In the Iconic movie "Wall Street" Bud Fox says "it's worth 25 bucks a share if its worth a dime!", referring to the fictional Bluestar Airlines, which has fallen on hard times and seen its share price tumble. I believe a similar argument can be offered for GT Advanced Technologies (GTAT), once a high-flyer, supplying much of the manufacturing equipment for solar and energy-efficient lighting products, but now a highly shorted, speculative stock.
At first, the argument seems rather empty, but on further analysis, one might ask why the shares are priced so low. Usually, when a stock sells for under $5, there is either something seriously wrong with the fundamentals or the company is in the early phases of its life, such as biotech firm with a drug in development. GTAT exhibits both of these traits in one way or another. The company's existing Photovoltaic and Polysilicon businesses are under attack due to persistent overcapacity issues in the solar industry. On the other hand, there is a great deal of uncertainty surrounding the Sapphire unit, which investors had hoped would carry the company until a recovery in the solar market materialized.
Some Background Information on the Sapphire Business
In 2010, GTAT acquired Crystal Systems, Inc, a crystal growth technology company that produces sapphire material used in LED applications as well as other specialty markets. This turned out to be a prescient move by management, as the solar industry capitulated in 2011, and GTAT's revenues from solar equipment have declined substantially since then. But, more encouraging, is the fact that GTAT successfully commercialized the sapphire technology and began selling ASF systems-furnaces used to produce monocrystalline sapphire material, commonly referred to as sapphire boules (these sapphire boules are used to make sapphire wafers, one of the preferred substrates for manufacturing LEDs)-by mid-2011. Indeed, by the third quarter of 2012, the Sapphire unit made up around 11% of revenue and nearly 49% of the $1.5 billion backlog. However, GTAT somewhat misjudged the competition and the rate at which sapphire usage would continue to grow globally. The widespread adoption of LED technology that the company foresaw has not taken place as quickly as initially assumed.
Sapphire Sales Slow
As per the September 30th 10-Q: "The price for sapphire material has recently experienced significant decreases. We expect that current decreased prices will continue. Consequently, we anticipate that demand for our ASF systems will also remain lower than in previous quarters. Further, customers may request delivery of ASF systems be delayed until the price of sapphire recovers which would delay the timing of which amounts attributable to ASF systems roll-off of backlog and into revenue and the timing on which we enter into new contracts to sell ASF systems. Additionally, we may receive requests to cancel deliveries, which would reduce our backlog."
That explains why Sapphire revenues declined during the third quarter 2012 to $12.6 million, from $36.3 million during the second quarter 2012.
Top Brass Remains Hopeful
The guidance for 2013 anticipates a much slower delivery of the Sapphire backlog than previously assumed. However, some of the company's ASF customers, most of whom are located in China, were in the process of securing funding from the Chinese government. Management noted that if funding were obtained, the customers would be able to "make a much bigger investment in CY13 than previously anticipated."
The company also stated "Our view is that the current slowdown in the market is temporary and that there are several catalysts that will spur future demand." It goes on to say "We believe LED demand is likely to strengthen by the end of CY13 as adoption by the general lighting market accelerates and government regulations aimed at phasing out the use of incandescent lighting continue to be implemented."
Furthermore, several OEMs are testing sapphire technology's potential for application in touch screens used in mobile devices. If successful, this could represent a significant opportunity for the company. As of now, this potential new revenue stream does not appear in any way in the current share price due to the perceived risks to adoption and from competing products. However, given management's strong track record of commercializing new technologies, one would think the market would place some value on this opportunity. Moreover, in November 2012, the company spent $10 million to gain access to Twin Creek Technologies' Hyperion implanter technology, which ought to "provide a path to cost reductions in the manufacturing of sapphire covers that will allow the use of sapphire at costs that rival current solutions while dramatically improving performance."
That the company would spend money during this period says a great deal. GT went out and invested money in a new technology in order to bolster its position in the market, despite having limited resources, a sign of confidence, or at least of foresight, in my view. In fact, management said on the most recent call, that it was putting the M&A program on hold for at least the next year and will be focusing on growing the business with the pieces it has in place. Moreover, throughout what was undeniably a difficult year in 2012, GTAT maintained an impressive R&D budget of around $72 million, positioning itself well for growth when its served markets stage a comeback.
Is GTAT Done for Good?
