Hutchinson Technology: $20 Book Value, $2 Share Price

Hutchinson Technology (HTCH) closed Friday at 2.05, a stunning 90% discount from its book value, approximately $20 per share. Hutchinson's primary operation is the design and manufacture of disk head suspension assemblies. Principal customers include Seagate (STX) and Western Digital (WDC). They closed their 2008 fiscal year on a sour note, with a large, non-cash write-down of Deferred Tax Assets. The company has strong R&D, proprietary and patented technology, and precision manufacturing expertise. In addition to the write-downs, 4th quarter results were hurt by “ramp-up” expenses on their TSA+ technology, which is now in production.

I have followed HTCH for several months, originally buying it at 14.xx for both my personal and Marketocracy portfolios. I sold the personal holding at a small loss, not because I saw problems with the stock, but because I wanted the funds for other purposes. I added to the Marketocracy position as prices declined this month. The shares are now blowing up and down Wall Street, like $20 bills in the wind, waiting to be picked up by passersby.

The situation reminds me of a case where I made some pretty good money in June 2007 – Komag (KOMG), a manufacturer of disks for disk drives, with the same set of customers that HTCH has, ran into a slowdown and the shares tanked to well below book value. The company appeared to be well-run and had a strong balance sheet. I was able to buy it in the low teens, as I recall, and it was acquired by Western Digital for 32.25 per share. The disk drive industry is in the process of consolidation. It was an agreeable experience, marred only by the relatively modest size of my position, and one I would like to repeat.

HTCH originally came up when screening the sector for strong cash flows, and is now trading at .46 of cash flow, according to Morningstar. Anything under 8 X cash flow is attractive: but, .46? When analyzing stocks, I like to compute a ratio of earnings to cash flow – some companies are aggressive with depreciation or for other reasons show very low earnings compared to cash flow. Hutchinson averaged something over 4 per share cash flow from 2003-2007, with earnings frequently less than half that amount. The 10K section on accounting principles says they test cash flows associated with assets and impair when they see problems. Because most of the assets are building and equipment, I would have expected usable lives and straight line depreciation, but what I saw was testing for impairments.

Technology moves fast in the computer business, so maybe their approach is realistic.

Cash and investments stands at around 11 per share, long-term debt is 90% of equity, higher than I prefer. The quick ratio stands at 4.5, the current ratio is 5.7. They have long term debt to renew in 2010, but cash and investments on hand cover the amount, and cash flow, as noted, has been strong. Earnings have been pressured by the slowdown, and I see little reason to anticipate that 2009 will be easier than 2008. However, management expects that they will maintain market share in 2009, and they continue to do their R&D and keep up with the industry. Expenses have been pared as necessary., promptly and decisively. If and when TSA+ achieves greater acceptance, gross margins and profits should increase as production ramps.

There is 72 million remaining on their buyback authorization, after they spent 57 million during the last quarter buying shares at an average price of over 16. 23 million shares remain. Here's the interesting thing: 72 million divided by 2.05 per share is 35 million shares, but there are only 23 million left to buy. I expect that the company will repurchase as many shares as prudent cash management permits. Wayne Fortun, President and CEO, recently bought 20,600 shares at 4.68. At 2.05 per share, today's investor can do substantially better than this insider, always appealing.

I have had good luck over the years with situations of this type, a technology stock with a strong balance sheet and a genuine business, trading at a discount to physical assets, usually on concerns for industry slowdowns. At times Teradyne (TER) and Pericom Semiconductor (PSEM) have met this profile.

In any event, I am going to scoop up shares of Hutchinson; otherwise they will just blow away and be swept up as litter and recycled or burned. What I need is one of those sticks with a nail sticking out of the end, to spear them off the ground.

Disclosure: Author holds a long positions in HTCH, no positions in PSEM, TER, WDC or STX

Comments

[leo.vip:]

I fail to understand how you can pitch this company that has underperformed the industry. It has had double digit negative % growth since last year, -668% net income growth and only 4.8% 5yr avg sales growth. Not only that, but it's profit margins are also sub-par compared to the industry with negative pre-tax and net-profit margins. Investing in a company with ROE of -22.7% when the industry average is positive 13.3? Its horrid performance makes it clear why this stock is selling at such low prices. I do not claim to know much about investing and I am still learning but when I see all those red numbers for a company and green for the industry it turns me away. Does the possibility of a buy-back and take-over really outweigh all those things? Any feedback would be helpful, I am still trying to get a hang of all these things.

2008 Nov 24 01:57 PM

[Tom Armistead:]

I look at this from a long term view, in 2000 and 2001 they lost money and the stock got cheap. Then as the computer industry came back they made money and the price recovered, from a low of 12.81 to a high of 43. Any kind of recovery would lead to large gains from the 2.05 Friday price. At 1/10 of book value you have margin of security, it's hard to lose much.


On Nov 24 01:57 PM leo.scipio wrote:

> I fail to understand how you can pitch this company that has underperformed
> the industry. It has had double digit negative % growth since last
> year, -668% net income growth and only 4.8% 5yr avg sales growth.
> Not only that, but it's profit margins are also sub-par compared
> to the industry with negative pre-tax and net-profit margins. Investing
> in a company with ROE of -22.7% when the industry average is positive
> 13.3? Its horrid performance makes it clear why this stock is selling
> at such low prices. I do not claim to know much about investing and
> I am still learning but when I see all those red numbers for a company
> and green for the industry it turns me away. Does the possibility
> of a buy-back and take-over really outweigh all those things? Any
> feedback would be helpful, I am still trying to get a hang of all
> these things.

2008 Nov 24 03:48 PM

[Busted:]

Be careful on this play. HTCH just sued Citi and UBS because they got stuck with $101M in "auction rate securities". That money is now in limbo and should be written down substantially but they have only written down about $8M of it sof far. They have about $160M in cash and cash equivalents at end of last quarter which is just enough to cover the $150M convertible bond due in Feb 2010. Last quarter results also show that they are running cash flow negative. Don't count on a buy-out for them as the $150M bond due in 2010 and another $225M bond due in 2026 will get triggered for redemption in the event of a change in control or liquidation i.e. they are not cheap enough to buy even though their market cap has collapsed. This is a company that looks like it is running out of cash in a really bad time!

2008 Nov 25 08:54 AM

[Tom Armistead:]

According to the conference call transcript, the auction rate securities are substantially backed by student loans, 97% guaranteed by the US government. They were marked to market because they are held for sale.

After reading the conference call, I think the risks here involve the transition to their new TSA+ product/technolgy and also in BioMeasurement from development to profitable sales.

They have 263 million in cash, marketable securities and auction rate securities, and are managing cash carefully.

Rather than plunging in, a caustious investor could monitor the transition quarter by quarter and try to enter when the transition issues were clearer.


On Nov 25 08:54 AM Busted wrote:

> Be careful on this play. HTCH just sued Citi and UBS because they
> got stuck with $101M in "auction rate securities". That money is
> now in limbo and should be written down substantially but they have
> only written down about $8M of it sof far. They have about $160M
> in cash and cash equivalents at end of last quarter which is just
> enough to cover the $150M convertible bond due in Feb 2010. Last
> quarter results also show that they are running cash flow negative.
> Don't count on a buy-out for them as the $150M bond due in 2010 and
> another $225M bond due in 2026 will get triggered for redemption
> in the event of a change in control or liquidation i.e. they are
> not cheap enough to buy even though their market cap has collapsed.
> This is a company that looks like it is running out of cash in a
> really bad time!

2008 Nov 25 11:41 AM