When we provide coverage to our readers, our goal is to discuss what is of highest value to an investor group. Although there were many exciting things announced during Nvidia’s GTC conference, one of the topics that AI semiconductor investors should take the time to discuss is the launch of cuLitho as it pertains to extreme ultraviolet (EUV) lithography.

At GTC, Nvidia announced a new cuLitho library to extend support for GPUs into its lithography software products. The future goal of this partnership is to move beyond the advanced 3nm node and to achieve a 2nm or smaller by “pushing the limits of physics” by combining EUV lithography process GPUs and software to employ algorithms that simulate the production process.

Years ago, we discussed Huang’s Law on the I/O Fund Forum. This was around 2020 when the Wall Street Journal published a paywall article entitled: “Huang’s Law is the New Moore’s Law.” The article was also discussed on Mother Jones where it pointed toward Nvidia’s pace of innovation on GPUs exceeding Moore’s Law. In 2018, Jensen Huang stated at GTC that GPUs were “25 times faster than five years ago” whereas Moore’s Law would have resulted in only a ten-fold increase. The more important part of Huang’s Law as it relates to ASML is that Huang stated: “The innovation isn't just about chips — it's about the entire stack."

Particularly, as microchips become smaller, it becomes harder for chip advancement to meet the speed of Moore’s Law. As investors, we felt that Moore’s Law running out of room, so to speak, would narrow the road for the winners. The thoughts we’ve been publishing for many years point toward entering an era of excellence where the most talented teams/competitive designs would forge forward by combining advances in architecture, interconnects, memory and algorithms. However, we have to give a solid nod toward the process in how these chips are made, as well – especially the chips that are surpassing the limitations of Moore’s Law.

To say the semi war is heating up is true, but it’s equally important to understood who the victors will be and why. This is why we’ve dedicated an enormous amount of time to writing about Nvidia’s A100 and H100 GPUs (27 articles in 4+ years!), and AMD’s Zen architecture. For ASML, we want to dig deeper into the tools and processes that power the market-leading foundries that are producing advanced semiconductors.

What is EUV and DUV Lithography:

Note: I’ve bolded the main points for easier reading.

Taiwan Semiconductor is the global leader in manufacturing advanced nodes, which are defined as those less than 10nm. Currently, TSM is producing a 3 nm chip compared to competitors who are delayed at the 7nm size. Powering TSM’s ability to shrink node size are ASML’s EUV lithography machines. We use words such as “A100 Ampere” or “H100 Hopper” or “Genoa,” “Milan,” “Bergamo” for AMD – but helping to drive the robust demand for these designs is the advanced node, or nanometer size.

Extreme ultraviolet lithography builds on ASML’s success with DUV lithography, or deep ultraviolet lithography. The word lithography means to “write on stones.” In the semiconductor industry, lithography uses a light-sensitive polymer or “photoresist” to write patterns on silicon wafers. Light is projected through the blueprint of the pattern that is printed. When the pattern is encoded in light, the system’s optics shrink and focus the pattern onto a photosensitive silicon wafer. After the pattern is printed, the system moves the wafer and makes another copy. Lithography creates the formation of 3D images on the substrate for the transfer of the pattern to the substrate (or the base of the silicon wafer). For each circuit, the lithography and pattern transfer are repeated anywhere from 10 to 30 times.

In simple terms, each silicon wafer has dozens of thin layers that make up billions of transistors. These layers are printed with lithography – which are extremely precise rays of light projected through a mask of the chip design. When light hits the surface, it prints the miniscule designs. Keep in mind, Apple has 10 billion transistors in each iPhone.

EUV is a new process that is needed for more advanced nodes, whereas DUV has been powering semiconductor fabs for decades. Deep ultraviolet lithography uses a 254 to 193 nm light whereas EUV uses a 13.5 nm light. This is 14X shorter than DUV lithography. As the wavelength of the light source becomes very narrow, fabs can produce chips with smaller features. Hence, the smaller nodes that TSM produces (3nm, 5nm).

EUV lithography machines are only produced by ASML as the process of creating EUV light is very complexvery complex. Outside of ASML’s machines, EUV only exists in outer space.

Per the company, “in our laser-produced plasma (LPP) source, molten tin droplets of around 25 microns in diameter are ejected from a generator at 70 meters per second. As they fall, the droplets are hit first by a low-intensity laser pulse that flattens them into a pancake shape. Then a more powerful laser pulse vaporizes the flattened droplet to create a plasma that emits EUV light. To produce enough light to manufacture microchips, this process is repeated 50,000 times every second.”