Given the challenges faced on all fronts, it should come as no surprise that investors are convinced the company's glory days are behind it. But why is GTAT essentially being priced for bankruptcy?
The reasons are twofold: 1) Operating cash flows turned negative during the third quarter, even with net income remaining positive. The reason for this seems to be the rather large decrease in the deferred revenue account (a cash outflow), presumably linked to a return of customer deposits. Indeed, the company said in its preliminary outlook that it would end 2013 with a cash balance in the range of $225 million to $275 million, down from cash of more than $479 million on September 29, 2012. This suggests management expects additional cash outflows to occur over the next 12 months. Investors should note, however, that the company still expects to expend between $75 to $80 million on R&D in 2013, and some of that can likely be cut if the need should arise.
2) GT Advanced does not expect a solar market recovery until 2014. When the market does eventually bounce back, the company expects it to be "driven by high efficiency, low cost, monocrystalline materials technology." This is good news for long-term investors, since GTAT has poured substantial sums into developing this polysilicon technology (mono-crystalline), HiCz. But, it also means substantial looses and write-offs could be incurred this year. Indeed, GTAT expects to recognize only a small fraction of the $140 million DSS backlog (multi-crystalline) it had on its books at the end of the third quarter. As a result, it also expects to write down most of the DSS inventory, recognizing further losses. However, barring the assumption that GTAT would simply give away this inventory for free, I have to assume that the company is being overly pessimistic right now, and that at least some revenue will be recognized from this "obsolete" technology.
GTAT Should Emerge From the Wreckage
Things do look pretty bleak right now. As another article on Seeking Alpha points out, GTAT's management has given up on trying to be optimistic. While this may not be a sure sign of things getting much better anytime soon, it does provide some reasonable reassurance that the situation won't get materially worse from here on out.
And the company is doing everything it can to stay profitable. Last October, GT announced it was laying off 25% of its global work force, in an effort to streamline operations and as part of a major restructuring. Then, in January 2012, the company said it would sell its St. Louis manufacturing facility, where it had been developing high-efficiency polysilicon technology, HiCz, and transfer the assets to another facility in New Hampshire. The move is expected to save about $15 million annually. Although GTAT does not anticipate any HiCz revenue to occur until 2014, the company says it will still be able to fill orders in the event that demand arises sooner.
Despite the extremely negative sentiment on the last conference call, GT still expects to be profitable in 2013, with earnings per share in the range of $0.25-$0.45. Management deserves a hefty amount of credit for this.
Often times, when a company is not expected to make sales or profits in the foreseeable future, analysts resort to a balance sheet approach to valuation. For GTAT, it has been said many times that its cash position exceeds it market cap, and therefore the company is undervalued. Even the net cash position (cash minus debt) stands at $181 million, or over $1.50 a share. As I explained earlier, the cash position is expected to shrink throughout the year and due to its nature (primarily customer deposits), should not be used as a measure of value. Similar value arguments have been put forth with respect to such metrics as the price-to-book value, which has fallen below 1 recently. Again, book value can, and often does, fall due to assets, particularly intangible assets (e.g. goodwill), being either written down or written off.
The more pertinent question to be asking, in my opinion, is whether or not GTAT can stay afloat for the next year or two, because if it can, it would be one of the prime beneficiaries from the next round of solar investment. I believe that it can, given the difficult steps it has taken to create a leaner organization. Looking ahead, solar companies will need to invest in new technology on order to lower costs and compete effectively in the global market, and GTAT's HiCz technology will likely lead the way. Above all, GT is a technology company, and it has proven this by not sparing any expense when it comes to its R&D budget and acquiring new assets. A company that does not believe in its future does not act this way.
The Stock Could Be Dead Money Over the Next 12 Months
Investors looking for a short-term trade would probably be better off steering clear of GTAT, since the stock may not provide a meaningful return on investment over the next 12 months. But long-term buyers could realize nice gains, because there's no way this company's shares would only be worth $3 in a rationalized solar market. Once new orders start rolling in for HiCz equipment in 2014, GTAT should realize higher margins and profits. Assuming, conservatively, that the company earns $90 million on revenue of $600 million in 2014 (a net margin similar to 2007's, when sales were only $244 million), gives earnings per share of $0.75. At a 9x multiple, the shares would trade at $6.75 12 to 18 months from now, a nearly 120% gain from the recent price of $3.10.