Lashinsky's follow up:
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Cabot's Story Was Too Good to Be True, After All
By Adam Lashinsky
Silicon Valley Columnist
Originally posted at 10:02 AM ET 3/14/01 on RealMoney.com
There was a big red stain on a sea-of-green screen Tuesday, and it was the stock quote for Cabot Microelectronics (CCMP:Nasdaq - news), the semiconductor-related chemicals company. Cabot stock plummeted 22% to $46.88 after the company warned Monday night that, oops, contrary to prior guidance, the slowdown in the semiconductor industry would slow its growth rate after all. Fiscal second-quarter revenue will be 15% to 20% below the previous quarter, Cabot warned. The shares ended Tuesday down 44% from their $83.63 mark on Feb. 26, when a piece here pointed out that Cabot's amazingly expanding valuation seemed too good to be true. (By comparison, the Nasdaq Composite is down 11% in the same time.)
There's a lesson to be learned here: If a stock doesn't smell right, be very afraid. That's the case even if Wall Street -- ever mindful of the next potential investment banking deal -- remains bullish. In pre-bubble days, when Herb Greenberg pointed out these types of inconsistencies, it might take two or three years for a story to unwind. In today's environment, inexplicable valuations get resized in weeks. Conclusion: When a stock price doesn't pass the red-face test, get out of the way.
To review, Cabot Microelectronics is in the seemingly enviable position of supplying technology that's key to a major product shift. Its primary market is for chemical mechanical planarization slurries, a brew used to etch and flatten silicon wafers during chip production. Slurries are particularly necessary in a new technology that utilizes copper in the manufacturing process, and because the newest chipmaking equipment uses copper, Cabot is riding high.
As recently as Jan. 29, when it last reported quarterly earnings, Cabot predicted 50%-plus year-over-year sales and earnings growth. Some Wall Street firms, most of which had underwritten the April 2000 initial public offering of Cabot Microelectronics as a carved-out piece of conglomerate Cabot (CBT:NYSE - news), cheered and said the semiconductor-oriented chemical company's stock should soar. And soar it did, from $66.14 to as high as $100.13 on Feb. 15.
The short reason for Cabot's ascent is that it told investors it was more or less insulated from the economic and cyclical downturn affecting the chip industry. It also warned that economic conditions could hurt its customers, but Wall Street ignored that. One fund manager who specializes in chips told me that if chip production slowed, Cabot would suffer, no matter how crucial its technology is. Compare that to Cabot's own statement Monday:
During February and continuing into March we have seen a drop in wafer starts, which appears most pronounced at semiconductor foundry manufacturers. This is attributed to high chip-inventory levels and a slower inventory burn in our customers' end-market applications, which is compounded by the overall economic slowdown. Thus, we, like other companies in our industry, are experiencing a slowdown in customer orders.
Interestingly, Cabot said Monday it's sticking to its previous projections of 50% earnings growth and net margins of between 16% and 18% for the fiscal year that ends in September, despite having lowered revenue guidance for the quarter than ends in March from around $63 million to $55 million. It will pull that rabbit out of the hat of a second-half recovery in its end markets. Not surprisingly, Wall Street largely goes along with Cabot's assumptions, though once-burned analysts are becoming more cautious.
"Because of the higher growth for these high-end chips, we believe excess inventory will be absorbed much faster than for the overall industry," Merrill Lynch's John Roberts told his clients. He rates the stock an accumulate with a 12-month price target of $56.
Goldman Sachs analyst Kimberly Ritrievi estimates that Cabot's stock could fall to between $40 and $47.50. To get to that level, she's applying a multiple of 25 times her estimate of annualized earnings per share of 40 cents per quarter for several quarters at the low end and 25 times her calendar 2001 estimate of $1.90 a share at the high end. Still, she suggests that "long-term investors should take the opportunity [of Cabot's decline] to buy."
Finally, Robertson Stephens analyst Sue Billat reiterates her previous buy recommendation on Cabot, noting that at 31 times her estimated fiscal 2001 earnings of $1.90, Cabot is attractive. That stock must be really good-looking after Tuesday's plunge; it now trades for just 25 times Billat's estimate.
Oh, in case you're wondering, the underwriters of Cabot's IPO of nearly a year ago were Goldman Sachs, Merrill Lynch and Robertson Stephens.
For a slightly more sober view, consider the perspective of an analyst who so far is outside the underwriting tent. As noted, Cabot had a relatively low cash balance of $15 million at the end of December, and is considered a prime candidate for either a takeover or a future financing. UBS Warburg's Jeffrey Cianci notes in a missive to clients that "EPS [earnings per share] is showing high sensitivity to any bounce, and we still expect speculation about a deal could surface by year-end."
Cianci is alluding to the likelihood that a bigger chemical company would want to snap up Cabot. But according to Cabot's filings with the Securities and Exchange Commission, if it were to be acquired before Sept. 29, 2002 -- the second anniversary of its tax-free spinoff from papa Cabot -- Cabot Microelectronics could be liable for a tax liability to Cabot Corp. Hence, a deal is not right around the corner, unless an acquirer wanted to factor in Cabot's unpaid tax bill.
Cianci now projects earnings growth in the mid-30% range for two years running, and as such believes that Cabot is a strong buy, given that its forward price-to-earnings ratio lags behind its growth rate.
Perhaps he's right, though my sources say that as time goes by Cabot's technological lead will diminish as other companies figure out how to make its type of slurries. At least Cabot Microelectronics now trades in line with the rest of the semiconductor industry, about what you'd expect from a company that got 15% of its revenue last year from Intel (INTC:Nasdaq - news). |
