FormFactor Looks Like Tough Sell

Shares of chip production equipment maker FormFactor are sitting at all-time lows but even at these depressed levels a takeout would be a tough sell.
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NEW YORK (

TheStreet

) -- With technology M&A all the rage and its valuation near all-time lows, the chances of chip production equipment maker

FormFactor

(FORM) - Get Report

ending up in play may have gotten a slight boost, but they still don't look very good.

The stock got a genial 3.4% lift to $6.95 on Thursday after an upgrade from Goldman Sachs. The firm went to neutral from sell, citing the company's cash balance of nearly $400 million, or $7.91 per share, as the overriding reason. But analyst James Covello also said an acquisition of the Livermore, Calif.-based company is "more likely" at these levels.

"

With the stock now trading at cash, even assuming continued losses in 2011, and the enterprise value turning negative, we believe incremental downside in the shares is limited," he said in a research note. "Further, we believe that the current valuation makes FORM a more attractive takeout candidate given our view that it still has good underlying technology with leading market share in the advanced probe card market."

While the prospect of a buyout probably sounds great to anyone getting into the stock now, the premium would have to be a stunner for the majority of investors who built a position in the past few years and held it. The shares hit historical highs above $47 in August 2006, and held above $40 into October 2007, but it's mostly been downhill from there.

In just the past 52 weeks, FormFactor shares are down almost 70%. The company, whose products are used by semiconductor companies to electrically test their chips, has racked up losses in 10 straight quarters and seen its annual revenue fall from $462 million in 2007 to $135.3 million in fiscal 2009. Wall Street is currently forecasting a loss of $2.30 a share for fiscal 2010 with revenue projected at $205 million.

By the time the latest setback came earlier this week -- a lower revenue outlook for the third quarter to between $46 million and $48 million from a prior view of the low-to-mid $50 millions -- the damage was already done as the stock had declined nine of the 12 sessions prior to the August 31 announcement, and shed a mere nickel on the actual news.

And therein lies one of the major obstacles for any potential deal: The valuation is so completely washed out, the current management team, which took the reins in late May, would be hard-pressed to get a decent price; especially considering the timing of turning a profit again is uncertain. The other problem is that an acquirer trying to snap up FormFactor on the cheap would have its work cut out for it, and might see a backlash in its own share price.

"You can never completely discount the potential for a deal," said analyst Patrick Ho of Stifel Nicolaus, which makes a market in FormFactor, in a phone interview with

TheStreet

. "But it takes two to tango. I don't think they

FormFactor's management are willing to sell, and any company looking to take them out would have to be very bold because they would be taking on all the heavy lifting."

Ho has been a bear on FormFactor for a long while. He currently has a hold rating on the stock, and has been at sell or hold for roughly four years. He was sharply critical of the past two management teams, but is more optimistic about the new group -- CEO Carl Everett and CFO Richard DeLateur -- who have both spent parts of their careers at chip giant

Intel

(INTC) - Get Report

.

"These guys give me some confidence," he said. "You know they've been in big battles before." Ho believes it will take 12-18 months to turn FormFactor around as management needs to "fundamentally repair the business model" because of the damage caused by previous management, who dropped prices too aggressively.

Ho expects the company's cash will give Everett and DeLateur a chance to right the ship.

"They have enough to keep off the vultures," he said, projecting cash burn through the end of 2010 will be between $55 million and $60 million. "Right now there's no reason for FormFactor to give away their IP

intellectual property."

At the same time, there may also be very little reason to buy the stock until there's evidence of progress in the turnaround. Goldman's Covello set a six-month price target of $6 on the stock even as he upgraded it, implying downside of another 14% from here.

--

Written by Michael Baron in New York.

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