According to TSMC, “the aim is so precise that it’s like shining a laser from the moon to hit a coin from the earththe aim is so precise that it’s like shining a laser from the moon to hit a coin from the earth.”

Mirrors are an important component to how ASML achieves precision “down to the atom.”

ASML is partnered with a company called ZEISS for high-precision lenses and mirrors. The numerical aperture (NA) measures how much light the lens system can collect and focus. This is important because ASML is creating a machine called High-NA that will increase the numerical aperture from 0.33 to 0.55. High-NA is especially important at the advanced node level of 3nm or smaller. TSM is expected to have High-NA machines by 2024.
EUV lithography uses mirrors instead of lenses. According to ASML, these mirrors are the flattest surface on earth with smoothness that is less than one atom thick.

Production:

EUV machines produce 3,000 wafers per day, and there can be hundreds of chips on a 300-millimeter wafter, and up to 10 billion transistors per chip. The machines cost $200 million and are expected to reach an average sales price of $300 million in the future. Due to this cost, ASML has very few customers albeit large customers. TSMC makes up 40% of ASML’s revenue. Intel and Samsung are the second and third largest customers.

ASML’s Customers

ASML supplies fabrication plants, which produce semiconductor chips for design companies. Due to the cost of the machines and complexity of the process, ASML has exactly five customers. A few of the biggest fabs in the world are ASML customers: TSMC, Intel and Samsung. The other two are memory suppliers, Micron and SK Hynix.

ASML is capable of producing around 50 units of EUV equipment per year with a lead time of one year to six months. This is leading to a strong pipeline for both EUV and the next-gen High-NA lithography equipment. The company is expected to grow production capacity to 60 billion units in 2023. Management has stated (quite clearly) that average sales price (ASPs) will increase over time, for example, what was a $200 million machine will eventually cost $300 million.

Here is the production capacity ASML is expecting:

“[We have] plans of 600 DUV (deep ultraviolet), 90 EUV systems by 2025-2026 and 20 EUV High-NA systems by 2027-2028.”

TSMC:

We own TSMC stock but we’ve also been clear there is geopolitical risk to weigh. Taiwan operates in grey area where it has its own constitution and democratically-elected leaders, yet Beijing considers Taiwan as its territory. The island hosts the world’s most important foundry for advanced node semiconductors, and China is seeking a “reunification” with Taiwan. Meanwhile the United States is at odds with China by supporting TSMC in building two chip plants worth $40 billion in Arizona.

Taiwan Semiconductor, or TSMC, is ASML’s largest customer making up 40% of sales. In terms of advanced nodes, 90% are produced by TSMC. Customers include Apple, Qualcomm, Nvidia and AMD. Per the chart below, TSMC owns 60% of the foundry market.

TSMC is able to supply advanced nodes at high volume — such as 7nm or smaller — due to ASML’s EUV lithography technology. TSMC plans to introduce High-NA technology from ASML for the first time in 2024 to produce 1.8 nm chips.

Samsung:

Samsung is the world’s second largest foundry. According to BusinessKorea, Samsung ordered 18 of ASML’s 55 EUV machines in 2022. The company is investing over $4 trillion in EUV lithography equipment. Samsung has roughly half the EUV machines that TSMC has.

Samsung produces memory chips, plus GPUs for Nvidia, CPUs for IBM, smartphone processors for Qualcomm, and is also working with Baidu on AI chips for its cloud data centers. In 2021, the company used EUV technology to mass produce a 14 nm double data rate (DDR5) memory chip. This was the smallest chip to be produced in the memory industry. This memory chip is capable of powering AI/ML applications. The DDR5 chip increases wafer productivity, lowers power consumption, and doubles data processing speeds. At the time, a third-party analyst stated DDR5 would account for 41% of the world’s global DRAM market, up from 0.1% in 2021.

Micron and SK Hynix compete with Samsung on memory chips and are also ASML customers.

Intel:

Intel is building two fabrication plants worth a combined $20 billion, located in Ohio and Arizona. In 2022, Intel placed its first order for an advanced chipmaking tool “worth more than $340 million.” The Q4 2021 results indicated a customer had ordered five EUV lithography machines plus one order for the High-NA machine, due in 2025. This order was generally understood to be Intel, per the Reuters report.

Side note: I’ve had fun throwing shade on Intel on this site from a design perspective, however, I would not write Intel off as a foundry on American soil.

