TowerJazz Initiated: Outperform

TowerJazz is a pure-play semiconductor wafer foundry with two IC plants in Israel and one in California that manufacture SiGe, MEMS, RF, embedded flash-based memory, analog/mixed-signal, and CMOS image-sensor devices.

Revenue for the third quarter reached an all-time high and December guidance is for 26% sequential growth on the top-line against an industry average growth of 4%.

Tower Semiconductor (TSEM: 1.72 0.00 0.00%) appears to be hitting its stride as the firm has solidified itself in the specialty semiconductor area. Tower’s designs are typically more complex than the manufacture of standard technology. This has the effect of drawing industry leading customers to the firm and makes it harder for them to leave for the competition. We initiate with an outperform rating.
 
We feel TowerJazz should outpace its foundry competitors as well as the overall semiconductor industry in 2010. Specialty foundry enjoys higher margins and is less susceptible to industry downturns. In addition the firm is out in front on several industry leading technologies such as HPA, Power, and optical. The Tower and Jazz merger was completed at a time when the rest of the industry was struggling to survive. The balance sheet is a source of strength which likely sets up the firm for further growth activity in the future.
 
The recent capacity expansion is a clear sign that solid demand from customers has returned. We value the firm based on a price to earnings multiple of 6.8x FY 2010 EPS estimates or an enterprise value/sales ratio of 1.3x.  This is slightly more conservative than the industry median because of Tower’s high debt load. That said, the firm could quickly shed this debt with grants from the government. This analysis leads to a price target of $3.50.