Stock Fools Love: FormFactor

FormFactor (Nasdaq: FORM)
Trading at $24.26 as of 2/9/05

This article is part of our annual Stocks Fools Love Valentine's Day special.

If your sweetheart is expecting a Valentine's Day card from you, wafer test probe cards probably aren't what he or she has in mind. But the rewards from an investment in FormFactor, the leading manufacturer of advanced probe cards, will last longer than any old box of chocolates or dozen roses will. Through semiconductor slumps and PC booms, FormFactor has been a steady performer.

Whether it resides in your computer, your cell phone, or your handheld PDA, every integrated circuit has to be tested to make sure it works right. As chips have become smaller, the complexity of the testing process has grown exponentially. Where it was once possible to use individual needles to probe and test chip function, the incredible shrinking chip has made it virtually impossible to cram any more needles into place. Enter the MicroSpring, FormFactor's proprietary invention. It's a custom-designed, micro-machined tool no bigger than a pencil point. It connects simultaneously across hundreds of chips with thousands of contacts and tests them in only a handful of "touchdowns." It is generations ahead of its rivals.

Founded more than a decade ago, FormFactor went public in 2003 and already is the market-share leader in the test probe card industry. Annual revenues grew 25% in 2003 and were on pace to double in 2004 before a contamination problem at a factory (soon to be decommissioned) caused a stumble at the end of last year. Even so, annual revenues should be up 80% this year, and with a new plant now online, FormFactor should again be operating true to form.

Yet the stumble has created opportunity. When FormFactor lowered fourth-quarter revenue and earnings estimates, the stock tumbled 28% from a 52-week high of $29 on December 3, to an intraday low of $20.95 after the news broke earlier this month. When Tom Engle and I recommended FormFactor for the Motley Fool Hidden Gems newsletter last July, it was trading at almost the same price, $20.85. So even as it's recovered somewhat in the intervening weeks and is up 16% from our recommended price, the stock still sits 16% off those highs and continues to earn our valuation of $36 to $40 three years out.

FormFactor's customers include some of the biggest names in the semiconductor industry: Intel (Nasdaq: INTC), Infineon (NYSE: IFX), Samsung, and Elpida Memory. Its primary market is the dynamic random access memory (DRAM) segment, but the company has been moving into the expanding flash-memory and flip-chip logic segments, too. Those area areas should provide growing revenues and market-share strength in the future.

The semiconductor industry is beginning a transition to smaller chips and bigger wafers from which to cut them. Even though analysts expect the industry to experience little to no growth this year, and perhaps even a decline, the migration to these new architectures is inexorable, and FormFactor is one of the few places that can make the probe cards necessary to test them. The chip suppliers must invest now to be able to supply the coming demand. So even though the semiconductor industry is considered quite cyclical, FormFactor has been able to weather the buffeting winds that hurt others.

The company is progressively more profitable each quarter. It has no debt and $66 million in cash, which it tapped into to build its new factory without saddling the company with debt. And, of course, it enjoys a commanding leadership position in the industry. Whispering "FormFactor" into your sweetheart's ear may not light the fires of romance, but the profit potential of this manufacturer of a disruptive technology should fill your heart -- and your portfolio -- with love.

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Fool contributor Rich Duprey considers a box of Krispy Kreme doughnuts and a six-pack of Coors Light to be a romantic dinner. He owns shares in FormFactor but doesn't own any of the other companies mentioned. The Motley Fool is investors writing for investors.