Cypress Semiconductor - Current Revenue Base Cannot Support The Valuation

| About: Cypress Semiconductor (CY)
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Cypress Semiconductor (NASDAQ:CY) surprised the market with a disappointing guidance for the third and fourth quarter of the year, triggering a 15% sell-off.

I remain on the sidelines given the huge operating leverage of the firm, which works both ways of course. I think the current valuation requires a revenue base of $900 million to a billion, something which I don't see easily attainable within a year.

I remain on the sidelines.

Third-Quarter Update

Cypress surprised the market in a negative sense by updating its third-quarter guidance, while issuing a preliminary guidance for the final quarter of the year.

Third-quarter revenue is now seen between $184 and $187 million, down from a previous guidance of revenues between $201 and $207 million, marking a severe miss. Revenues are seen down 8.6% on the year before and down by 4.1% compared with the second quarter.

Non-GAAP gross margins are seen between 53.5 and 54.0%, higher than previously anticipated. As a result, non-GAAP earnings per share are seen between $0.10 and $0.12 per share, which compares with a previous guidance of $0.17 to $0.18 per share.

On a GAAP basis, Cypress expects to report a loss between $0.11 and $0.09 pr share.

Third-quarter results are expected to be released on October 17.

CFO Brad Buss commented on the cautious update, "We are seeing greater than expected weakness in our mobile handset revenues, mainly within Asia, due to a customer push out of certain new handset programs to Q1, as well as order reductions at various end customers in Chinato balance inventory levels. Unfortunately this is resulting in a negative impact to Q3 revenue that was not anticipated in our original guidance."

Soft Fourth Quarter As Well

On the back of the softness, especially in TrueTouch, mobile handsets and greater inventory adjustments, the fourth-quarter guidance is under pressure as well.

As a result, fourth-quarter revenue is expected to fall another 9-11% from the third quarter. This implies that revenues are seen between $165 and $169 million. At the midpoint of the range, revenues are seen down around 7% compared to last year.

Gross margins are under pressure on lower factory utilization. Yet operating expenses are expected to fall as well on tight cost control and lower variable-based compensation.


Cypress ended its second quarter with $102.0 million in cash and equivalents. The company has $227 million outstanding under its long-term revolving credit facility, for a net debt position of around $125 million.

Revenues for the first six months of the year came in at $366.2 million, as Cypress reported a $24.4 million loss. Based on the guidance above, full year revenues are seen around $720 million, while the company is expected to report a full-year loss, which most likely will surpass the $50 million mark.

Trading around $9.75 per share, the market values Cypress at $1.45 billion. This values the company at roughly 2.0 times annual revenues.

Despite the losses, Cypress pays a quarterly dividend of $0.11 per share, for an annual dividend yield of 4.6%.

Some Historical Perspective

Shares of Cypress have witnessed a great deal of volatility over the past decade. Shares fell to lows of just $1 in 2003 in the aftermath of the dot-com crisis. They steadily rose to their mid-20s in 2011, but fell to just under the $10 mark at the moment.

Between the calendar year of 2009 and 2012, Cypress increased its annual revenues by a cumulative 15% to $70 million, after revenues nearly peaked at $1 billion in 2011.

Net losses of $150 million in 2009 turned into a $168 million profit in 2011, before the company reported a $22 million loss last year. Note that full-year losses for 2013 are expected to increase significantly again.

Investment Thesis

Revenues are key for Cypress as the company's bottom line is extremely affected by revenue swings. Between 2010 and 2011, revenues were up by $118 million, boosting the bottom line by some $93 million. In between 2011 and 2012, revenues fell by $225 million, causing net earnings to fall by some $170 million.

So you can appreciate the dramatic effects of the revenue swing on the business and the bottom line. This shows that while the company claims the business model is agile and based on variable costs, in reality this is not materializing. Given that revenues in 2013 are expected to fall by another $50 million compared to 2012, this does not bode well for full-year earnings, or better said, losses.

The company notes that weakness is related to certain customers in the mobile handset market, as it sees no broad weakness. Some large end customers are delaying the push-out of new models to Q1 of the next year, while others continue to reduce inventories. The company stresses that it expects significant financial leverage in its operating model if revenue growth eventually returns.

Despite the sell-off I am not convinced. The company is on track to report losses for the second year in a row, after reporting peak earnings of $168 million in 2011. To regain profitability, revenues have to rise by at least 10% next year, and that is just to break even. To support the current valuation, annual revenues should at least come in around $900 million to a billion, something which seems rather challenging for next year.

I remain on the sidelines, given the dynamics outlined above.

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.