Computational Lithography & cuLitho Announcement at GTC:

The need for accuracy increases with smaller nodes. Computational lithography can help by optimizing the scanner, masks and processes. Rather than only relying on the design, AI lithography improves the process by using algorithmic models of the manufacturing process. ASML is able to produce a replica of the desired chip patterns on the wafer, which helps to meet the accuracy required for nanoscale chips.

At GTC, Nvidia announced a partnership with ASML and TSMC to launch a library called “cuLITHO.” The goal of cuLitho is to use software to optimize the lithography process. There will be increasing demand pressure on ASML to produce their coveted machines into the foreseeable future. cuLitho allows computational lithography to improve the process to make the most of each machine.

Each device requires a mask set of photomasks that mask the architect of the design to physical features. The cost of a mask set is becoming very expensive. For example, a 10 nm requires about 76 individual photomasks and this number increases as the chip gets smaller. According to SemiAnalysis, “at 90 nm to 45 nm, mask sets cost on the order of hundreds of thousands of dollars. At 28nm it moves beyond $1M. With 7nm, the cost increases beyond $10M, and now, as we cross the 3nm barrier, mask sets will begin to push into the $40M range.”

cuLitho offers what’s called inverse lithography to speed up the photomask process and drive down costs. By using software and algorithms, photomasks that took two weeks to process can be generated overnight. This will be especially important as designs move from 3nm to the 1.8nm. For Nvidia, the goal is to sell more GPUs as the need for lithography increases. The company advertises that 500 Nvidia Hopper GPUs that run CuLitho can do the work of 40,0000 CPUs.

For ASML, the company is dependent on CPUs and can now start to support GPUs. ASML has stated computational lithography is especially important for the High-NA EUV lithography due for production at TSMC in 2024 and at Intel in 2025.

TSMC’s motivation is to stay at the cutting edge as a foundry and to drive down costs by moving the expensive operations from CPUs to GPUs.

According to Nvidia’s Advanced Technology Group VP Vivek Singh: “If a silicon foundry has three data centers, it'll need 100 data centers by the end of this decade if the trend of the last 15 years continues – that's not feasible. And what about power? 45 megawatts might be okay, but 45 gigawatts? Something's gotta give."

By moving the patterning, lithography process to GPUs, companies can make 3-5X more photomasks using 9X less power.

Geopolitical Export Controls

ASML is not allowed to sell EUV technology to China. This began in 2018 when ASML signed a Chinese customer for its EUV lithography machines. The Trump Administration worked with the Dutch government to block the sale and to enforce export controls. The Dutch government did not renew ASML’s export license, which effectively stopped the sale. Rumors are that the customer was SMIC, China’s biggest chip-making foundry.

The export controls on ASML have continued under Biden by requiring “advanced computing semiconductors or related manufacturing equipment” to apply for a license if they want to export to China.

Financials and Q4 Earnings Call:

ASML’s earnings are this week. We don’t own the stock yet so those we do own have a higher priority – “i.e., bird in hand.” In addition to this, TSM is reportedly lowering its capex right now. Therefore, ASML’s timing for entry may be a bit better in H2.

Revenue:

Revenue can be lumpy for ASML. The company is expected to report revenue growth of 80% in the upcoming quarter for a total of $7.08 billion, up from 15.30% last quarter.

The next two quarters – June and September – are expected to be at 26.3% and 27% revenue growth. This will be $7.09 billion and $7.25 billion, respectively.

Pictured Above: ASML has lumpy revenue (but a strong backlog alleviates this concern)

Annual revenue is expected to track at 25% for FY2023 and 13.40% for FY2024.

There was negative revenue in the September 2022 quarter. This happens because ASML must source many parts to deliver one machine. The company is especially susceptible to supply chain issues. However, the company has a lot of visibility due to the backlog (see below) and a quarter of lumpiness is not a big concern to the longer-term story.

Earnings:

Earnings have been trending up nicely for ASML. Quarterly EPS was in the $2.00 range in 2021 and is now in the $3.00 to $4.00 EPS range. This bottom-line growth trend is expected to continue into the foreseeable future, hitting $5.00 Quarterly EPS in 2023 and up to $8.00 EPS by 2025.

Margins:

Gross Margin in the 50% range. This can be affected if ASML impacted by the Deep UV mix effect versus higher margins from EUV.
Operating Margin in the 33% range. R&D Spending is around 15% of sales and this has been consistent.
Net margin of 29% leaving net income at $1.94 billion. Net profit has been consistent and the company has been buying back shares.

