Sidelining Saifun: No Pleasant Surprises, But I'm Following It Closely

"No surprises in the first quarter," was the response from WR Hambrecht to Saifun Semiconductors' (SFUN) first quarter financials. What they meant was no pleasant surprises. Hambrecht cut their 2007 sales forecast for to $42 million from $52 million, and its earnings per share forecast to $0.54 from $0.75. They predict that the company's sales for 2008 will come in at $52 million, with earnings per share at $0.60.

"The next few quarters look challenging for Saifun as the majority of its revenues come from the NOR market with Spansion Inc. (SPSN) and Macronix International Co. Ltd. (MXIC)," says WR Hambrecht. "In addition, we do not believe that SMIC will ramp up data related products until late 2007." WR Hambrecht therefore advises investors to "remain on the sidelines" until such time as the company's products finally catch on in their markets, although it stresses that it continues to remain a believer in the technology in the long-term.

Both my assumption and that of many others is that Saifun's developments are at the forefront of memory technologies. I have no doubt whatsoever about this, since the company would not have been floated at so high a value had that not been the case. Four criteria are used when valuing technology companies in IPOs. The first is the dream behind the technology that the company wishes to sell to the public. Second is the technology's potential market, should be it a success. The third is the underwriter and his market strength, and the fourth criterion is the way the company in makes its presentation and that depends on the management. All these conditions were met when Saifun floated on Nasdaq, and the two offerings that the company has made have been a great success.

The stock was issued at $23.50. It rose $38.50 in less than six months, and in March 2006 Saifun held its second offering, this time at $30.25. This means that the company has exploited to the fulest the opportunities for raising finance from the capital market, finance which is so central to the goals and strategies of companies like these. If we look at Saifun's graph since the secondary offering, we will see that the stock has been tumbling almost continuously. Put simply - for some reason, the magic has worn off, and the company has lost touch with its investors.

What caused this? This state of affairs usually happens when a company that once provided a dream proves incapable of delivering on it immediately. The stock, you will note, began to tumble long before the company's relationship with its key OEM, German semiconductor company Infineon Technologies AG (IFX), came to an end. This would imply that some on the market had begun to have doubts, or that they had lost interest in Infinity [they may, perhaps, have checked out Infinity and found that it was losing market share to the Korean company Hynix Semiconductor (KSX), which uses a rival technology], or they simply grew tired of waiting for the breakthrough and offloaded their shares.

As I see it, the widely publicized row between Saifun's founder, chairman and CEO Dr. Boaz Eitan, and M-Systems founder Dov Moran certainly didn't help. Then in October, we learned from Saifun about the termination of the relationship with Infineon's subsidiary Qimonda AG. The ensuing fall in the stock turned into a mini-avalanche, since the dream that the relationship with Infineon represented, imploded as soon as it collapsed. Many investors who bought Saifun's shares when the company floated are now thinking to themselves that if Qimonda has canceled its contract with Saifun and if the company is having difficulty getting its technology into the market, then it may perhaps be a great technology, but not exactly the one that market was waiting for.

It is worth remembering here that most of those people who invested in Saifun did so because they were convinced that with the ink barely dry on the agreement with Infineon, here was a technology (which they didn't understand at all) from the promised land that would replace the existing standards, a sort of Qualcomm of the semiconductors industry. What were these investors supposed to think, after Infineon backed out and Hynix came along and had success with a rival technology of its own?

All this says nothing at all about the stock's future performance. Undoubtedly, its current situation is not good, and this is more likely to continue than not. But it should be remembered that we live in an age when a slight technological change at the right time and with the right support can turn worlds upside down.

What I am getting at here is that I personally would not touch Saifun at present. I am following it closely, though, and because of that gene that triggers the greed instinct, I have been telling myself that I will be able to buy it a lot cheaper, even though the chances of buying it at the bottom are virtually nil.

So my guiding principle where Saifun is concerned is this: Since the company is selling and is even making a profit, I will opt for what is known as an "economic multiple plus." What does this mean? I will take the lower range of the current consensus for 2008, which predicts earnings per share of $0.43 (the higher range, incidentally predicts $1.12, so the consensus doesn't mean much), which gives a multiple of 26. Economically, this is a fairly high multiple for a company like this, which itself said that it would take some time to reach commercial success. So my goal at present is to start picking up the stock at $7 and lower, because at $7, I will get a multiple of 16 for 2008.

This is my gut feeling, and as this is an subject that very few people understand, I ask that you check it thoroughly with those that do understand it. Just remember that those who thought they understood were way off the mark in their valuations of Saifun a year ago.

Disclosure: The author invests in various equities and may have a personal holding in the stock of companies named.

SFUN 1-yr chart:

Published originally by Globes [online], Israel business news - www.globes.co.il
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.