While other chip stocks have risen dramatically this year, analog-chip maker

Sipex

(SIPX)

has soared higher, its stock up 185% to $10.53 as of Thursday's close. That beats even the stunning 82% rise of the benchmark Philadelphia Stock Exchange Semiconductor Index.

Yet much of the demand that's propelled Sipex shares has come from an unlikely buyer -- the same investment outfit that also owns Sipex's biggest customer, the privately held Canadian chip distributor Future Electronics. The private investment company, called Alonim Investments, now owns about 35% of Sipex, assuming the exercise of promissory notes and a warrant.

The highly unusual links between supplier and customer -- with both companies tied to the same investor -- has at the very least caused some head-scratching among outsiders. Critics say the setup could give Future Electronics an incentive to make Sipex's sales appear better than they really are.

Some investors shrug off the worries, speculating that Alonim is poised to buy Sipex outright and offer further upside for the shares of the Milpitas, Calif.-based company, which has a market cap of about $283 million.

For its part, Sipex says the close links with Future Electronics have been key in helping it engineer a turnaround over the past year. "This company was practically bankrupt, on the verge of bankruptcy, and myself and people from Future have put this company back together," says Sipex CEO Walid Maghribi. "This relationship has only been very positive for shareholders of this company."

But others say the relationship could get Sipex into trouble, paving the way for the stock price to tumble. Accounting experts say the very nature of the arrangement should elicit concern. "There are red flags all over this, and it starts with the conflict of interest between Alonim and Sipex," says Charles Mulford, an accounting professor at Georgia Tech.

Both Sipex and its largest customer have been troubled by accounting problems in the past. While no one alleges that Sipex, Alonim or Future are currently involved in any wrongdoing, one hedge fund analyst whose firm is shorting the stock says he's "never seen an arrangement like this."

"There's a natural incentive on Future's side to overstate Sipex's real business so it can personally profit," says the analyst, who asked to remain nameless. Future, a Canadian components distributor with an estimated $2.6 billion in sales, accounted for nearly one-third of Sipex revenue through the first half of 2003.

Sipex CFO Phil Kagel says, "We comply with all

SEC

reporting disclosure requirements so

the relationship shouldn't concern anyone because we make sure that the business relationships are disclosed fairly."

Accounting Issues

Sipex was dinged for sloppy accounting in its most recent financial year. Accounting firm KPMG found fault with "material weaknesses" at Sipex during its fiscal-year 2002 audit, citing its inventory bookkeeping among other worries.

Sipex has since pledged to clean up its accounting. It brought on a new CFO, added an independent board member to chair an audit committee, and promised to improve its inventory control system.

Despite those reforms, KPMG resigned from the Sipex account in June 2003. (It's since been replaced by Deloitte & Touche.)

"For KPMG to walk away in the middle of the year is very odd," says Todd Fernandez, an analyst for Glass Lewis & Co., a research firm that advises institutional investors on proxies and corporate governance issues. "In these types of situations, it is common that an auditor will walk away from an account if it's considered high risk or if the previous deficiencies pointed out have not been rectified."

Maghribi says the switch was a natural outcome of Sipex's move from Massachusetts to Silicon Valley last year. "It was appropriate for everything to change that was associated with the old regime," he says.

Even assuming for a moment that Sipex has since become a model of accounting propriety, there's another concern: Future Electronics was previously accused of accounting irregularities.

In 1999, Future Electronics came under a three-year investigation by the Department of Justice, which alleged it had bilked customers such as

Motorola

and

Texas Instruments

out of an estimated $100 million a year by manipulating sales and inventory accounts.

The case was ultimately dropped without charges being filed.

Others say Future's history is hard to ignore. "Future and their previous problems with inventory management and possible channel-stuffing should heighten concern, not only about Sipex's internal controls and ability to properly account for inventory but in general the whole supply and distribution chain from Sipex to the end customers, with Future in the middle," says Fernandez.

