Everyone knows that Nvidia (NVDA) currently has the best AI chips. However, there is another segment of the semiconductor industry that is just as important to AI as Nvidia’s GPUs (graphics processing units).

The demand for advanced packaging is growing rapidly because the computers training AI programs need high-bandwidth memory (HBM) interfaces. There is no point in having GPUs to do the advanced computing if you can’t transfer data to and from them quickly. And the faster the data can be transferred, the faster the models can be trained.

For higher-bandwidth memory, designers have been favoring what is referred to as a stacked design, in which several memory chips are stacked on top of one another and then packaged with a GPU. All these chips need to be connected by several tiny wires, a process known as advanced packaging.

The big problem with advanced packaging is that it creates an extra layer of complexity. The need to connect more chips adds more potential malfunction points—and that is where the technology from this under-the-radar AI play comes in.

Let me fill you in on all the details.

Camtek

The company is Camtek (CAMT), and its metrology and 3D sensing systems are crucial. Its sensors—coupled with the company’s proprietary software—detect faults and stop manufacturers from sending out any faulty products.

Camtek has developed sensors that shine light onto the semiconductors and then analyze what bounces back, a bit like sonar. By using its proprietary software, its systems can build up a 3D picture of the chip, identify its faults, and ultimately improve the yield of the manufacturer.

The main chiplet and high-bandwidth manufacturers are Taiwan Semiconductor (TSM), Intel (INTC), and the two Korean powerhouses, Samsung and SK Hynix. While Camtek doesn’t reveal the exact deals it signs, it says that 70% of its business comes from “tier-one manufacturers,” which I would assume include the aforementioned companies.

Besides the Nvidia chip shortages, other bottlenecks in the supply chain are delaying the AI revolution. As Brady Wang, an analyst with Counterpoint (a technology market research firm), told the Financial Times: “There is a capacity shortage both in advanced packaging and in high-bandwidth memory (HBM), both of which are limiting production output.”

Taiwan Semiconductor plans to double its capacity for CoWoS, an advanced packaging technology needed to make Nvidia’s H100 processor, but warned the bottleneck would not be resolved until at least the end of 2024. The two main suppliers of HBM are South Korea’s SK Hynix and Samsung.

Camtek’s Bright Future

Once the supply chain shortages subside, companies in the AI server supply chain could reap massive benefits.

A number of tech research firms forecast shipments of servers for training AI algorithms will triple in 2024. And they expect the share of AI servers in the overall server market to rise from just 7% in 2022 to about 20% in 2027.

The need for advanced packaging in AI is the main reason to be bullish on Camtek.

Currently, the advanced packaged GPUs are being used in data centers. For example, when someone uses ChatGPT, their request is processed in a data center and then transmitted back to the desktop or phone.

However, the brokerage firm Jefferies expects advanced packaging to eventually be used in personal computers, which will lead to a tenfold expansion in demand. And if advanced packaging is rolled out in smartphones, Jefferies thinks demand could expand to 100 times its current level!

Among the semiconductor sensing and inspection equipment companies, Camtek has the highest exposure to advanced packaging. In 2022, 55% of its revenue came from advanced packaging, compared with 22% at rival Onto Innovation (ONTO).

So far in 2023, the ratio has climbed above 60%, giving Camtek the highest exposure of its peers to demand for AI and the tailwinds created from the ramp-up in AI investments from cloud computing companies, including Microsoft, Google, and Amazon.

The fact that Camtek is already beginning to reap the benefits is evident in its results: in the third quarter of this year, the company received orders for 240 systems for the inspection of HBW and advanced packaging applications. In total, these orders are worth around $170 million, with $130 million coming from advanced packaging. As CFO, Moshe Eisenberg, said: “The strongest driver, no doubt today, is on the advanced packaging part, which is chiplets and HBMs. And that’s no doubt a growth driver that is going to be dominant for the next couple years.”

A big benefit of an increasing share of revenue from advanced packaging is that it is a more profitable business. This has already helped Camtek’s operating margin improve from 16% in 2019 to 25% last year. I believe that, as advanced packaging-related sales growth continues, margins should keep expanding.

Buy Camtek

The only concern I have is that the market seems to have spotted Camtek’s exposure to the AI semiconductor investment boom. So far this year, the share price is up 188%. Even as recently as August, it was trading at just 20 times its forward earnings. That has now jumped to 28 times, although this is still lower than rival Onto’s forward multiple of 31.

Nevertheless, CAMT is a buy anywhere below $66.