Disco Corporation (DSCSY, TSE:6146) develops, manufactures, and sells precision machines and precision processing tools for semiconductor and electrical components manufacturers. Disco's business model is to bundle its three core technologies of dicing, grinding, and polishing, and provides systematic solutions which include equipment, consumable tools, and after-sales services for its customers. By relentlessly focusing on the niche market, the company has been dominating the semiconductor dicing/thinning equipment and tool market for decades. I think Disco possesses many of the characteristics of a wonderful business. The stock has plunged more than 50% from a bubble level reached in July 2024. Even after such a significant decline, Disco's stock is fairly valued. In this article, I will dive into the details of Disco's business model and moats.
Disco's brief history
Disco's corporate website provides a detailed description of Disco's corporate history. Disco was called the Dai-Ichi Seitosho Company company when it was founded in 1937 by Mitsuo Sekiya in Kure City of the Hiroshima Prefecture. Its initial business is the production and sales of vitrified grinding wheels. In 1950, Disco developed the abrasive wheel to process key part of electricity meters and achieved 100% market share. In the 1970s, Disco developed its DAS/DAD slicing machines, automatic scriber/dicing saws. In the 1980s, Disco achieved market dominance in the global dicing saws market. In the 1990s, Disco developed automatic dicing saws and grinders for the 300 mm-compatible wafers.The company's stock was listed on the Tokyo Stock Exchange in 1999. After 2000, Disco moved its headquarters and R&D center to Tokyo, continued to upgrade its equipment and technology, and introduced some of the most popular products. The company has maintained its market dominance in the precision processing equipment and tools market with the advancing of semiconductor manufacturing technology.
Disco's business
Disco develops, manufactures, and sells precision machines and precision processing tools mostly for semiconductor manufacturers. The company's website states that "Disco specializes in three types of processing essential for manufacturing: Kiru (cutting), Kezuru (grinding), and Migaku (polishing)".
Disco's products are used throughout the wafer fabrication process. The company has a very good diagram explaining the steps that Disco's products are involved the wafer fabrication process.
Disco's major products are grinders, polishers and dicers. In a nutshell, grinders are used to thin wafers, polishers are used to shine wafers, and dicers are used to cut dies. Dicers and grinders account for the vast majority of Disco's equipment sales.
Based on information gathered from SEMI and MordorIntelligence, the worldwide market size for dicers and grinders is about $2.6- $3.0 billion. Disco's revenue for FY 2023 is approximately $2 billion, of which dicers and grinders equipment account for about 64%, indicating a global market share of close to 50%.
Among Disco's competitors, only Tokyo Seimitsu (Accretech Corp) has a sizable presence. According to Accretech's IR website, the company's total revenue for FY 2023 is about 135 billion yen, or about $880 million. Accretech's most recent integrated report further breaks down its revenue mix. Processing systems account for about 30% of Accretech's revenue. This puts Accretech's processing systems sales at about $250-260 million, about 8-9% of total market share. Clearly, Disco dominates the global semiconductor dicers and grinders market. With market share at least 4 times its closest competitor, Disco reminds me of KLA-Corporation (KLAC).
Disco's unique culture
When doing research on Disco, one aspect that jumped out is Disco's unorthodox culture. Most Japanese companies operate under the bureaucratic seniority-wage system in which positions and salaries are based on length of service rather than performance. Disco, however, appears to have adopted a meritocracy-based performance system. This is exemplified by Disco's unique Business Improvement Activity system called PIM.
Under the PIM system, employees are constantly competing for rewards using Disco's internal accounting unit called "Will". The way the "Will" works is very interesting. If a Disco employee needs someone for, he or she will need to pay "Will" to the helper. For instance, it was reported that during COVID, Disco's sales teams paid factory workers who were willing to commute to show up in the office. Another interesting design of the PIM system is the PIM League system, which is analyzed in details in this case study. Basically all Disco departments are like sports teams who compete against each other to win matches. The constant internal competition starts from the top and permeate all the way to the bottom.
While intense internal competition is a common practice in U.S., South Korea and China, it's extremely rare in Japan. This unique culture may explain Disco's superior performance against most of its Japanese peers, which I'll analyze in the next section.
How Disco stacks up to other major semiconductor equipment companies
I think currently Disco is what Warrren Buffett would call “a wonderful business at fair price. As the following table shows, Disco is trading at a significant premium to its European, U.S and Japanese peers in most valuation metrics.
Disco's unique competitive position, faster growth, and higher margin profile may justify some valuation premium.The following table shows that Disco's revenue growth has been faster than Advantest, Tokyo Electron and Screen Holdings by a large margin over the 5-year period of time. Only Lasertec's revenue grew faster than Disco.
Not only did Disco grow faster, its margin profile is also superior to its Japanese peers. Disco's current gross margin is an astounding 68.7%, even better than KLA Corporation's close to 60% gross margin. This is very unusual in the semiconductor equipment industry. Disco's Japanese peers' margin ranges between 37% and 52%, in-line with the gross margin profile for large U.S. players such as Applied Materials(AMAT) and Lam Research(LRCX). However, Disco's net margin differential against its peers is much less than the gross margin differential, indicating potential room for improvement in operation efficiency.
Risk discussion
For a company as dominant as Disco, it's not easy to imagine major risks that can topple the company. However, there is one risk I think investors need to pay close attention to. This risk is not unique to Disco. It's a risk that affects almost all Japanese and U.S WFE suppliers, which is the China risk.
In Disco's case, China accounted for about 35% of Disco's global sales during the first three quarters of FY 2024, according to Disco's Q3 2024 earnings presentation. As Disco dominates China's dicers and grinders market, the Chinese government is keen to bring more domestic competitors to the market. Among the major domestic players, I think GL Tech poses the biggest threat to Disco in the long term.
GL Tech entered the back-end dicer market by acquiring UK's Loadpoint, which is the inventor of the semiconductor dicing machine. To solidify its position, GL Tech also acquired the Israeli company ADT, which formerly was the cutting equipment and blade division of Kulicke and Soffa Industries (K&S). According to GL Tech's website, both Loadpoint and ADT have decades of experience in the semiconductor dicing market, especially for the back-end process.
GL Tech has leveraged its advantage as the domestic supplier and was already qualified by China's leading OSAT players such as JECT and Huatian Technology. It looks like GL Tech and other domestic Chinese players will continue to take share from Disco and Accretech in the back-end process market. However, in the frond-end market, the Chinese domestic players are still far behind.
Conclusion
Disco is a great Japanese company operating in a niche market within the vast global semiconductor equipment industry. Disco's market leadership and margin profile is enviable. In addition, the market demand for Disco's products is increasing due to the development of leading-edge logic and advanced packaging. At the current price, Disco is fairly valued. However, it's a wonderful company worth following in the long term.
