Rubicon Technology - Silicon Solar Wafer Industry Parallel Makes It Avoidable

| About: Rubicon Technology, (RBCN)
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Rubicon Technology (NASDAQ:RBCN) is a US based producer of sapphire crystals and wafers which it supplies to the global LED and semiconductor industry. This small company saw a spectacular run during 2010 and 2011 when a demand spike from the LED industry drove the company's revenues and profits upwards. The company sales fell by almost half in 2012, as Chinese overcapacity sharply drove down sapphire prices and pushed RBCN into losses. The LED industry saw sharp growth as backlighting in notebooks, TVs, cell phones etc., is driving a growth in demand for LEDs. However, that market has more or less saturated with new demand coming from general lighting purposes. Apart from the LED market, sapphire is starting to be tested out as a material to be used in smartphone covers. GT Advanced Technology (GTAT) is working hard to build new products which could potentially replace the Gorilla Glass being used in top end smartphones. In 2013, Rubicon has seen a sharp increase in the stock price and has almost doubled from its 52-week low, as sapphire pricing has improved somewhat in the last couple of quarters though it still remains below the breakeven level. I am not positive on the RBCN stock as the company directly competes with the Asian producers, who are well funded and have driven down prices below costs.

Rubicon Negatives

1) Analogy with Solar Wafers is Scary - The western manufactures such as Renewable Energy and Solarworld used to be the biggest manufacturers of silicon solar wafers before the Chinese companies entered the industry. Companies such as GCL Poly, ReneSola (NYSE:SOL) and LDK Solar (NYSE:LDK) quickly built up so much capacity that they drove the prices below costs. Many of the western makers have now either exited solar wafer manufacturing completely, or drastically reduced their operations. Something similar seems to be happening to the sapphire wafer industry as well. The western solar wafer makers too hoped that the cyclical downturn would end and they would return to normalcy. But these companies were forced to exit, as silicon wafers are still selling for 20-25c/watt compared to $1/watt in 2009-10.

Sumco which is the 2nd biggest producer of semiconductor wafers is closing down its solar wafer division after reporting a massive loss in 2011. The company will close 2 of its solar wafer divisions and shed more than 1000 jobs. Many of the Western companies like REC, Schott have already closed their solar wafer divisions due to a 70% reduction in solar wafer price in 2011. Only big Solar Wafer Producers like GCL, Renesola can be expected to survive the biggest down cycle in the solar industry.

Source - Greenworldinvestor

The number of solar factories closing in Europe has increased tremendously in the 2nd half of 2012 despite a record surge in Germany which would have raised 2011 solar growth to 25%. However the relentless price pressure from Chinese solar panel companies has decimated the solar companies in the West. While there have been a number of famous cases of bankruptcy like Solyndra and Solon, there have been bigger solar factory closedowns. REC has closed down more than 1 GW of wafer capacity while a pure play Spanish solar wafer factory also closed down recently. British solar wafer maker PV Crystalox is also near the verge of failure. Solar Wafer prices have fallen by almost 60% in the last 1 year with the prices much below the cost of production in Europe. It seems unlikely that any solar wafer maker will remain alive in Europe by 2013.

Source - Greenworldinvestor

The capital investment barriers to building sapphire wafer capacity are also quite low. You can build sapphire wafer capacity quite cheaply in 6-9 months which means that any period of supply shortage will be short lived as companies rapidly build up capacities.

Paul Coster - JPMorgan

It is, so what are we talking about for production line and approximately in terms of CapEx.

Raja Parvez - President & CEO

Well CapEx if we have to, for example if you look at the front end if we have to add additional capacity from beginning let's say 35% to 40%, you are talking about $50 million of investment. In the back end if you double the capacity from 30,000 wafer per month to 60,000 wafer per month, we are talking roughly about $25 million and time line anywhere from about 6 to 9 months.

