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  Here's hoping Integrated Silicon will enhance our portfolio

BENJ GALLANDER and BEN STADELMANN

Friday, August 22, 2008

The Contra methodology demands that our primary stock-purchasing period occurs near the year's end, during tax-loss season. Last year, the stock for which we had the most enthusiasm was Integrated Silicon Solution. Shortly after the company completed a share buyback at $7 (U.S.), the stock proceeded to fall, and on January 13 our bid price of $5.76 was reached. However, only 73 percent of the order was filled, which obscured the true level of our interest in the company's shares.

 Now, if you were a person with a vivid imagination, you might surmise that Integrated is an operator of a chain of cosmetic surgery clinics. But you'd be mistaking silicon for silicone, the gel form that is used to augment the human form.

Chemistry buffs will know that silicones aren't made entirely of silicon atoms and have different physical characteristics from elemental silicon. Indeed, science can be fun. But actually, Integrated designs and markets — but does not manufacture — integrated circuits in the semiconductor industry. Known as a "fabless" semiconductor company, it contracts out production to Asian foundries in order to create a leaner cost structure.

Owning this company requires you to be aware that it operates in a highly commodified, and therefore ruthlessly competitive, industry. Over the next few years, some firms will go bust while others consolidate. In our minds, Integrated will be a survivor, with the possibility of being an acquirer or one of the acquired. This is a company with a great set of attributes that includes a strong balance sheet with negligible debt and lots of cash, and an A-list of customers like Samsung, Sony, 3Com, Cisco, Ericsson, Motorola, Nokia, Bose, Philips and Siemens.

 After a long, tough period from 2001-2006, last year the ink finally flowed black. With the release of the third-quarter results in July, Integrated has now been profitable for eight consecutive quarters. Revenue guidance is being met, but the numbers haven't wowed the crowd because of weak pricing in the memory chip market for laptops and other personal computers. That's nothing new in an industry where the long-term price trend is still dropping.

 The company has been trying to send a signal to the market that its stock is cheap and a good investment. Back in September 2007, the company issued a modified Dutch auction self-tender offer, where it paid $6.30 a share for about 3.1 percent of the outstanding shares. After that, the price flailed in the open market. Might this happen with another Dutch auction currently being held by another Contra holding, Franklin Covey? One wonders whether research has been done to determine the percentage of companies that experience a subsequent decline.

Our sell target of $18.89 does seem a bit ambitious, but this is a former high flier that has been at better than double our goal. The current price is cheaper than what we paid, and the recent 52-week low hasn't dampened our keenness for Integrated. Plus, our recent lack of fear of an extended rise in the Canadian dollar relative to the U.S. has resulted in a lovely currency gain.

We also like the fact that this company is also a bit of a play on Asia, as it has design groups in China and Taiwan and seems very cozy with their customers on that continent. When pricing pressures ease and new products generate interest, we look to see a spark in the share price.

One final point of interest we forgot to mention. Integrated's headquarters are famously located in Silicone — er, Silicon Valley. And even if there is a Silicone Valley somewhere, our guess is that it's probably found between the twin peaks of Malibu and Rodeo Drive.


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