Does One Hand Wash the Other With Cree and Friends?
By Herb Greenberg
Senior Columnist
(ad's comments: Greenberg has been right on the money on Lerner & many other stocks. This article is a string of very negative articles about Cree.)
11/29/00 6:31 AM ET
URL: thestreet.com
So, Banc of America Securities came out Tuesday and shaved this year's earnings estimates on Cree Research (CREE:Nasdaq) by a nickel, and the stock tumbled 14%. The reason: weakness at rival Toyoda Gosei in Japan, which makes LED chips that are brighter than Cree's.
But is that really Cree's biggest problem?
Let's just say that's not why short-sellers find Cree so appealing. "What I see at Cree reminds me a lot of what I first saw at Lernout & Hauspie(LHSP:Nasdaq)," says Marc Cohodes of Rocker Partners, who is referring to Cree's web of related-party and not-quite-arm's-length transactions. (Rocker Partners holds a 5.2% stake in TheStreet.com, according to SEC filings.)
Cohodes, who is short Cree, is best known to readers of this column for raising red flags on Lernout; he was recently quoted here as mentioning Cree as one of several stocks on his current hit list, without a "why." The "why" is those related-party transactions. They're always reason for concern, no matter how well they're disclosed, because on the one hand, they simply don't look good and always are suspicious; on the other hand, they can easily lead to overstating revenue or understating expenses.
Both appear to be the case at Cree, a maker of LED chips, which was first mentioned here in July 1999 for its too-close-for-comfort relationship with fake diamond maker C3, now called Charles & Colvard(CTHR:Nasdaq). Not only is C3's then-CEO Eric Hunter the brother of Cree CEO Neal Hunter, and not only was Cree a big C3 investor, but Cree had a multiyear deal to sell crystals to C3.
C3 is now stuffed with around four years' worth of inventory from Cree. Four years! If you didn't know better you'd think C3, whose business has subsequently done horribly, was created for the sole reason of becoming a customer of Cree.
Ah, but not to worry: Cree now says that C3, which once accounted for as much as 20% of Cree's sales, is no longer an important customer. Eric Hunter has since left C3, but guess what! He has started a new company called World Theater.
One of World's biggest investors, taking $5 million of a $19 million offering, is none other than (You guessed it!) Cree. According to World's private placement memorandum, World plans to construct an "On-Demand Electronic Billboard Network."
Well (and this is where it starts to get interesting), not far from Cree's headquarters in Durham, N.C., is the U.S. headquarters of Lighthouse Technologies, which was known as Real Color Displays when it was a subsidiary of Cree. Lighthouse has the same management and many of the same employees as it did when it was part of Cree. While they're no longer directly related, however, Lighthouse appears to remain a Cree customer. Cree, in fact, boasted that its chips were used in Lighthouse's big screens at the Republican National Convention.
What does that have to do with World? World is a potential indirect customer of Cree via Lighthouse, because Lighthouse makes screens that would be used in any electronic billboard network. A Lighthouse official told me that World has already bought several screens from Lighthouse for demonstration purposes. (Still with me?) World officials couldn't be reached.
Then there's Cree's relationship with Microvision(MVIS:Nasdaq), which makes scanning technology. Over the past two years, Cree has invested $17 million into Microvision. Microvision, in turn, has agreed to spend $12.6 million (Gee, wonder where they got it!) to fund research with Cree.
That spending by Microvision directly offsets, or lowers, Cree's research and development costs. Last year alone, Cree says that Microvision's payments lowered Cree's R&D expenses by $3.1 million. (Put another way, if those R&D expenses had been shouldered by Cree, its fiscal year 2000 operating income would have been about 8% lower, and earnings per share would have come in 3 cents lighter than analysts' expectations.)
Cree has similar development agreements with Xemod, in which it has invested $11.3 million, and Spectrian(SPCT:Nasdaq), whose UltraRF unit Cree is buying. Cree hasn't, however, disclosed dollar amounts of those develoment agreements. And speaking of Spectrian, it has two divisions, the Amplifier division and UltraRF. UltraRF, it turns out, has virtually one customer: Spectrian's Amplifier division, and as part of the takeover, Spectrian will continue to purchase chips from UltraRF for two years.
Does the UltraRF deal require Spectrian to purchase a specific amount of chips, as did the agreement with C3? Will the UltraRF and Xemod development agreements offset Cree's R&D expenses? In the cases of Microvision and Spectrian, isn't Cree merely taking money off its balance sheet, handing it over to another company, and having it come back, one way or the other, into its income statement? If not, why? And why shouldn't Cree investors be concerned about its related party transactions?
I asked some of those questions, and a few more, to Cree's execs in a written email (after they didn't return my call of last Wednesday). Their response (I kid you not!): Go read the 10-Qs and 10-Ks. "We believe these appropriately disclose our historical transactions," a spokeswoman said. And as for the UltraRF deal, she suggested I read the press release.
Well, I did and did ... and did, and still couldn't find the answers to my questions.
Your move. (With Cree's stock trading at around 45 times next year's expected earnings, it had better be a good one.) |