Paul Coster - JPMorgan

Okay I got it, but it's not like a 75 so we are not talking billions here.

Raja Parvez - President & CEO

No not to that level.

Source - Rubicon

2) Cyclical Market - The sapphire market is still in infancy and has already suffered from a big down cycle due to over capacity. While the market is starting to turn slightly upwards, there is no reason to think that the supply will not increase as the prices improve.

3) Revenue Decline and Losses - Rubicon generated an operating loss of $13 million in 2012 as its revenues almost halved from the previous year. The company's history shows that it has made significant profits only during 2 years and the revenues/profits have shown a lot of volatility. The company's sales in the current quarter declined by ~60% from the previous quarter as inventory levels with key customers remained inordinately high. Investors generally give a low valuation multiple to a stock which shows inconsistency in its financial results.

4) Material substitutes - There are alternative materials to sapphire that can be used in the LED industry. This has the potential to further disrupt Rubicon's business model which is entirely dependent on sapphire products. GaN on GaN, GaN on Si, Silicon Carbine etc., are some materials which are said to have better properties than sapphire. Though their technology is still maturing, they remain a long-term threat to sapphire material in the LED and semiconductor industries.

Now GaN-on-GaN obviously GaN-on-GaN is a near perfect substrate for LEDs, but it's still in R&D stage, but even I think moving forward I do not believe the GaN-on-GaN is going to be the high volume runner for a very specific segmented use where LED chip cost is not an issue. You could use that, but I believe you know you didn't mention but a lot of the reports GaN-on-silicon, okay still at R&D people have been working GaN-on-silicon for a number of years still there are technical challenges and they are not small challenges. There are significant challenges. So even though, even if five years from now, some of those substrates become available and can be operationalised.

Source - Rubicon

5) Low Competitive Barriers - Rubicon does not seem to have a differentiated product in the commodity sapphire market. Though the company is one of the few to produce six and eight inch sapphire wafers, I am not sure whether this is a sustainable competitive barrier.

While we expect pricing for two-to four-inch product to continue to gradually increase this year, pricing of six-inch/16 wafer is becoming more challenging. Competitors are trying to enter the six-inch market by offering prices below cost. While it is yet to be seen how effectively they will be able to compete given the current limited six-inch customer base right now it will likely result in pricing pressure in the near term. We believe we will finally begin to see greater adoption of six-inch wafers among major LED chip manufacturers within the next year.

Source - Rubicon

Rubicon Upside Risks

1) General Lighting market for LEDs - The LED industry is going to see a new wave of demand growth as the general lighting market starts to adopt LEDs, since the prices are coming down. LEDs have become much more cost competitive with other lighting alternatives and this should help drive a growth in LED demand.

2) New Products - Rubicon is investing heavily to develop a new sapphire product (PSS) which will lower costs and expand its market. The company is also hopeful of increasing sales to its silicon on sapphire (SOS) electronics customer.

Stock Valuation and Performance

Rubicon's stock has climbed quite steeply from its 52-week low of $4.83 but still remains far below its all-time peak of ~$33 reached during 2010. The company's valuation is no longer cheap with a P/B of 0.9x and a P/S of 2.9x. Stocks operating in cyclical industries with wide fluctuations in profits get a lower multiple from investors.

Summary

Rubicon Technology, despite its name, is not a technology stock but more of a commodity player in the sapphire material industry. The company's stock will keep moving like a yo-yo depending on the supply-demand balance in the sapphire industry. With the Chinese government looking to capture the LED industry, I don't think any stock investment is a very good idea in this sector. The Chinese over-investment in the wind and solar industries has destroyed billions of dollars of investor value in these industries. Something similar happened in the sapphire industry in 2012. I am not sure that the small increase in sapphire prices is sustainable. I would look to avoid RBCN and try to invest in LED/sapphire stocks which can offer technology/process/manufacturing differentiation. Investors can look at GT Advanced Technology as an alternative.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.