North Coast Solar Stocks

September 27, 2007

A Solar Payoff for Cypress Semi

Filed under: SPWR — Tags: , , , — Jason @ 4:29 pm

By TIERNAN RAY

THURMAN JOHN “T.J.” RODGERS, the brash, outspoken founder and chief executive of Cypress Semiconductor, may be warming to a breakup of his company. If so, it could be a windfall for Cypress investors.

Cypress, whose chips are the brains behind the “click-wheel” in some models of Apple’s iPod Nano, has seen its stock rise 74% this year, largely on the strength of the shares of SunPower, its solar-energy subsidiary. SunPower shares are up 125% this year.

But Cypress is still undervalued, say investors and analysts. With Cypress’ market cap at $4.44 billion, and its 55% stake in SunPower worth $3.6 billion, the rest of Cypress, its traditional semiconductor business, is being valued at about $5 per share, drastically below its fair value of $11, say some analysts.

A splitting up of Cypress’ chip business and the subsidiary could boost the valuation of the chip unit and endow the company with billions in cash.

Rodgers has resisted breakup calls from hedge funds as recently as last year to restructure. For one thing, he has to pay taxes on SunPower if he does anything before November 2009.

But analysts say a tax-free deal could be engineered quickly. And some say that lately they sense a greater willingness on Rodgers’ part to entertain such possibilities.

That’s a good bet to take. For, even if Rodgers did wait, investors buying Cypress shares today would get a valuable chip business trading at a mere one times revenue with almost a billion in cash and a demonstrated willingness to buy back shares.

“Take all the cash Cypress is sitting on, and the bang-up job they’re doing streamlining the [chip] business, and you’ve got good upside without any more outperformance from SunPower,” says Kevin Landis, who runs Firsthand Capital Management, which counts Cypress as the firm’s single largest holding.

But that’s not reflected in Cypress’ share price, says Landis, because, “You’ve got a sandwich of a turnaround story [at Cypress] and a growth story [at SunPower],” and it’s hard for investors to appreciate both stories at once.

A year ago, Barron’s magazine Senior Editor Bill Alpert astutely predicted that Cypress stock would rise based on strength in the SunPower business, whose results Cypress reports on its income statement.

[cy]

Stock Price: $28.73
52-Wk High: $29.65
52-Wk Low: $15.92
Market Cap: $4.44 billion
Est. 2008 EPS: $1.19
2008 P/E: 24.3x
Est. Long-Term EPS Growth*: 12%
Est. (’08/’07) EPS Growth: 54%
Revenue (trailing 12 months): $1.3 billion
Dividend Yield: None
President & Chief Executive: T.J. Rodgers
Headquarters: San Jose, Calif.
* Based on analyst estimates looking ahead three to five years.
Sources: Yahoo! Finance, Thomson First Call, Thomson Financial/Baseline.

SunPower, which Rodgers bankrolled early this decade with a check for $750,000, makes the silicon-based photovoltaic cells that convert sunlight to electric power in a solar panel.

And SunPower sales are, well, hot, more than tripling, year over year, in the July quarter, to $174 million, and accounting for 47% of Cypress’ total consolidated sales.

SunPower revenue may rise 53% next year and 39% in 2009, estimated Cowen & Co. analyst Robert Stone in a recent note to clients.

But even as SunPower has boosted Cypress shares, Cypress’ traditional chip business has remained stubbornly “mispriced,” valued at about $800 million — roughly one times its projected chip sales this year.

That’s stunningly cheap for a chip business that’s much less dependent on commodity computer-memory chips than it was just a few years ago. Rodgers has focused the company increasingly on high-margin products, called “Programmable Systems on Chip,” like the kind in the Nano.

By keeping capital expenditures about flat, the chip unit’s free cash flow per share could jump from 20 cents this year to 90 cents in 2008, estimates Doug Freedman with American Technology Research.

“Cash flows are becoming much more stable and consistent,” says Freedman. “They’re not going through the oversupply situations [Cypress had with memory chips], and they’re getting paid for the value of their product.”

Last December Rodgers dismissed calls from Robert Chapman, head of activist hedge fund Chapman Capital, to break up the two businesses.

But some believe Rodgers, who has been called the “Bad Boy of Silicon Valley,” is being shrewd, not stubborn, and that he’ll appease the market’s desire for restructuring sooner rather than later.

“I wouldn’t doubt they’ll do something to restructure before 2009,” says Sandy Harrison, who follows the stock for Signal Hill Capital Group.

“Knowing T.J.,” says Harrison, “he will see what kinds of cards the market is dealing and ride off into the sunset.”

Rodgers declined to comment for this article, according to a Cypress spokesman.

In fact, Cypress could sell SunPower with minimal taxation today, says Robert Willens, a managing director with Lehman Brothers who analyzes tax implications of spinoffs.

The deal would involve SunPower acquiring a small operating unit of Cypress, taking on debt, using that loan to pay cash to Cypress, and then giving the Cypress shares, perhaps with a special dividend, to Cypress shareholders.

“There’s a blueprint for doing this and it works beautifully from a tax perpective,” says Willens.

“Historically, [Cypress] hasn’t had much of an appetite for any of this stuff,” concedes Willens.

But the presence of hedge fund Third Point ups the ante. In August, Third Point increased its stake in Cypress to 5% of the company.

“This is a different kettle of fish now with an institution like Third Point,” says Willens.

“They’re more of a brand name” than Chapman, and can therefore presumably exert more influence.

To be sure, buying Cypress stock means believing that SunPower has, at the very least, no downside to it, and possibly some upside, and swallowing hard at the multiple being paid for SunPower — 41 times next year’s projected earnings of $2 per share, says Jefferies & Co. analyst Adam Benjamin.

“People may not realize the earnings potential of the chip business at Cypress,” says Benjamin. “But they also may not be willing to give it its proper multiple because so much of the breakup value of the company is in SunPower.”

But betting against SunPower hasn’t proved very profitable, and it’s likely the solar craze will continue to power Cypress’ results as long as SunPower continues to perform. Be it now or in 2009, the market will warm to all the good things going on in Cypress’ chip business.

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