Form Factor Appears Deeply Discounted

Stock Black Book’s idea this month is one of those rare opportunities to buy a company that is discounted so deeply you get almost as much cash in the bank as the company is worth. This limits the down side risk assuming it continues to deliver positive free cash flow [FCF], which it has done the past three years in a row. The part that is even better is they have no debt so you get to keep all the cash. Sound too good to be true, well it’s not. This is the great part about a cyclical business like semiconductors. When the market is angry investors have a huge opportunity to take a relatively low risk investment. Last month I brought to your attention a well run company with a large amount of debt. This month I decided to discuss the opposite extreme.

Company Profile

Form Factor (FORM) designs, develops, manufactures, sells and supports high performance advanced semi conductor wafer probe cards. This is an industry I am very familiar with and will help show you the value proposition that a company like FORM has to offer to their customers. FORM has a proprietary microspring technology that allows their customers to buy leading edge advanced technology to test full silicon wafers in the DRAM and Flash markets. DRAM and Flash are both crucial memory products that are part of the bill of materials for items like computers, cell phones, iPods, digital cameras and many other consumer electronics. DRAM currently makes up 70% of their revenue, Flash is 18% and Logic is 12%. This is a critical test for semiconductor companies as it allows them to sort good die (product) from bad die to avoid adding more value to a bad product (i.e. throwing money away). This would be like checking to see if a loaf of bread is moldy before adding all the meats, cheese, vegetables and condiments so you avoid wasting food. The die is expensive, but the value added later by packaging it, testing it and stacking it with other working die can be very costly and significantly erode margins if not caught early in the manufacturing process. FORM makes every probe card custom for every customer and each product a customer manufactures. This is a very specialized high margin business used to make commodities that produce relatively lower margins.