I initially wrote up Jazz Technologies (JAZ) roughly nine months ago. At that time, the stock was at $3.90/shr.  Today it trades at $1.40/shr, having lost 2/3 of its value in the interim period.  This loss has occurred despite marked improvements in the company’s operational and financial profile.  Today, JAZ can be purchased for run-rate multiples of 0.7x revs, 7x economic EBIT and <5x EBITDA.  The company’s financial performance continues to improve, so these multiples should come down on a go-forward basis.  JAZ currently has a run-rate free cash flow yield of nearly 25%, and enough NOLs to shield income for the foreseeable future.  The business today trades at just 45% of book value; book value that, importantly, contains no goodwill.

 

I refer you back to the original write-up for a more detailed description of the company’s history, business, and management team.  In short, JAZ was formed as a SPAC and subsequently purchased a Newport Beach-based fab facility that makes specialty mixed analog/digital semiconductors.  The company is headed by former senior execs from Apple.  The company’s IP is solid; only IBM holds a similar IP portfolio in the mixed analog/digital space.  Primary end markets include power management and wireless. 

 

Since 1Q 2007, JAZ has increased quarterly revenue from $48mm to $55mm (+15%).  The company has gone from generating negative EBITDA during its first quarter following closure of the deal (1Q 2007) to $7.8mm in EBITDA in 3Q 2007 (15% EBITDA margin; this excludes gains on convert repurchases booked during the quarter).  Free cash flow has moved from negative $12mm to positive $1.7mm in 3Q 2007.  Utilization, which hit a low in 2Q 2007, has moved from 56% to 93%.  Effectively, management has brought the company back to run-rate revenue and EBITDA levels in-line with what were formerly viewed as peak levels, with incremental manufacturing capacity still remaining to drive further upside.

 

With respect to capitalization, management has been extremely aggressive with respect to reducing equity capitalization.  Management has repurchased 8.5mm shrs (off an original base of 27mm shrs) and 25.1mm warrants since closing the transaction.  In addition, several million dollars of converts have been repurchased for roughly $0.70 on the dollar.  Virtually all excess cash remaining following closure of the deal, as well as all free cash generated in the interim, has been used to reduce equity capitalization and potential dilution.  The company has a $65mm revolver that carries virtually no covenants.

 

Stock performance has obviously been terrible.  I believe that this is in large part a function of the company’s origins as a SPAC.  Through year-end 2006 most SPACs traded up, at least modestly, following closure of their respective transactions.  2007 was the opposite.  As deals became more contentious and management teams had to resort to more arm twisting to get deals closed, SPAC stocks consistently began to trade off following closure of the deals as a increasing percentage non-natural holders ended up owning stock going into the vote.  JAZ was one of the first names to begin demonstrating this behavior following closure of its fab purchase in Feb 2007.  Compounding this effect was an ugly first quarter of operating results posted by the company due to a short-lived inventory correction.  The transition from traditional SPAC investors to tech- and semiconductor-oriented investors has been slow and painful for existing shareholders of JAZ.  In addition, as the dollar value of the stock dropped and various holders of JAZ had less portfolio exposure to the name, it became a favorite for year-end tax loss selling.  For example, on Dec 14 a large holder of JAZ units (units are a combination of one share of stock and one warrant) blew out of a 1mm unit block at a price roughly 30% below last trade.

 

The company’s SPAC legacy has also been responsible for another overhang – the sale of material amounts of shares by CEO Gil Amelio.  In order to get the initial deal approved by shareholders Amelio borrowed a substantial amount of capital thru an external entity in order to purchase shares from dissenting shareholders.  He borrowed the capital from a hedge fund at a high interest rate, and has sold two large blocks of stock back to the company in order to get himself out from under the existing loans.  It is obviously never comforting to see management selling shares, but the circumstances around these particular sales alleviate my concern to a large degree.  Both Gil and CFO Pittman have always been upfront about Gil’s intention to personally delever, and the sales have from my perspective had the silver lining of allowing the company to find large blocks of stock that wouldn’t otherwise be available.  Gil remains the company’s largest shareholder by a wide margin.

 

Last week, JAZ preannounced 4^th quarter numbers.  Revenue is expected to be at the high end of the originally guided range ($53-$55mm), and utilization rates continue to improve.  JAZ continues to gather new mandates for additional customer programs.

 

JAZ management has been working feverishly to purchase a 2^nd fab.  Management’s goal is to purchase a 2^nd generation Asian-based fab for $100-$200mm.  Doing so will allow it to leverage its IP on a much broader scale.  There are numerous large customers who refuse to do business with a sole-sourced supplier and, moreover, addition of an Asian-based fab would materially improve JAZ’s cost profile.  I believe that management’s operating execution, customer wins, and cost cutting performance to-date instill a high degree of confidence that they have the ability to execute successfully on this initiative.  The purchase of a 2^nd fab is something of a double-edged sword from a stock perspective.  On the one hand, purchase of the fab should be a major catalyst for the stock, as well as having the potential to be hugely accretive to value.  On the other hand, it is highly likely that there will be an equity component to whatever financing plan is used to purchase the fab, and equity issues at current levels have the potential to be highly dilutive.  There are a number of levers the company can pull to reduce this dilution, but it would be naïve to assume that there won’t be materially more dilution pain with the stock at $1.50/shr than there would be were the stock at $3.00/shr.

 

On the 3^rd quarter 2007 conference call, management announced that it was in advanced negotiations for a fab.  As a result, the company’s general counsel decreed that it could no longer be in the open market purchasing stock as knowledge of the details of the negotiations constituted material non-public information.  While the company continued to repurchase converts and buy blocks of shares back from institutional holders, its absence from the open market has removed an important floor under the stock.  This situation will not persist indefinitely and, given the relatively modest trading volumes, the company’s return to the open market could have a material beneficial effect on trading prices.

 

In the original write-up I laid out several valuation scenarios – all of which have material upside.  I will not focus as much time in this write-up on valuation, as there are numerous moving pieces that may impact any individual’s assessment of intrinsic value.  Suffice it to say that I believe that the stock is a multiple bagger from here on the existing fab alone.   Financing of the new fab is a giant wild card that has the ability to swing theoretical valuation around markedly, so I will point you back to my original write-up for a few scenarios with respect to how things could play out.  Notwithstanding short term movements in the stock, I think it is unlikely that you lose significant capital here on a business accreting cash at 25% to equity with ample liquidity, a strong management team, improving utilization, and great IP.