Bear Stearns: Emcore is leading company, convertible pays investors to wait for recovery

By Ronda Fears

Nashville, Tenn., Dec. 17 - Putting a buy recommendation on Emcore Corp.'s 5% convertible bond due 2006, Yaw Debrah, head of convertible research at Bear Stearns & Co., said in a report Monday that Emcore is strategically positioned as a technology leader in the compound semiconductor industry and its convertible's high yield pays investors nicely to wait for the recovery.

Debrah acknowledged the company has seen dramatic end-market demand weakening in 2001 and that the short to medium term revenue outlook for its products has been slashed significantly. But, he added: "We believe that with strong long-term fundamentals, the convertibles' 14.2% yield-to-maturity and 7.09% current yield pay an investor to wait until a recovery in the company's end markets becomes evident and there is an acceleration in the profitability of the company."

The positive view on the company, he said in the report, is based on Emcore's leading position in the provision of compound semiconductor devices, materials and equipment; broad product portfolio and potential growth of new product areas; backlog providing visibility to the company's short and medium term revenues; good liquidity position and low cash burn rate in 2002 compared to 2001; and an expectation of a recovery in the company's end markets starting in the second half of 2002.

The semiconductor business is in a slump, and despite a 77% rise in the company's revenues during fiscal 2001 to $185 million, Emcore has not been immune from slumping end market demand. This slump in demand culminated in fourth quarter revenue of $48 million showing a 9% decrease sequentially. More telling, the report said, the backlog of orders dropped from $140 million to $92 million. Revenues for the first fiscal quarter ended December are expected to be in the $20 million to $25 million range.

Emcore believes that the equipment business has bottomed and current orders are driven by technology buys, Debrah noted in the report. Customers are buying equipment for new R&D programs for tunable lasers in the optics side and higher productivity manufacturing on the LED side and order cancellations to date have been minimal.

For 2001, on a revenue base of $185 million, Emcore was $3.2 million EBITDA positive and EBITDA covered interest expense 0.9 times. Taking into account interest expense for the year of $3.7 million and capital expenditure of $89 million, the company generated negative free cash flow of $89.5 million. Financing was primarily in the form of the $175 million convertible, which was issued in May.

At Sept. 30, Emcore had $71 million in cash and cash equivalents and another $77 million in marketable securities after completion of the plants expansion. In total, the company had about $148 million in liquid funds. The debt of the company is essentially the $175 million convertible. With liquid funds of $147 million, major capital expenditure completed and no debt principal payments due until the maturity of the convertible in 2006, Debrah said the company has adequate liquidity to fund operations through 2002 while the semiconductor markets recover.

Management guidance for fiscal 2002 is for revenues to be flat in the range of $20 million to 25 million for the first two quarters, then ramping up to about $45 million by the end of the year. Average blended gross margin for the year is expected to be about 35% and the company is looking to spend roughly $40 million and $25 million in R&D and SG&A expense in the year.

Modeling these numbers, the Bear Stearns convertible research department estimates that Emcore will generate roughly $4 million in EBITDA. With estimated capital expenditures in the $5 million to $7 million range, interest expense for the year of about $9 million and modest cash generated from lower working capital needs, analysts estimate the company will burn through about $15 million of cash in the year. This is comfortably covered by the company's liquid funds of $148 million at the end of fiscal 2001, the report noted.

Bear Stearns semiconductor analyst Charles Boucher projects flat sequential revenue growth in first quarter 2002, 5% sequential revenue growth in second quarter and 15% sequential revenue growth in third and fourth quarters. This results in total revenue growth of 2% in 2002, slightly more conservative than the Semiconductor Industry Association estimate of 6% revenue growth, Debrah noted. Boucher expects a sharp recovery in 2003 driven by relatively easy comparisons, with revenue growth of 30% and unit growth of 20%. Boucher's second half 2002 and 2003 growth outlook assumes a robust economic recovery in the U.S. starting by about mid-2002, Debrah noted in the report.

Emcore 5% convertible due 2006

Issue size: $175 million, not rated

Convertible price: 70.50

Stock price: $13.27

Conversion premium: 159%

Conversion ratio: 20.5074

Conversion price: $48.763

Current Yield: 7.09%

YTM: 14.24%

Yield pick-up: 7.09%

Call: May 20, 2004, at 101.25

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