I wrote about GT Advanced Technologies (GTAT) on July 20 when it was trading at $5.00 a share. The stock made a round trip up to the high 6's and then back to $5.35 where it closed Wednesday. There have been a variety of new developments, none of which undermine my thesis that this is a very attractive investment - especially at the current price level.
GTAT is in three business - the production of sapphire and sapphire production equipment, polysilicon equipment, and photovoltaic equipment - the first two account for roughly 90% of revenue. The last two businesses are impacted by developments in the solar sector and, although GTAT has a huge order backlog, there is a definite possibility that the solar related businesses will decline. The sapphire business relies primarily upon sales to the LED lighting industry and is not connected with the ups and downs of the solar industry. It is projected that about 45% of total revenue for calendar 2012 will be generated by the sapphire business.
The perception of imminent decline in the solar part of the business has driven the price of GTAT stock down to bargain basement levels. At $5.35 a share, GTAT's market cap is $630 million and, with $187 million net cash, its enterprise value is $443 million. Earnings for the fiscal year ended March 31, 2012, were $146 million and estimated earnings for calendar year 2012 were recently reaffirmed to be $1.30-1.40 per share. This puts the company in range of an enterprise earnings ratio of 3 or 4. Obviously, a lot of bad news has been priced in.
The new developments are, 1. a press release cautioning that third quarter results will be weak because certain earnings will be moved to the fourth quarter but reaffirming calendar year earnings estimates, 2. the announcement of a large sapphire equipment order with a suggestion that this may indicate the likelihood that sapphire will be used on mobile devices, and 3. the announcement of the pricing of a $205 million convertible debt offering carrying a 3% coupon and maturing in 2017 (the conversion price is $7.71 per share). The debt offering is at a slightly lower interest rate and with a slightly later maturity that existing debt. It will probably be used for either expansion or acquisitions but may also be used to replace some existing debt.
I basically see one of four things happening here in the next 1-3 years:
1. Steady as She Goes - Gross revenue and earnings stay at roughly current levels as sapphire business replaces solar business. The stock will gradually trade up to a reasonable PE of 10-14 times earnings producing a price in the mid to high teens.
2. Explosive Growth - Sapphire is widely adopted for use in mobile devices and GTAT is well-positioned to dominate the sub-industry. The sky is the limit.
3. Orderly Retreat - Solar revenue and net income decline faster than sapphire income can grow and the company manages the situation by cutting costs. If there is modest growth in the sapphire business, that business alone should be able to generate enough cash flow to justify the current share price.
4. Disorderly Retreat - A combination of a precipitous decline in the solar business and management missteps produce a sharp decline in earnings and even a year or so of losses. The share price can decline substantially before the situation is rectified.
I think that the most likely outcome is some combination of numbers 1 and 3. The recent developments tell us that the sapphire business is healthy and may have an explosive upside. More importantly, however, the convertible note offering tells us that the underwriter is satisfied that the danger of 4 is remote. While the notes are convertible, it is unlikely that they would be priced to yield 3% with a 5 year maturity and no requirement that they be used to retire existing debt if number 4 were considered a likely prospect.
This means that a substantial downside is unlikely and that a huge upside is possible if only the company can maintain its current earnings level. There is also a smaller chance of an even bigger upside in the event of a major breakthrough in the use of its products. This is not the place to invest your rent money because there is definitely some risk. But priced at this level, the upside is disproportionate to the downside risk by a substantial margin.