FormFactor: Nowhere to Go But Up

Feb. 6.08 | About: FormFactor, Inc. (FORM)

If you read through FormFactor’s (NASDAQ:FORM) recent Q4 2007 conference call transcript, several things clarify its current price drop:

  1. They had trouble introducing last year’s new Harmony product which is slated for higher pin counts at lower nanometer sizes. In the interim, a competitor was able to take share from them at the lower end of their market. FormFactor will now have to compete to get back the market share they lost. However, Harmony is completely out of the R&D stage and is ramping.
  2. The company said that it will satisfy the pipeline for its Harmony business starting in the June quarter by a factor of 2x. They believe their customers will ramp 65- to 68-nanometer technology very hard by the mid-year, and that’s where their new probe cards will shine – in the most complex part of the test market.
  3. The company predicts the first half of the year will be challenging, and the second half will be stronger. (This is what I have been hearing out of other chip companies as well – looking for a 2H2008 recovery.) Customers will be ramping DDR3 in the second half for the first time (a major event), and this ramp will be a boon to Form’s advanced probe cards.
  4. The memory market hit tough times in the last half of 2007, as difficult as 2001, and because both chip makers and suppliers are now having to sell memory below their cash cost to manufacture or distribute it, chipmakers are dropping capex for test in the first half of the year. This drop is market-related, not company related. It is an extreme, short-term consideration based on a severe contraction in memory pricing.
  5. The current price of the stock ($17.10) is not that far above the company’s net cash position ($11.06/share), and there will be little cash burn in the first quarter; so the company is considering an aggressive share buyback. By my own pencil, FORM could buy back 20% of their shares (10ML) at $18/share and still have $9.75/share in cash ($357 ML) remaining with no debt. An aggressive $180ML+ buyback would put a floor under the shares. Adjusted for the 3 month average volume, that’s two weeks of concentrated buying.
  6. Lastly, there are technical support levels to consider. Form Factor is at five-year lows, resting precisely at the price it has based four times before. It’s uncanny how these things can repeat. Form Factor’s current position is as much a factor of the overall stock market and the bearish chip market as it is its own temporary miss. They still spend nearly twice as much as any competitor on R&D; and their probe cards are considered the class act in the test sector.

Based on FORM’s valuation – its strong cash position, 1.1x book value and no debt – plus market considerations (short term pain at the bottom of the chip cycle, long term gain later) – I continue to rate FORM a strong buy with a 12-month target of $30.

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