6 Reasons to Love Rambus

Yesterday I wrote about Southwest Airlines (NYSE: LUV  ) . My inability to love paying 32 times earnings for a slow growth company with a 6.7% return on equity (ROE) -- operating in the highly contested discount airline industry -- generated a lot of mail that read, "You don't understand how to value stocks."

LUV lovers are going to convulse when they see a loving look at memory pioneer Rambus (Nasdaq: RMBS  ) -- selling at a lofty 12 times sales.

Didn't Rambus soar after the dismissal of an FTC case in February, yet it sells for less than half that price today? Yep, it's the same company, and it is still chasing Infineon (NYSE: IFX  ) , Micron (NYSE: MU  ) , and others in court to collect past and future royalty fees. So, why love Rambus?

Reason #1: Third-quarter results were fantastic. Revenues increased 36%. Royalties (79% of sales) were up 24%, and contract revenue (21% of sales) jumped 107%.

Reason #2: Earnings increased 54% from last year's third quarter (excluding the favorable effect from a lower tax rate). Operating margins increased from 22.4% last year to 27.5% -- handily beating the less than 6% margins at competitors Infineon and Micron.

Reason #3: What a balance sheet! No debt and $219 million in cash, cash equivalents, and marketable securities.

Reason #4: Look at the snapshot of the company's performance. Return on equity (ROE) is a strong 14.3%. Although the earnings multiple, with today's price rise, is over 60, consider that earnings are growing strongly. Based on analyst estimates for 2005, the stock is currently trading for 40 times 2005 earnings -- and analysts' expectations were exceeded this quarter for both revenue and earnings.

Reason #5: The future looks bright. From new Dynamic Point-to-Point (DPP) technology to turning recently purchased Cadence Design System (NYSE: CDN  ) serial link patents into contracts, the company's technology position is strong.

Reason #6: Day to day, companies such as Intel (Nasdaq: INTC  ) and Hitachi (NYSE: HIT  ) pay royalties to Rambus. If Rambus wins its Infineon suit, it is estimated that $40 million in high-margin royalty income will flow annually to Rambus (not including payment for legal fees and past royalties). Although court outcomes are unpredictable, and it may be years before a final settlement is reach, this is icing on an already impressive cake.

Summary: Before adding this up and saying "Rambus is a sure thing," realize that royalties follow memory market prices. When memory prices fall, Rambus' earnings fall, and they fall hard.

The stock is down almost 45% over the last 52 weeks -- making the valuation more closely reflect future business prospects (reasons 1 though 5) than what might happen if the courts rule in its favor (reason 6). Add it all up, and there is a lot of love with Rambus.

Fool contributor W.D. Crotty does not own stock in any of the companies mentioned.

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