I have rated Rudolph Technologies (Nasdaq: RTEC) a Sell based on a recent price of $11.81 and a fair value estimate of $35-$40.
According to the company, they are a worldwide leader in the design, development, and manufacture of high-performance process control defect inspection, advanced packaging lithography, metrology, and process control software systems used by microelectronics device manufacturers.
I admit it took me almost a week to decide if my rating was reasonable. Normally when I have a company that has a price to value ratio of less than one, I rate the company a buy. But this one...
Going through the most recent annual financials, there was really nothing that caught my eye. All in all the financials seemed quite boring actually. The liquidity ratios were all great, the profitability ratios were great, the debt ratios were great, and the free cash flow ratios were also very good. The cash conversion cycle at 322 days didn't really excite me, nor did the AR days of 95, or the AP days 15, telling me that the company will pay its bills 6 times before it is paid for its services.
While that may be a commendable way to do business, management should consider putting a system in place that will allow funds owed to the company to be collected much sooner than 95 days or allow payables to be paid over a much longer period.
One thing I did uncover in my research was that the company has been in business 14 years. During that time, management has never split the company's shares. Nothing odd in that really. But what I did find odd was that after 14 years in business, and as a claimed world leader in its industry, the stock is actually trading at a price that is 54% lower than when the company went public. I admit, I am not used to seeing that sort of anomaly without a stock split in the mix.
I also noticed that the days to cover number stood at 34. While this number is fairly meaningless to me, I added it to my worksheet as a measure of trading volatility. In the world of short sales, the days to cover number is determined by dividing the number of shares being shorted, by the number of shares that trade in an average day. Normally, that number is a seven or an eight. As the volatility increases, the number falls, and as the volatility decreases, the numbers grows. Seriously? 34 days? That's longer than the last ten seconds of an NBA game.
One of the other factors that finally influenced my rating decision was earnings, $1.61 for its current fiscal year. But, when I looked closer, I found that 27% of the company's net income came from a reduction in income taxes. Backing the negative income tax amount out, earnings fell from $1.61 to $1.17. This adjustment also impacted year over year earnings growth which fell from 63% to 19%.
Several years ago I developed a metric that uses year over year earnings growth to determine what a current growth adjusted stock price should be. While the methodology is certainly not infallible, more times than not, it comes pretty close to the current trading price of the stock. The current trading price number based on year over year earnings of $1.61 is $25.71. The current trading price number after adjusting for the tax refund is $13.97, fairly close to its recent close, and fairly close to analysts' mean target price of $13.
A company review, which is what this report actually is, would not be complete if I didn't at least scan through the latest 10-K SEC filing. It was here that I found a "you did what?!" item. It also sealed the deal when it came to a rating for this stock. The 10-K revealed that the company has a contingent liability of between $25K and $31.6 million that came about because Rudolph management, in my opinion, was clueless.
It seems that in 2007 the company purchased another company and assumed certain liabilities of the purchased company, one of which was a pending patent infringement lawsuit. Fast forward to 2011 when the company goes to trial over the patent infringement and looses. The wining company is awarded trebled damages plus all attorney's fees, all of which Rudolph has appealed, stating, "the company has a meritorious defense".
Raspberries to you management. You screwed up and you know it.
As one might imagine, there is much more to the story than I have mentioned here. But to me, as an individual investor, the bigger question is why would I want to invest my hard earned money in a company that has a management team as seemingly inept as the one Rudolph has? Personally, I find it hard to believe that Rudolph's management team, prior to purchasing the company that was purchased, did not ask the company's attorney for a legal opinion on the merits and loss probabilities of the pending litigation. I mean it just seems such a basic thing to do.
The other thing that just seems beyond the pale is why Rudolph did not purchase some sort of insurance to cover the potential negative effects of this litigation. At the very least the insurance company's legal team would have reviewed all pertinent information and conveyed their findings to the insurance company, whom, one can only assume, would have conveyed the information to Rudolph's management.
As I said, these steps on the part of management all seem so basic to me that I find it unbelievable, that management, seemingly, did not take them. In fairness, I do not know that these things did not happen. But I do know that the company's latest 10-K doesn't make any mention of having insurance in place to cover this potential loss, at least that I could find.
Growing a company through acquisitions is a fair strategy. But for this strategy to succeed a strong, astute, and adaptable management team, able to understand the risks of an acquisition far better than the rewards, is required. Unfortunately, those are attributes that appear to be lacking in the management team of Rudolph Technologies.
Disclosure: Wax Ink is a baseline equity research company not licensed or registered with any government agency and has no position in any stock mentioned in this report..