For its part, Sipex adopted a revenue recognition policy in late 2000 that aims to dispel concerns that it might somehow overstate revenue. It doesn't recognize any sales on chips sold to Future until the distributor, in turn, sells the products to its end customer.

Because of the policy, "there's no way for them to manipulate anything," asserts Maghribi. "Their sales have been very, very controlled by us because we don't want to build inventory, because sooner or later they may want to return it." He says Sipex receives regular reports on how Future's products are selling, which it uses to monitor inventory and "make sure there's no hanky-panky going on."

"There's not a lot of room for funny business in that relationship," maintains Todd Cooper, an analyst for Stephens who has an overweight rating on Sipex. He says this "sell-through" revenue recognition policy mitigates any concerns he might have about close ties between Sipex and Future. His firm hasn't done banking for the company.

Future did not respond to requests for comment.

Turnaround and Takeover?

To be sure, some onlookers cast Sipex as a turnaround story, and a buy-side investor who declined to be named said he likes Sipex partly because he thinks there's a decent chance Future will eventually purchase all of it.

Sipex has an agreement that limits Alonim's ownership stake to 35%, but one corporate governance expert says if Alonim made a generous bid, the company would likely have a fiduciary duty to accept.

In any case, two analysts dispute the takeover scenario, saying Future would risk alienating its other chipmaker customers if it bought Sipex. And Future's annual sales -- estimated at $2.6 billion -- would seem to be more valuable than those of Sipex, with a mere $66.3 million in 2002 sales.

Leaving aside the likelihood of a Sipex takeover, it's true that fundamentals are improving at the company. Bulls point out it has exited some of its legacy products and is investing in new kinds of chips, while on the financial side it's managed to narrow losses dramatically from 75 cents in the year-ago third quarter to 7 cents in the just-ended period.

The buy-side investor says he thinks highly of the CEO Maghribi, who he says "has done a remarkable job in turning around the company." Cooper points out that within a year, Sipex has hoisted gross margins from -28% to 29%. His firm hasn't done banking for Sipex.

Yet even if a turnaround is under way at Sipex, business looks relatively lousy compared to its peers.

While most other chipmakers are finally reporting double-digit growth, on October 30 Sipex said its third-quarter year-on-year sales stayed flat at $16.5 million. After posting its 12th consecutive quarterly loss, the company ventured that it might show a profit in the first half of next year.

"Right now is the strongest seasonal time anybody has seen in the whole downturn and these guys can only guide flattish," says the analyst shorting the stock. "If things seasonally turn down, they'll run out of cash at the current burn rate in about five quarters."

Involved Owners

Despite its uncertain outlook and some past accounting troubles, some argue that Sipex is a bad candidate to short, simply because of the heavy buying by Alonim.

Alonim Investments, headed by Robert Miller, now directly owns about 8.1 million shares of Sipex common stock out of a current share count of around 28 million, and it stands to accumulate millions more shares over the next few years through the exercise of convertible notes and a warrant (though its stake is capped at 35%).

And it can't easily exit those investments. Sipex has struck an agreement under which Future/Alonim can't sell more than a certain percent of its shares a year over the next four years. If it sells more than the agreed-upon amount, it will be penalized by being forced to give up half its profits on the incremental sales. "They have to get our approval," says Maghribi. "They are in for the very, very long-term."

Moreover, Alonim's Robert Miller isn't the only one who's buying: his family members are also getting a cut of the action. Son Rodney Miller, an employee of Future Electronics, is so optimistic on Sipex's prospects that's he's used a line of credit with broker CIBC Wood Gundy to help finance his purchase of 200,000 shares (accounting for about 0.71% of common stock outstanding).

And Robert Miller's wife Margaret has purchased another 100,000 shares using the working capital of her advertising company, Quebec-based MJM Capital.

With those presumably in the know betting in favor of Sipex, it's tough to make a straightforward case for shorting the stock.

Yet it's also hard to overlook the odd triangle among Alonim, Future and Sipex, which more than one analyst has described as "mutual back-scratching." Against the backdrop of Sipex's outsized stock gains, that should be more than enough to make investors tread lightly.