Cypress Semiconductor and Suntech Power: A Stub Play

Cypress Semi-conductor (CY) recently did a partial spin-off of Suntech Power (STP), that now trades as a stub. Stub's are always of interest to me as they sometimes are seriously mis-priced, allowing for arbitrage situations to occur. I did take a look at a possible arbitrage situation with CY and STP, but found that CY holds B shares of STP which call for 10 votes a piece per share, while A shares only have a single vote. This made the B shares more difficult to value, and lowered the confidence I had in my valuation. However, I concluded that if STP made a sharp upward move that significantly valued the stub far in excess of its parent, a situation similar to the one that occurred when 3Com spun-off Palm, I would be confident in executing an arbitrage strategy if I could find the shares. However, I think a better way to capitalize on the CY-STP situation would be to buy shares of CY, for two reasons. First, they are planning on spinning of the rest of STP by 2009, and by that time, alternative energy could be in the infancy of a likely bubble that will be caused by federal government subsidies and regulation. Second, activist investors at Third Point may provide the catalyst needed for STP shares to be given to shareholders earlier than the scheduled 2009 date, with the added kicker of trying to get the market to fully value CY's semi-conductor business, which has undergone a major restructuring. Third Point's logic is spelled out below: The purpose of the acquisition of beneficial ownership of the securities by the Funds is for investment, and the acquisition was effected because of the Reporting Persons' belief that the Company represents an attractive investment based on the Company's business prospects. The Reporting Persons generally support the existing strategy of the Company and believe that the Company's management team and its Board of Directors (the "Board") have, since the beginning of 2006, been very effective in identifying and enhancing the value of Sunpower for the benefit of the Company's shareholders (which the Reporting Persons believe has already been reflected in the valuation of the Common Stock) and in significantly increasing the value of the Company's semiconductor business (which the Reporting Persons believe has not yet been reflected in the valuation of the Common Stock). Specifically, the Company's management has taken important steps in divesting money-losing, underperforming, non-core and commodity semiconductor units over the past 18 months and in materially reducing the physical infrastructure associated with the semiconductor business, resulting in a large and permanent reduction in capital spending requirements. The Company's management has also refocused the semiconductor business on fast-growing, value-added and higher-margin products, which the Reporting Persons believe will result in strong free cash flow generation by that business. In addition, from a corporate finance perspective, the Company has "refinanced" its convertible debt advantageously and sold Sunpower shares, allowing it to repurchase Common Stock on an opportunistic and accretive basis. However, during this same period, as management has made these many positive strategic moves, the implied value of the semiconductor business embedded within the Common Stock market price has declined by about 15%, significantly underperforming the semiconductor indices, which have risen. Given this sustained period of underperformance by the "semiconductor portion" of the Common Stock, and given that further buybacks of Common Stock at current levels would not be nearly as accretive as those in the past, (as Sunpower now makes up roughly 80% of the value of the Common Stock), we believe that it is time for management and the Board to aggressively pursue various strategies that should cause the significant value of the Company's semiconductor business to be fully reflected in the market price of the Common Stock. While the Reporting Persons appreciate that management has committed to distributing the Company's stake in Sunpower no later than 2009, the Reporting Persons believe that there are tax-efficient mechanisms to do so sooner and believe that the Board (which the Reporting Persons understand is well aware of these issues) should expedite its review of these mechanisms in order to implement as soon as practicable a strategy that will allow the Company's shareholders to realize the value of the semiconductor business well before 2009.