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Visiting Veeco

|Includes: Veeco Instruments Inc. (VECO)
Shares of Veeco Instruments (NASDAQ:VECO) got slammed this past week, falling more than 20% from peak to trough in three days. What was the reason for this decline...a downgrade from Buy to Hold from Citigroup. Citi dropped it's price target from $52 to $50, and the stock dropped from 50 to 40. This is shocking....someone takes investment advice from Citigroup?
Institutions, especially one with as inglorious a record as Citi, are notorious for issuing upgrades and downgrades at times that are least favorable for the public. There is also the question of their agenda, could they be downgrading in an effort to depress the price to assist some in purchasing (or covering) shares at a lower price? Almost 1/3 of the float of VECO is held short, so there are many who have an interest in seeing the share price decline. Citi did not disclose their positions in VECO. Furthermore, this is very old "news" Citi is regurgitating.
I have been in and out of VECO several times in the past year or so, and it has treated me well. I had relinquished all my shares in the past couple weeks, and took advantage of the drop in the latter part of this past week to start rebuilding a position.
Why is there such a large short interest in VECO? The biggest part of Veeco's business is the sale of their MOCVD machines to LED and solar cell manufacturers, based primarily in the Pacific Asia region. In China, there have been subsidies to manufacturing companies to help develop that industry in their region. The various Chinese subsidies are due to expire in mid 2011. For example, the Yangzhou Economic Development Zone provides a $1.5M subsidy for each machine purchased, which is due to expire on July 11, 2011. The argument is that the subsidies have done much to achieve their goal of helping a few Chinese LED companies develop, the installed base of tools is now sufficiently large enough, and the Chinese government will be less inclined to continue subsidies that go out of their country going forward. As a result, orders are being pulled into the quarters where purchases are subsidized, after that, revenue and earnings would drop significantly.
The subsidies are due to expire, but it is not yet known what policy will be put in place after that. As a result, earnings projections for Veeco are all over the map. On the high end, there are estimates above $6 for 2011. On the low end, if all the Chinese subsidies were eliminated by July, there are estimates as low as $3.50 for the worst case scenario.
My perception is that the market has priced in the worst possible result, the total elimination of subsidies, and the greatest resulting negative impact to VECO's earnings. Even if Veeco's earnings dropped to $3.50 next year, the stock is still selling for less than 12X next years doomsday estimate.
VECO's balance sheet is very clean, with a war chest of cash, almost $11/share in cash and ~$100M in debt, yielding a current ratio of 2.77.  Market cap is less than 2X sales and 3.1X book value.
The huge short interest in VECO is also attractive to me. Having been on the receiving of a few short squeezes in my life, I've seen what can happen to shares of technology companies when there is high short interest and any positive developments occur. Almost 1/3 of the VECO float is held short, which translates to an 8.4 days to cover value, an extremely high number. This saga is going to play out over the next couple years. VECO is volatile stock, with a beta of 2.87. I would take my advice from Bette Davis' character in All About Eve, "Fasten your seatbelt, it's going to be a bumpy night".
Disclosure: long VECO and trading shares