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2/20/2004
03:52 PM
William Schaff
William Schaff
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Taking Stock: Cabot Microelectronics Deserves Second Look

Its fundamentals seem significantly less cyclical than rivals'.

Where have all the cheap technology stocks gone? One could buy inexpensive stocks a year ago; now bargains are hard to come by, in my opinion.

Almost every sector of tech stocks has rallied, leaving interesting valuations only on those companies most investors believe have problems. Many of these stocks are controversial, and this often is reflected in the high short-interest ratio (i.e., investors betting that the stock will decline further) or in sharp increases or decreases in the stock price. Cabot Microelectronics is one of these stocks.

Cabot is a small, specialized player in the semiconductor capital-equipment arena. Most stocks in this sector have risen over the last 12 months, but not Cabot. The stock rallied nicely in the first half of 2003 but has since declined steadily from a high of $68.83 to the current level of $44 to $45.

Cabot provides polishing slurries to a process called chemical mechanical planarization. A semiconductor consists of multiple layers, and each layer has to be completely level before the next one is added. Chemical mechanical planarization achieves this by polishing the silicon wafer with a pad and a highly specialized slurry. The semiconductor industry increasingly has been moving toward this process and away from other methods because of the demand for more-precise products. The industry suffered a severe downturn in the past few years, but Cabot increased revenue every year as it became the leading provider of slurries for 130-nanometer semiconductor technology.

Stocks normally decline for a reason, and, in Cabot's case, there are several. The first relates to the company's competitiveness in 90-nanometer semiconductor technology. Only a few companies are making semiconductors with this narrow line width; most are still testing it. But initial competition for slurries for 90-nanometer technology may be greater than for 130 nanometer, leading to a potentially smaller market share for Cabot.

Another issue is the company's drop in gross margin during the last quarter to 48.8% from 50.7% in the previous quarter. Cabot blamed the drop on the tightening of tolerances demanded by customers, which led to cost overruns and costly expedited delivery. Management says the drop was an aberration and Cabot will be able to get gross margin back into the normal range of about 50%.

Cabot has had quite a bit of executive turnover in the past year. New CEO Bill Noglows was one of the company's founders. It also recently appointed a new CFO, head of research and development, and VP of corporate development, and is looking for a replacement for its VP of human resources.

Cabot's stock isn't cheap compared with other semiconductor capital-equipment companies, but it appears to be significantly less cyclical to me, which in my book warrants a premium. Relative to its own history, Cabot is trading at the cheaper end. However, with a short-interest ratio of 25%, some investors are betting management will fumble.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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