This article was highlighted for PRO+ subscribers, Seeking Alpha’s service for professional investors. Find out how you can get the best content on Seeking Alpha here.
Rubicon Technology (RBCN) has seen its financial results decline for years due to increasing competition in its industry, dragging the share price down with it. While the declining share price was completely rational, the company has adopted a new strategy since then. Management has been working for years scale down the old business, hoard cash, and look for new opportunities. It seems like not many are aware of the transition that Rubicon is going through, leading it to be severely undervalued.
Rubicon is a vertically integrated, advanced materials provider that is specialized in monocrystalline sapphire for applications in optical and industrial systems. After experiencing the increasingly negative effects of increased competition, management understood that it had to scale down its operations in the industry in order to survive.
In connection with the decision in 2016 to limit our focus to the optical and industrial sapphire markets and exit the LED market, we developed a plan to close our Malaysia facility, scale down and consolidate remaining operations in the U.S. and sell additional assets that would not be needed. We evaluated our U.S. and Malaysia asset portfolios to identify assets needed for our current business strategy and excess assets that were no longer needed. We determined we had excess machinery, equipment and facilities. Excess U.S. and Malaysia assets were evaluated based on assuming an orderly liquidation plan, which considers economic obsolescence and sales of comparable equipment, as it is our intention to sell these assets.
This plan would commence under Timothy Brog, who became CEO of the company in 2017 and had been on the board since 2016. The new CEO has experience in multiple fields, with some of the more important ones being the following:
Mr. Brog served as a Managing Director and portfolio manager to Locksmith Value Opportunity Fund LP from September 2007 to August 2010. He served as Managing Director of E2 Investment Partners LLC, a special purpose vehicle to invest in Peerless, from March 2007 to July 2008. Prior to his experience at Locksmith Capital and E2 Investment Partners, Mr. Brog was President of Pembridge Capital Management LLC and the portfolio manager of Pembridge Value Opportunity Fund LP, a deep value hedge fund, from June 2004 to September 2007.
His past as an activist will serve him and the shareholders of Rubicon well. Before Rubicon Technology, Brog was the CEO of Peerless Systems. The share price of Peerless Systems had fallen from its highs of over $8.40 in 2006 to $1.80 in 2008, the year that Timothy Borg became a board member. Just like with Rubicon, he became the CEO after a while. He was appointed in 2010 and managed to sell the company for $7,00 per share in 2015.
Part of the new CEO’s compensation comes on the back of RSU’s, stock rewards based on the performance of the shares. These are the ones that are still outstanding:
Source: DEF 14A
The RSUs vest in the amounts set forth below on the first date the 15-trading day average closing price of Rubicon Common Stock equals or exceeds the corresponding target price. These RSUs expire on March 15, 2021. Such rewards align the CEO’s incentive with that of the shareholders.
Thus far, the new CEO has been busy cutting costs and selling assets, which has resulted in a massive cash build and a cash flow that floats around the breakeven point since assets that cost money were sold. At the end of the last quarter, Rubicon had a cash position of $25.1 mln, up from $17.7 mln at the end of 2016. Total liabilities have been brought back to $1.2 mln from $2.6 mln during the same period.
After the last quarterly earnings were released, another asset sale was announced. An asset in Malaysia that was held for sale on the balance sheet at a valuation of $4.1 mln, has been sold for net proceeds of $4.5 mln, a better result than expected. This also brings the total cash position to $29.6 mln, or a net cash position of $28.4 mln if we subtract all liabilities.
At the same time, management has been able to bring costs down thus far, that the cash flow has only been slightly negative. About -$0.4 mln in cash was burned over the last twelve months, while free cash flow was -$0.1 mln. That being said, management has already been putting its cash to good use by purchasing back their own shares as it spent $0.6 mln during the same period to repurchase shares. So without spending money to increase shareholder value, cash flow would have been slightly positive.
Further share repurchases are expected. The company currently holds around 8.4% of all outstanding shares but announced a $3 mln share repurchase program in November of 2018 that runs until November 2021, of which it has not even used $1 mln so far.
With a market cap of $23.5 mln and taking into account the latest announced acquisition, Rubicon trades at a P/B value of 0.7 with a P/C ratio of 0.8 despite not having a cash burn at the moment, no debt, and almost no liabilities.
It is safe to say that the business is currently quite stable with a strong balance sheet that provides both safety and opportunity. The next step would be to look for ways to grow the business again, which management has already started doing. In May of 2019, Rubicon acquired certain equipment and assets from a large pharmacy operation.
Rubicon Technology, Inc. (Nasdaq: RBCN) announced today it has acquired certain equipment and assets from a large Indiana based pharmacy operation, including its licenses to operate in 11 states. In addition to the acquired assets, Rubicon hired their highly skilled employees and was able to maintain the necessary licenses to continue to operate the pharmacy operations. Rubicon DTP LLC, a newly formed wholly owned subsidiary of Rubicon Technology, will primarily operate this business under the name Direct Dose Rx.
Direct Dose Rx will focus on delivering prescription medication, vitamins, and over-the-counter drugs to retail customers, skilled nursing facilities, and hospitals for patients that are being discharged. Rubicon has a contingent liability which size depends on the amount of revenue it reports within a set time or whether Rubicon itself will be sold, and if so, for how much. You can find the specifics here, under 2.5. The transaction itself was “ not material to its financial statements.”
Direct Dose Rx’ business is something entirely different compared to Rubicon’s original business model, about which the CEO commented the following:
Although this type of transaction was not exactly what Rubicon was looking for, the low risk and high rewards of this investment are compelling.
Exactly when the company expects this deal to pay off remains unclear for now as Rubicon is still in the process of negotiating agreements with drug wholesalers, applying for licenses with pharmacy benefit management companies and renewing/creating partnerships with skilled nursing facilities. But it is worth noting that Rubicon has plenty of NOL carryforwards in case the newly acquired business, or one that is yet to be acquired, turns profitable in the not too distant future.
At December 31, 2018, we had separate Federal and Illinois NOL carryforwards of $181.1 million and $195.0 million, respectively, which begin to expire in 2021 and 2020, respectively.
The one real risk associated with investing in Rubicon is that the massive cash pile will be used for the wrong purposes such as spending a lot of cash on bad investments, for example. But considering the CEO’s background in the investment market and his previous experience as a CEO, he should be able to determine how to improve the business without taking on much risk.
One other risk to keep in mind when looking at this stock is the lack of liquidity. Rubicon is undercovered and has thin order books. This poses certain risks. Make sure you understand and accept these risks before you open a position.
Stocks that trade with a discount to both P/B and P/C ratios usually have either terrible balance sheets or a high cash burn. Neither one is the case with Rubicon. The initial downfall that the stock has seen over the years was justified. But the current valuation is the effect of people failing to understand or notice the transition that the company is making and what potential it has.
It really comes down to the fact that this is a low risk, high potential reward play. The cash and book value offer shareholders enough value for downside protection while management looks for ways to drive growth again. Slightly positive news regarding a new business like Direct Dose Rx could cause a stock like this to surge due to the extremely low valuation, for example. Should the shares rise to merely its cash level, which is still extremely low, there would be a 25% upside from the current levels. Although I believe that a lot more upside can be expected once any form of success is reported. Therefore I am long Rubicon.
Disclosure: I am/we are long RBCN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.