Cash and Buybacks:

Free cash flow for the year 2022 was €7.2 billion or $7.56 billion. The company had announced a new share buyback program in November 2022 to be executed by December 31, 2025, for an amount of €12 billion.
The company had cash and investments of €7.4 billion or $7.91 billion and debt of €4.57 billion at the end of the December quarter.

Key Metrics:

Backlog:

Backlog is a key metric for ASML. At the end of 2022, ASML grew backlog by 67% for a total of $40.4 billion Euro, or $43 billion USD.
Net bookings were $6.3 billion Euro, which was $3.4 billion EUV and $2.9 billion Non-EUV. Logic drove 66% of bookings and memory 34% of bookings.

Product Mix:

The company shipped 54 EUV systems in FY2022, up from 40 systems.
Per the earnings call, the product mix for EUV bookings is about 75% logic and 25% memory.
DUV systems grew 13% to $7.7 billion Euro

Revenue mix is as follows:

Logic System Revenue contributes $10 billion and grew at a rate of 4%
Memory System Revenue contributes $5.5 billion and grew at a rate of 34%
Installed Base Revenue contributes $5.7 billion and grew at a rate of 16%.

Earnings Call:

Comments on Strong Backlog:

“We've experienced several quarters of very strong bookings, which now provides backlog coverage significantly beyond 2023, which is almost twice the expected 2023 system sales. Based on discussions with our customers and continued improvements in the capability of our supply chain, we are planning to increase our output capability this year. We're planning to ship around 60 EUV systems and around 375 deep UV systems in 2023, with around 25% of the deep UV systems to be immersion. We still plan a significant number of fast shipments this year, which under the current way of working will result in a similar amount of delayed revenue out of 2023 that came into 2023.”

Comments on Expected Growth of Product Mix and ASPs:

“And for the people that weren't really carefully listening, what that really means in terms of ASP for EUV, we talked about it before. Originally, we were looking at €160 million. We've then been talking about €165 million to recognize also increased functionality, I think, with the increases on ASP on the inflation. I think it's good to go somewhere between €165 million and €170 million. I think that's, on average, I think, the right way to go.”

There was a second comment on the call about revenue growth:

“Also presented during our Investor Day last November, we see an opportunity based on different market scenarios to reach an annual revenue in 2025 between €30 billion and €40 billion and in 2030, an annual revenue between €44 billion and €60 billion.”

More on the Demand and Backlog:

“Having said that, of course, last year, we kept informing you that the demand on us significantly exceeded our build capacity, sometimes to 40%, 50% […] I think — and that gives us a lot of visibility into 2024 also. Customers give us orders throughout the year, very significant levels of orders, which actually have over €40 billion in the backlog, which is almost twice the system sales that we expect to have in 2023.”

Quick Note on TSMC Capex:

We are on the eve of ASML’s earnings report and TSMC will officially report the next day. There has been a pre-announcement which we covered here. However, per a Barron’s report, TSMC may be lowering its capex. Right now, 2023E for capex is for $32 to $36 billion, or $34 billion at the midpoint.

Pictured above: Management guidance for 2023 is $32B to $36B, representing a YoY decline of 6.3% at the mid-point

Per an article behind Barron’s paywall, one analyst is expecting TSM to further reduce its capex in the upcoming earnings report. We will see what happens and plan an entry into ASML accordingly. Although ASML serves other foundries, it’s likely TSM has to participate for renewed stock price action as it contributes 40% of revenue.

Conclusion:

The main takeaway is that the future of chips will be powered by ASML’s full monopoly on EUV lithography machines and there is no competitor at this moment (literally not one competitor). With a deep and undeniable moat, the restraint on stock price, if you will, is that production capacity is limited as ASML can only produce a certain number of machines every year.

We feel it’s best to buy this stock when we see capex increase across leading foundries. Right now, we are seeing some indication foundries are going to reduce their capex in the near term, yet this AI semiconductor train is headed in only one direction, which is up. Some finesse on entry now will pay off, coupled with strong due diligence on the entries we are seeking.

ASML’s estimates are likely based on capex estimates. If the AI war heats up, ASML may be able to charge higher ASPs, while doubling its bottom line. Overall, ASML offers lower risk than most tech stocks while serving overwhelming demand. Should we continue to see demand dry up in other tech verticals, ASML’s rare, bottlenecked backlog will stand out in the current macro environment.

Note: ASML reports today.

ASML: Monopoly on Extreme Ultraviolet Lithography