Friday, November 17, 2006

Calls of Note Part 2

- Friedman, Billings, Ramsey comments on MEMC Electronic Materials (NYSE:WFR) following checks with distributors, competitors and customers that suggest strong near term biz trends, primarily driven by: 1) selling excess poly into the spot market with spot prices at >$250/kg (vs. contract prices ~$85/kg); 2)200mm wafer prices up 1%-3% QOQ; 3) strong demand by memory customers.

However, checks also support our more cautious stance on WFR's LT growth prospects, driven by: 1) larger than expected industry wide poly capacity in CY07; 2) semi wafer customers currently receiving better longer-term contracts from Japanese competitors; 3) consistent with firm's thesis, Japanese competitors acquiring a number of Epi reactors in 4Q06 as they accelerate semi wafer capacity ramps (this factor alone helping them to secure longer term semi wafer contracts); 4) Epi wafer demand expected to grow faster in CY07 due to migration to sub 90nm (b/c Epi wafers have higher yields); 5) Japanese competitors estimated to have > 65% Epi market share.

Net/net, data points so far in 4Q06 suggest that WFR is on track to meet/exceed firm's estimates. However, industry contacts/data points also suggest that WFR's market share in semi wafer is increasingly at risk given competitors' capacity increases and its current willingness to offer customers attractive LT contracts.

- Cowen believes Suntech (NYSE:STP) traded down yesterday on concerns about Q3 results, specifically lower gross margins (due to higher wafer costs) and less-than-expected revenue contribution from the MSK acquisition (as it is just being integrated). Each of these is plausible, but, in firm's view, the downside risk to Q3 St. EPS is limited, and they expect sequential improvement from Q4 onward. Firm recommends investors use the pullback as an entry point.

Firm believes wafer volumes were already committed earlier, but higher prices set in Q3 may cause gross margin for the base growth business to be below expectations (firm has modeled 28.0%). And, with the mix of MSK revenue (at 10%E GM) blended margin could be lower than firm's estimate of about 25%. However, as in Q2, higher volume may be an offset. And, wafer prices should begin to ease in Q4.

Two recently announced, 5-year wafer supply contracts ($180MM with REC and $475-580MM with a Chinese supplier), plus the 10-year deal with MEMC, should reduce wafer costs from Q1:07 (up to 10%). This should offset ASP declines. Therefore, expected improvements in conversion efficiency from the new semiconductor groove process could boost margins.

Notablecalls: Two firm's telling essentially the same story from two perspectives. Not actionable but good to know category.

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