Cypress Semi Shares Harness SunPower

The company's stock has surged as investors start to notice its solar cell subsidiary.
By Chris Kraeuter ,

Shares of Cypress Semiconductor (CY) - Get Report are up almost 50% in the past five weeks and the primary driver is the chipmaker's SunPower subsidiary, which has been garnering increasing exposure as investors begin to notice its growth potential.

SunPower only accounts for a marginal portion of Cypress' revenue base, but the business is quickly showing it won't remain long under the shadow of its parent. The unit's results will be broken out separately from the overall company for the first time this quarter and the specter of an IPO looms on the horizon.

"SunPower is certainly not factored in to Cypress' stock price, but when it is, it

the stock price will be much higher," said Lehman Brothers analyst Ted Parmigiani.

SunPower makes silicon solar cells that transform sunlight into electricity and was bought by Cypress in 2002. It claims a technological and aesthetic advantage over its competitors because it makes all-black solar cells, which capture more light and look better than competing products. This matters because the primary buyers are residential customers.

Financially, the unit is still young. It runs only one production line and it generated revenue of $5 million in the fourth quarter. But sales are expected to double to $10 million this quarter and more than quintuple to between $27 million and $33 million in the next fourth quarter, according to SunPower CEO Tom Werner, who gave an investor presentation at the end of February.

During the next three years, SunPower has targeted a compound annual growth rate of more than 50%, which would result in 2008 sales of $225 million. The data points that Werner laid out for investors, however, reflect a more optimistic picture for SunPower.

Werner said a second production line will be installed in the third quarter and will ramp in the fourth quarter. A third line will be ready to go in early 2006 and line No. 4 is currently being planned.

Based on this timetable, with two full lines producing at or near full capacity, SunPower would be on track to generate around $150 million in sales in 2006. That figure grows closer to $200 million when partial sales are factored in from a third production line.

But Parmigiani said these targets are highly conservative. He predicted SunPower could hit $250 million in sales in 2006, with full capacity production on the second and third lines as early as the end of 2005. He sees four production lines exiting 2006 with an overall capacity utilization at 91%.

For 2006, Parmigiani estimated SunPower could contribute 31 cents a share of earnings to Cypress' bottom line, which has now been included in his earnings target for Cypress of 90 cents a share. (Lehman has received noninvestment banking revenue from Cypress in the past year.)

Analyst Erach Desai with American Technology Research is even more aggressive with his financial estimates, pegging Cypress earnings in 2006 without SunPower at 74 cents a share on sales of $1.05 billion. Including SunPower, he sees Cypress earning $1 a share on sales of $1.28 billion in 2006.

The consensus earnings target for 2006 on Wall Street is currently only 58 cents a share, so a substantial contribution from SunPower could significantly improve the investment outlook for current or potential shareholders.

That earnings addition could help steady Cypress shares, which have been a case study in the roller coaster that has characterized the networking, communications and computing industries in previous years. After peaking at $55 in mid-2000, Cypress plunged as low as $3.80 in late 2002. The shares climbed through 2003 to around $21 as business improved throughout the semiconductor industry, but those gains eroded last year and Cypress shares fell back to the single digits. Shares trended between $9.50 and $11 from November 2004 to January 2005.

In the middle of January, Cypress warned investors about its fourth-quarter financials a week before it was due to announce results, and it set a host of job and cost cuts.

On the belief that the worst was behind the company, and at initial hints of SunPower's potential, investors started moving back into the stock more aggressively as January drew to a close. Shares are now around $14.15, just off an eight-month high logged at the start of March.

But the company's valuation still looks to be in check. Taking Parmigiani's 2006 EPS target of 90 cents, which includes the 30-cent contribution from SunPower, Cypress currently trades at 15.7 times 2006 earnings. That's below the low end of where its P/E ratio has sat for the past year. His 2006 sales targets, including $250 million in revenue from SunPower, yield a price-to-sales ratio of 1.7, compared with a 12-month average multiple of 2.2 and a low multiple of 1.2.

Of course, for any new company, the ability to navigate rapid growth can be a concern. As Desai wrote in a recent research note, "The sum of the parts yields upside to present valuation, primarily on the SunPower potential ... The risk to the dramatic anticipated ramp of SunPower's revenue is not a demand-side concern, but more dependent on management's ability to ramp incremental production lines over the next two to six quarters." (AmTech doesn't conduct investment banking services.)

But Werner gave some assurances that the company was making progress. He said he hopes to announce a strategic partnership in the next month or two and is continuing to track well in its manufacturing process, tacking on roughly five to eight percentage points a week to its yields, which represent the number of functioning chips a production line produces. Traditional semiconductor companies target yields above 90%. Werner said it ended the previous quarter with yields around 60% and it currently is producing between 70% to 80%.

Another concern could ultimately be SunPower's ability to get the raw silicon it needs to make its cells, but Werner said this isn't a short-term issue as the company is still relatively small.

Whether SunPower positions itself for an eventual IPO remains to be seen, but investors who saw a turnaround opportunity in the Cypress' mid-January stock selloff are starting to see the light.

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