- Rubicon is divesting its biggest operative segment and losing 80% of sales in the process in a bold managerial decision aiming at future performance.
- CEO hired 2 weeks ago with proven track record, having delivered a 20% CAGR to shareholders in a similar situation.
- Selling way below a conservative appraisal of cash in the balance sheet by year-end and lots of optionality from NOLs and acquisitions.
Rubicon Technology Inc. (OTC:RBCN) is a very interesting situation where a company decides to divest its sexiest, biggest operative segment to concentrate in the smaller, duller part of their operations losing roughly 80% of its sales in the process. And that may actually be a good decision!
RBCN operates as a vertically integrated, advanced materials provider specializing in monocrystalline sapphire for applications in optical and industrial systems. They use their own proprietary crystal growth furnaces to grow high-purity, low-stress, ultra-low-defect-density sapphire crystals.
Anyone remotely acquainted with sapphire is by now asking: why are they not invested in the LED and mobile device markets? After all, these are the largest, most appellative markets for sapphire, right? Well, they were a few years back, now not so much.
Actually, RBCN's business had been highly exposed to these markets up until September 2016, when the company decided to head for the exit as the industry suffered with oversupply and corresponding low pricing environment caused by significant investment in sapphire production in China caused by the increased demand occurred with the widespread commercial usage of LED and the growth in the mobile device market.
This was not an easy decision as these markets accounted for roughly 80% of the company's revenues. The thing is that it also accounted for a huge chunk of their fixed costs and the high investments needed to keep this segment afloat started to weigh heavily on the bottom line. RBCN initially tried to stay in the LED substrate market by limiting their product offering to six-inch diameter wafers and working hard to reduce cost to make its product profitable, with limited success: the company was indeed able to reduce costs but the continual decline of prices made the prospects of becoming profitable unlikely for the foreseeable future.
In the past few months, RBCN has been working on rescaling their operations in accordance with the new focus on the optical and industrial sapphire markets and divesting in the LED and mobile device operations. As part of this new strategic focus, RBCN sold their patterning equipment for $4.5 M, closed their Malaysian plant and are currently attempting to sell the real estate and equipment located there.
Additionally, RBCN determined they had excess crystal growth and fabrication capacity domestically, which caused them to relocate into existing leased facilities and vacating their largest owned plant. An auction for the excess equipment in the now vacant plant is to be conducted and the plant itself - a special purpose facility with extensive enhancements to power and water-cooling systems required for crystal growth production - is also in the market.
All in all, the company is actively pursuing the sale of a 134,400 square foot manufacturing and office facility in Batavia, Illinois, a parcel of adjacent extra land and a 65,000 square foot facility in Penang, Malaysia.
So, what does this mean for the shareholder?
The assets listed for sale are currently held on the balance-sheet for $15 M, after an impairment charge of $14 M recorded last quarter following the management assessment of market value considering the impending sale, which gives us confidence on the figure. This should consist of roughly $10 M for the US assets and $5 M for the Malaysian facility.
Accruing to this will be the proceeds arising from the sale of the Malaysian asset portfolio and the excess U.S. assets, mostly machinery, to which we ascribe no value for the sake of prudence.
The actual proceeds from the sale of these assets is uncertain - they could go up or down depending on market conditions, urgency in selling and the fact that the facilities are highly specialized in nature -, as is the timing in which they will occur, although management expects the process to be wrapped-up by year-end 2017. By that time, RBCN's cash position should have almost doubled to around to $33 M, or $1.23 per share.
Ascribing zero value to the $11 M that RBCN has in inventories and receivables, and considering it has no debt and liabilities amounting to only $3 M, a liquidation scenario would easily reach $30 M, or $1.12 per share by year-end for shareholders.
The thing is that RBCN is not liquidating, which means we should put a value on the company as a going concern. To do this, it is important to make some additional considerations.
Going forward, RBCN's operations will consist almost exclusively of the sale of optical and industrial sapphire components. In the last three years, these operations contributed with the following revenue:
2016: $4.6 M
2015: $5.1 M
2014: $7.1 M
Since this will now be the main focus of the company, the company should be able to at least stop the downward trend on sales.
On the costs side, alongside the shutdown of their Malaysia operation and downsizing efforts conducted in the U.S., overall headcount was reduced from 220 in October 2016 to 40 in March 2017 and the company intends to start outsourcing certain finishing steps to third parties in order to reduce staffing, equipment and footprint. Although it is difficult as of now to forecast the impact these measures will have on the bottom line, it seems safe to say the company's cash-flow position will be greatly improved, which at the very least will limit cash burn.
The thing is that the new operating focus, although more lucrative, is very limited in its growth potential. As such, RBCN is also actively evaluating the acquisition of profitable companies both in and outside of the sapphire market in order to accelerate growth and to utilize their substantial net tax loss carry-forwards. We dear to say that these acquisitions will be a very important part of the future value of RBCN.
As of 31 December, they had roughly $59 M in NOL-related DTAs or $2.19 per share, which were subject to a valuation allowance against the whole amount. This means that, effectively, these are currently ghost assets in the balance sheet. It should be noted that the company decided to establish the allowance against these assets previously to the turnaround plan, in a time the company was still operating - and had no plans to exit - in the unprofitable LED and mobile devices markets. As such, the probability of future usage of these NOLs based on the company's historical - rather than its future - operating performance is now impaired by the change in business being carried out. If a use was to be found for these NOLs - an acquisition, for instance - these ghost assets would materialize (at least in part) and an instant asset boost would occur.
Since acquisitions are being given greater consideration, Timothy E. Brog was hired on March 16 as the new CEO and President of the company. The choice for the position is a very interesting one, considering the work he carried out in Peerless Systems - an imaging software company turned investment vehicle.
Mr. Brog started his career as an M&A attorney. In 1996 he founded and co-managed the Edward Andrews Group, a boutique investment bank focusing on M&A and corporate finance for small and micro-cap companies until 2004. He next worked at Pembridge Capital Management, a small-cap activist fund and in 2007 he founded Locksmith Capital Management LLC, where he continues to serve as President.
In 2010 he became the CEO of Peerless Systems - a company with limited operating activities since it had sold its core imaging business in 2008. At the helm of the company, Mr. Brog used the cash from the imaging business sale to buyback 80% of Peerless shares via a tender offer at $3.25 per share vs its then $3.00 per share market share price, causing the share count to drop from 16.6 M to 3.4 M. In subsequent years, share count was further reduced to 2.7 M.
In 2015 - roughly 4.5 years after taking over as CEO - Peerless was sold to LCV Capital Management for $7.00 per share in cash, which means that Mr. Brog as CEO of Peerless enabled a CAGR of around 20% for his shareholders.
At the helm of RBCN, his mandate is clear: to replicate the work he has done previously in Peerless. Both situations are remarkably similar - you can read about Peerless in 2013/2014 here and here - and though it is impossible to know in advance whether he can work his magic again or not, the cost of failure seems limited by the valuation relative to the balance sheet and management's efforts to stop the cash burn.
All things considered, we believe RBCN is still currently undervalued at $0.80 despite a 45% run-up in the last month. We believe RBCN is conservatively worth year-end cash of $1.12 per share - a 40% upside from current price - in the near-term and potentially somewhere in the $2 - $3 range in the longer term depending on execution on the turnaround strategy and the effective use of the cash and NOLs.
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