Sterne Agee initiated coverage of Rubicon Technology (NASD: RBCN) with a Sell rating today and agreed with my thesis. If you recall, I inverted in my analysis to arrive at the growth rate necessary to bring RBCN’s price-to-fundamentals in line with larger, more-established chip makers. I wrote that because of competition, RBCN could not maintain the growth rate and margins that justified its then-current stock price.
For those using valuation as an argument to buy the shares, we believe current estimates do not adequately reflect gross margin pressure which will arise as new capacity comes on line. We are therefore modeling a steep drop-off in gross margin, exiting 2010 at 62%, 2011 at 30%, and 2012 at 22%. Using a 20X multiple on our calendar 2012 trough EPS of $0.50 implies a $10 target price. Should gross margins return to single-digits, then a stock price below $10 would not be out of the question.
Sterne Agee’s price target is almost exactly the price that I wrote could be RBCN’s low. It has already blown through my 25% drop best-case scenario since I covered. As I write this, RBCN has dropped 30% since I covered.
The short was a success for us, but could have been better had our stock borrowing costs not shot up. The rising borrowing cost forced us to cover the short because the risk-reward trade off was no longer overwhelmingly in favor of maintaining the position.