Calls of Note Part 3

Citigroup's Timothy M Arcuri is calling KLA-Tencor (NASDAQ:KLAC) top idea for new money (by wide margin) due to: 1) closure of options issue (potentially by month-end), 2) big internal restructuring that should boost margins, and 3) big upside to C2007 EPS. Firm's new sensitivity analysis suggests KLAC's C2007 EPS has upside to ~$3.85 (including ~$1.5B stock buyback). This is ~25% upside to their estimate and ~60% upside to consensus.

Firm's two key investment thesis are: 1) big internal restructuring that should boost margins and 2) potential for big EPS accretion driven by a large recapitalization/share buyback.

For the first part of analysis, firm models various upside scenarios for KLAC's C2007 revenue line. Historically, firm's analysis shows that the ratio of the average of 2Qs of KLAC's bookings (annualized) divided by forward 12-mo revenues results in a bookings to sales metric of roughly 0.925. Applying this historical average to their bookings for KLAC's Sept and Dec Q bookings, firm arrives at an estimate for C2007 revenue. Additionally, if we assume that Sept and Dec Q orders are collectively flat compared to June Q (currently firm models down 5-7%) and apply a similar bookings to sales metric, their analysis drives an additional ~$100MM of revenue. According to the firm, this analysis suggests KLAC's potential EPS accretion, solely from restructuring, ranges from ~$0.60-0.70 per share.

For the second part of their analysis, firm assesses the potential impact on EPS from a big recapitalization -- a likely scenario, in their view, given KLAC's overcapitalized balance sheet affords it flexibility in levering up to execute a large share buyback. In addition to the debt-financed share buyback, firm assumes KLAC will buy back additional shares financed by its existing cash balance as well.

Combining the two portions of their sensitivity analysis, firm summarizes two upside case scenarios. This analysis suggests KLAC's C2007 EPS has upside to ~$3.85, or ~25% upside to firm's estimate and ~60% upside to consensus.

Notablecalls: Citi is really pounding the table on KLAC. 60% upside to consensus? Nice way to catch some attention, Timothy. Expecting to see interest in the shares.