience is built on three factors:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>First, <strong>Disco holds no debt on its balance sheet<\/strong>. Instead, the company has cash worth some 1.5x times its past 12-month EBITDA. This financial buffer helps Disco to weather through storms.<\/li><li>Second, <strong>Disco generates one third of its revenue from consumables and spare parts, where margins are high<\/strong>. The demand for these products is driven by clients\u2019 capacity utilization rate which is less volatile than capital expenditures. Disco\u2019s consumable and spare part sales have gradually grown through the years, likely supported by growth in Disco\u2019s installed base (See Chart 4).<\/li><li>Third, <strong>Disco\u2019s strong market position supports the company\u2019s pricing power<\/strong>. This in turn helps Disco to offset cost increases with higher prices.<\/li><\/ul>\n\n\n\n<figure class=\"wp-block-image size-large graafi\"><a href=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts.png\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"609\" src=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts-1024x609.png\" alt=\"\" class=\"wp-image-8436\" srcset=\"https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts-1024x609.png 1024w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts-500x297.png 500w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts-768x457.png 768w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts-1536x913.png 1536w, https:\/\/sifterfund.com\/wp-content\/uploads\/discos-revenue-from-consumables-and-spare-parts.png 1800w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/a><figcaption>Disco\u2019s revenue from consumables and spare parts<\/figcaption><\/figure>\n\n\n\n<h3 class=\"wp-block-heading\">Exceptional corporate culture may add to Disco\u2019s resilience<\/h3>\n\n\n\n<p><strong>Disco\u2019s culture<\/strong> incorporates strong entrepreneurial spirit and continuous improvement. To boost this culture, Disco has created its <strong>own internal currency, called \u201cWill\u201d<\/strong>. Since 2011, Disco\u2019s employees and teams have used \u201cWill\u201d to pay for the use of company resources, such as office desks and PCs. <\/p>\n\n\n\n<p>In the bigger picture, sales transactions generate \u201cWill\u201d which trickles through the organization, as different teams compensate each other. For example, a sales team might compensate the manufacturing team for building a product for the client. At the end of each quarter, the balances of \u201cWill\u201d are paid in yen \u2013 resulting in hefty bonuses for some. <\/p>\n\n\n\n<p>At first sight, \u201cWill\u201d seems to merely complement Disco\u2019s rewarding systems and discourage the waste of company resources. However, \u201cWill\u201d can also be used to rapidly solve unexpected management issues. For example, during the COVID-19 pandemic, Disco had to ensure that its factories had enough employees working on-site. Instead of hand-picking the on-site employees, Disco distributed a set amount of \u201cWill\u201d among those employees who chose to turn up at the factory. <\/p>\n\n\n\n<p>As a result, Disco\u2019s internal market forces chose the optimal on-site employees, and adjusted the per-person reward automatically, reflecting the evolving popularity of remote work.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Overall \u2013 Disco meets Sifter\u2019s quality criteria<\/h2>\n\n\n\n<p>Disco holds significant competitive advantages which are reflected in the company\u2019s historical performance. In addition, Disco\u2019s market has a positive long-term growth outlook, and the company is able to weather short-term storms along the way.<\/p>\n\n\n\n<p><strong>Olli P\u00f6yh\u00f6nen<\/strong><br>Analyst, Sifter Capital<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Disco is a Japanese company that manufactures and sells equipment which are critical in the manufacturing of chips. What makes Disco Corporation a good long-term investment.<\/p>\n","protected":false},"author":11,"featured_media":10755,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11],"tags":[],"class_list":["post-8423","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-uncategorized"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.3 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Disco Corporation \u2013 A Japanese leader in a niche - Sifter Fund<\/title>\n<meta name=\"description\" content=\"Disco Corporation is a Japanese company that manufactures and sells equipment which are critical in the manufacturing of chips.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/sifterfund.com\/en\/disco-corporation-a-japanese-leader-in-a-niche\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Disco Corporation \u2013 A Japanese leader in a niche - 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