Cabot Micro's Story Seems Too Good to Be True, and Probably Is
By Adam Lashinsky
Silicon Valley Columnist
2/26/01 10:00 AM ET
The ruthless revaluation of technology stocks large and small these past 12 months has trimmed to near-reality the price investors will pay for tech companies whose "stories" aren't what they used to be. How delectable, then, to find a successful company in the semiconductor industry whose "story" is intact, but whose lofty valuation should concern its shareholders.
The little-known company in question is Cabot Microelectronics (CCMP:Nasdaq - news - boards), a specialty chemicals maker in the Chicago suburb of Aurora, Ill., that until last year was a unit of the diversified Boston industrial materials manufacturer Cabot (CBT:NYSE - news - boards).
As an inducement to continue reading, consider the meteoric rise of a company that gets nearly all of its revenue from the chip business. Since its April 4 initial public offering at $20, shares of Cabot Microelectronics have more than quadrupled to Friday's close of $83.63. Since it last reported quarterly earnings on Jan. 29, Cabot's shares are up 26%, in the face of the slaughter of the rest of the tech world. Contrast this with the receding fortunes of chip giant Intel (INTC:Nasdaq - news - boards), which accounted for 15% of Cabot's revenue for the fiscal year that ended in September. Intel's shares are down more than 50% since Cabot's IPO.
Wonders one chip specialist studying Cabot as a potential short-sale opportunity: "Is it not subject to the same laws of physics? If the industry is slowing, won't they be vulnerable?"
According to the company and the analysts who work for its investment bankers, the answer is no, because Cabot is riding a major technological shift, not industry cycles. Under closer scrutiny, that explanation has holes in it.
Cabot Microelectronics makes polishing slurries, a brew that's used to clean semiconductor wafers as they're being produced. It's part of a process called chemical mechanical planarization, or CMP. Cabot is particularly adept at aiding the manufacture of chips utilizing newfangled copper technology, all the rage in the semiconductor industry because copper makes the chips faster and more cost-effective. Copper is a big reason Intel says it will spend $7.5 billion on capital equipment this year despite the slowdown in its business. Because Intel is behind the competition in copper manufacturing, it must spend to catch up.
And Cabot is a prime beneficiary when new chips get made. In the quarter ended Dec. 31, it reported revenue of $68.6 million, up 97% from the year-earlier period. Like the good Midwestern manufacturing company that it is, Cabot is profitable. It earned $14.4 million, or 59 cents per share. And analysts see great things in store for Cabot. They forecast revenue of $281 million for the current fiscal year, a 56% increase, and earnings of $2.11 per share, a similar percentage jump.
Says Sue Billat, an analyst with Robertson Stephens (whose firm was an underwriter of Cabot's IPO): "In our view, Cabot continues to leverage its dominant position in CMP slurries to take advantage of major trends in semiconductor processing; in particular, the transition to copper."
This all sounds great, and Billat and others note that Cabot is somewhat insulated because materials suppliers fare better than equipment suppliers in a downturn. Cabot clearly is a profitable company on the come, the kind of old-line industrial company that should be in vogue on Wall Street for the next few years.
So how much would you pay for a company with about a quarter-billion dollars in revenue whose end-markets are in the most precarious state they've seen in years? Oh, about $2 billion at Friday's closing price. That's about 7 times forward sales and about 40 times forward earnings.
That seems reasonable if the growth forecasts hold. But consider what Cabot itself told investors at the end of January. "We believe the slowing economy in the last quarter resulted in some increased inventory for certain end-market applications," said President and CEO Matthew Neville in a statement. "We expect this to have a short-term effect as this inventory is reduced to normal level."
Well, we've heard that before.
The company isn't changing its tune from several weeks ago, even as the rest of the world has given up on a quick recovery. "Obviously there are differences between the markets we serve and the overall economy," says Carol Bernstein, Cabot's general counsel. "But as we discussed [on the conference call], we do see and did see an amount of inventory buildup [at our customers] that might have an impact on our business. We don't want to say there's no connection."
Cabot raised $83 million in its April offering, which left its former parent with an 80.5% stake. The Boston-based parent subsequently spun off that stake to its shareholders. Even with the IPO cash, however, Cabot's cash levels have dwindled to about $15 million on heavy spending on R&D and new facilities. The company generates about $11 million per quarter in cash from operations, and it has the ability to borrow up to $33.5 million under two credit lines. In its most recent 10-Q, Cabot said it has enough cash to fund operations for two years but that it "may be required to raise additional funds in the future through public or private equity or debt financing, strategic relationships or other arrangements."
Bernstein won't comment on whether Cabot will attempt a follow-on stock offering. But with the share price so high relative to the IPO level, it would seem prudent to try. Any offering likely would sock the shares in the short term, however.
There's no doubt that Cabot Microelectronics is a winner with a fair valuation if it hits its growth targets. But a semiconductor-related company that won't get hit by the macroeconomic climate?
Almost no one in the chip industry believes Intel really will spend its $7.5 billion on capital equipment this year. But even so, Cabot makes money when chips get made, after the equipment is built. "It's a direct corollary to wafer production," says the buy-side chip specialist. "What's relevant to them is how many parts are made. Intel could spend $20 billion, but if they make fewer chips, Cabot won't get a dime."
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