FormFactor: Morgan Stanley's Top Pick In The Sector

Morgan Stanley is positive on FormFactor (NASDAQ:FORM) saying they remain perplexed about the stock's lackluster performance in the last couple of months given the impending 2H07 ramp driven by 70nm DRAM node migrations, increasing logic opportunity, and potential NAND wins at Samsung/Micron.

Firm's meeting with the management team confirms solid design pipeline in Q2 and no signs of slowdown on 80/70nm DRAM migrations. They continue to believe that FORM's DRAM probe card revenues are highly correlated to bit shipments or DRAM unit shipments and not near-term capital spending or equipment order trends. This makes sense given that probe cards are used to test chips (and every memory cell or bit on the chips).

MSCO believes competitor's concerns on Advantest's potential entry in the probe card market are not new or a source of major concern in the near term. They think Advantest's growth in the tester market has been slowing and the company has been looking into new areas of growth, including advanced probe card market for more than a year. Checks suggest Advantest is still in the early R&D stages on a MEMs-based probe card and that the company is focusing more on vertical probe cards (one generation behind advanced MEMs cards).

Risk-reward looks attractive and 35%+ upside on FORM makes it our top pick. Firm's price target of $55 is based on a P/E of 25 times 2008 EPS estimate of $2.16, or a price-to-earnings growth (PEG) ratio of 1 based on their view that the company can increase its earnings 25-30% over the next several years.

Notablecalls: Goldman was out cautious on FORM yesterday morning, saying Advantest's potential entry in the probe card market is a long-term threat. The firm did maintain their Buy rating, though saying current levels are pricing in short term weakness in fundamentals. Yet, according to MSCO, there is no weakness as DRAM probe card revenues are highly correlated to bit shipments.

The stock is down 20% from its recent peak, with other semi names down around 10%. Must say I was surprised how little damage GSCO's note did to FORM stock yesterday. Are we getting close to the bottom in FORM? I'm not ready to make that call here, considering the overall weakness of the tape, but signs like this cannot be disregarded.

FORM 1-yr chart: