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Rubicon Technology, Inc. (NASDAQ:RBCN) is one of the primary suppliers of wafers to makers of Light Emitting Diodes (LEDs), Radio Frequency Integrated Circuits (RFICs) as well as Laser Diodes and other optical markets. The company came public at $14.00 in November and was a raging success. After immediately trading up to $20, the stock consolidated and then pushed as high as $35.00 this spring. Since that time the stock has begun to show weakness as many of the pre-IPO owners have begun liquidating their positions adding pressure to the stock.

Compounding the situation, RBCN is a high-multiple growth stock in what is fast becoming a fearful market. During times of economic growth, investors are often likely to pay a higher price for companies that can demonstrate potential to grow earnings significantly over the years. The idea is that while paying a premium for what the company represents today, investors accept the higher price because they look towards what the company will be worth in the future.

However, during unstable periods, investors typically reduce the premium they are willing to pay for the growth because an unstable economy or other issues cause there to be more risk or uncertainty in growth expectations. If the company reduces its earnings expectations during the same period, investors often are hit doubly hard because the premium is contracting at the same time the earnings denominator is falling.

Rubicon has the potential to fit into this category as it sports a PE of 46 based on the expected earnings for 2008 of 46 cents per share. The multiple comes down quite a bit when compared to 2009 expected earnings of 0.70 but that figure is certainly not set in stone as there are many moving parts both within the company and industrywide that could cause estimates to change.

Looking specifically at the business, Rubicon enjoys some of the strongest margins in the industry due to its skill in producing larger 4 inch and even 6 inch wafers. While the manufacturing process is quite complicated, suffice it to say that larger wafers are harder to manufacture, but they carry much higher margins due to usable surface area and synergies in the manufacturing process.

Analysts assume that the company has about a one year technology lead over its competitors which should give it a competitive advantage. The company ended 2007 sitting on a backlog of orders equal to roughly 95% of its expected sales for 2008 so this year’s revenue assumptions are likely stable. The IPO left the company with $75 million in cash which keeps them in solid financial state.

However, there are some aggressive growth assumptions being held by analysts and the investing public that may present a problem especially in a more difficult economic environment. As competitors begin to match RBCN’s technology over the next year or two, it is almost certain that price levels will drop as more companies compete for business. A primary risk lies in the fact that the top three customers make up more than 50% of the company’s revenue. If any of these contracts were lost or even just scaled back, it would have a material affect on revenues and earnings.

There is also the concern that as technology progresses, LEDs could play a smaller role than expected in lighting for applications. If that were to happen it could be devastating to the company which receives the vast majority of their revenues from LED based applications.

The stock has most recently been under pressure as the lockup period has expired for those who owned the company prior to the IPO. As these shares are sold on the market they are adding supply during a time when liquidity is contracting. This phenomenon will likely continue and even the perception of a large selling stockholder can cause institutions to hesitate in picking up shares as they expect to see lower prices.

The combination of a large selling stockholder, a high multiple, and a weakening appetite for risk sets the stage for a decline that investors should be wary of. I would suggest taking defensive action with this stock, hedging or selling long positions, and even potentially shorting for aggressive accounts.

RBCN Notes

Disclosure: Author has a short position in RBCN.

Source: Rubicon Technology: Dimming the Lights