20 February 2007

The First of the Fantastic Five - CY

The online version of the March 2007 Smart Money cover story beckoned an airport newsstand peruser (yours truly) with the headling "Double Your Money." My first thought, upon picking up the magazine, and buying it, was How long to double? The feature makes five sector picks with the idea of hitting a double in five years, namely biotech (FBT), water (PHO), semiconductors (XSD), small cap (IWO), and emerging markets (EEM). Some of these picks are intruiging--I would much rather spread my risk investing in biotech with an ETF, than with trying to pick an individual stock that could easily disintegrate on some unexpected bad news from the FDA. On the other hand, if I'm looking into water, I think I'd rather just pour some investible dollars into WTR instead of spraying them into the PHO ETF.

Reading further into the wood pulp version of the March '07 issue, I found a sidebar entitled "The Fantastic Five," eschewing the broad sector picks for some down-and-dirty individual stocks. Assorted money managers made some picks. I thought it might be worthwhile to look beyond the two sentences dedicated to each ticker. In this post, I'm going to look at the first of the five, Cypress Semiconductor (CY).

John Buckingham of the Al Frank Fund made this selection. Here are the two sentences from Smart Money justifying the choice:

"The company has $5 a share in cash and a $2 billion ownership stake in solar-cell maker SunPower. Given the company's $2.3 billion market valuation, Buckingham says, investors essentially get Cypress's solid microchip business for free."

Larry Cao, a Morningstar analyst, doesn't think much of CY, giving it a fair value of $6 a share. So much for the free "solid" microchip business:

Cypress' roots in commodified products have hurt its growth and profitability over the years. The low-margin and slow-growing SRAM (static random-access memory) product line remains about one third of its revenue. Invented in 1971, the technology is showing its age and has been giving way to flash memory products in handset applications. As a result, SRAM revenue dropped by about $100 million last year, to $300 million. A few other product lines such as specialty memory and USB products have better margins, but end-market demand remains a concern. These aging products will in aggregate grow at a below-industry rate, in our opinion.

Cao isn't as bullish as Buckingham regarding CY's cash hoard either:

Cypress is in decent financial shape, with about $400 million in cash and investments offsetting $600 million in long-term debt. But free cash flow--at less than 3% of sales the past two years--is somewhat meager in our eyes.

Cao believes that investors in CY could see some gains if the SunPower business were spun off. Some shareholders agree:

In December, activist investor Chapman Capital LLC urged Cypress to split off its stake in solar panel company SunPower Corp. (SPWR.O: Quote, Profile , Research) and then take its core chipmaking business private.

Trade publication Electronics Weekly posted a brief interview with Paul Bentley, CY director of sales and marketing. Here are some excerpts:

EW: On the lists of potential takeover targets of private equity funds, Cypress usually figures. Does Cypress feel these funds have anything to contribute to Cypress?
Paul Bentley: In October of 2006, we completed a review of strategic options relative to our market valuations. We concluded that we could deliver more value to our customers and to our stockholders by continuing on our current path.

EW: Is Cypress interested in the solar power market?
Paul Bentley: We are not only interested, but we are already a major player. Our SunPower subsidiary had revenues in 2006 of more than $230m, and they continue to grow rapidly. We also recently completed the acquisition of PowerLight, a leading integrator of solar-power installations. The acquisition allows us to deliver faster solar system innovation to our customers as we execute our plan to reduce the installed cost of a solar system by half over the next five years.

Zack's recently commented on CY's latest quarter:

Cypress Semiconductor (NYSE: CY) reported its financial results for the fourth quarter [Q4] of 2006. Revenue was $287.0 million, down 1.1% sequentially and below our estimate of $290 million. On a GAAP [generally accepted accounting principles] basis, earnings per share was $0.09. Including the impact of stock-based compensation, the pro forma EPS [earnings per share] was $0.08, below our estimate of $0.11. Revenue and gross margins in Q4 were adversely affected by softness in the communications market. On the other hand, SunPower revenue grew 14% sequentially and over 154% year over year. Also, entering the first quarter, revenue for that quarter was 86% booked. We rate the stock a Hold and have set a target price of $19.

What's my take?

CY does not paint an interesting fundamental story. Morningstar's Cao makes that point clearly. But I'm not sure he has the right perspective. For me, CY is not about its staid, low-growth semiconductor business. The core chipmaking business limits the dowside risks.

The investing thesis for CY is about potential:

1. Potential continued growth of SunPower;
2. Potential spin-off of SunPower;
3. Potential private equity takeover of CY.

The upside for CY is one or two of these theses coming true.

Up next...The Advisory Board (ABCO)


ilanit said...

In September I would have speculated that MS would not be treating a first-tier Los Angeles private equity firm like Blackstone this way. But as the Fall has progressed and the potential liability increased it is clear that banks are willing to risk even their largest clients to wriggle away from some of these deals.

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