GTAT: Ready to Rock
GT Advanced Technologies (GTAT) is one of the most interesting and most written about stocks out there right now. Matt Margolis, a contributor at Seeking Alpha, has become something of an internet sensation by publishing strong speculative evidence that Apple is using sapphire technology from GTAT to add solar charging functionality to the iPhone 6. That would be awesome for Apple and iPhone customers, but is only sort of interesting from the standpoint of investing in GTAT. Apple is going to buy a lot of sapphire from GTAT regardless of whether it has solar capability or not, and I think the value of that agreement with Apple is largely reflected in the current GTAT stock price of $18 per share. What’s more interesting about GTAT is everything else it has in its pipeline that the market seems to be not valuing at all.
To be fair, this isn’t a new or novel argument. Matt Margolis has published several articles on Seeking Alpha along similar lines and has concluded that the stock is worth $64 to $85 per share. He goes into a lot of detail and gets distracted by the solar angle, though. So a lot of my below conclusions borrow from his conclusions, but I’ll summarize, bring in other sources and add my own finance-driven perspective.
The main thrust of my argument is this: the agreement with Apple is probably worth about $15-$20 per share to GTAT on its own. I’ve ran some of my own numbers on this, which I’ll share below. An analyst at Goldman Sachs that picked up coverage on GTAT on March 4 came to a similar conclusion. The historical part of GTAT, which is supplying equipment to polysilicon producers is worth about $6-$8 per share. That puts the value today at $21-$28 per share, if you ignore the other new technologies that GTAT is developing and ready to commercialize separate from Apple and its historical polysilicon business.
Let’s start with the Apple agreement. In October 2013, Apple and GTAT signed an agreement whereby Apple will advance $578M to GTAT to set up a plant in Mesa, AZ that will produce sapphire, presumably for a screen or cover on the iPhone 6 and possibly other Apple products. Sapphire is something of a miracle product in that it is nearly as hard and scratch resistant as diamond. Mircoscopic scratches on the surface of a screen will dramatically decrease its strength, meaning a sapphire screen would be much less likely to crack if dropped. Sapphire also may or may not have dielectric properties that could lead to solar charging capabilities. Sapphire has to this point only been used on a limited scale in mobile electronics because of its cost, but GTAT has apparently brought the cost down to a reasonable level (management has indicated $9-$12 per phone.)
Matt Margolis has estimated that revenue from the Apple agreement will be approximately $2.2B in 2016. He is equal parts aggressive and conservative, and in total the estimate looks reasonable to me. GTAT has said that the margin on the Apple agreement will be less than its historical margin on polysilicon equipment, which is about 30%. In addition, GTAT has published gross margin guidance in 2014 of 24%-27%, and it appears that at least half of that revenue will be from Apple. The company has 135M shares outstanding and a fairly complicated capital structure due to the presence of convertible debt and $500M in cash, but I think it’s reasonable to use 135M shares as a baseline in 2016. Making various assumptions on the gross margin, tax rates and earnings multiples, I get to $15-$20 per share in value just from the Apple agreement alone. Goldman just published a research report estimating this value at $15 per share.
Now to address the company’s historical business, which is selling equipment to polysilicon producers, who in turn sell the polysilicon to solar cell manufacturers. Polysilicon is a commodity, the price of which rises and falls based on supply of polysilicon and demand for photovoltaic (PV) solar cells. This market has swung dramatically over the last 5 years with polysilicon prices as high as $450/kg in 2008 falling to under $20/kg in 2013. As a supplier of equipment to polysilcon factories, you can imagine what this has done to GTAT’s financial performance. Operating income peaked at $270M for the fiscal year ended April 2011 and fell to ($122M) for the fiscal year ended December 2013. The periods in-between (2012 and 2013) were called the ‘apocalypse’ in polysilicon by one media observer.
Over that 5-year period which appears to comprise one full boom-and-bust cycle in polysilicon, GTAT produced operating income of $80M on average. So while the polysilicon business may be a roller coaster, it is on average worth something. And with the cost of PV solar cells coming down dramatically in the last couple of years, the market is setting up for a big uptrend. I’ll leave the details aside, but I think the historical business is worth $6-$8 per share. The stock price of GTAT has swung pretty wildly over the years, including a few big peaks, but has traded between $4-$10 per share for most of that time.
The stock today is worth at least $21 per share with the polysilicon business about to head into an uptrend. That’s pretty good, but there’s a lot more to consider. GTAT management has been jumping up and down trying to get Wall Street to notice that it has several big initiatives that are about to bear fruit that have nothing to do with Apple or their historical business. They even scheduled a special analyst day on March 14 to highlight those technologies. The presentation is easy to find on the GTAT web site. The presentation addresses the Apple agreement on the first slide and then devotes the next 83 slides to everything other than Apple.
In all fairness to Wall Street, the presentation is very technical and management didn’t do themselves any favor by throwing everything out there with roughly equal weight. Many of the technologies are new flavors on the traditional business, which is nice because it means they’re not losing sight on their core business, but it doesn't necessarily reflect upside.
Three of the technologies however are completely new and represent $3B per year in new revenue by 2018-9 according to estimates from management. Those technologies in order of size are: 1) Hyperion, which is a technology that can cut materials in super-thin wafers with no waste and is therefore a huge improvement over existing technologies ($2.2B per year, orders expected in 2014); 2) Merlin, which is a new integrated system for assembling and attaching solar cells ($0.6B per year, orders expected in 2014); and 3) HVPE and PVDNC, which are technologies that will dramatically increase the efficiency of producing sapphire LED screens ($0.2B per year, beta tools ship in Q4 2014).
I’m not going to do the math to estimate a per share value, but potential upside of $3.0B per year on a company with 30% margins is a great option to be buying for free. The ride might be a little bit rocky this year because GTAT isn’t expecting to return to profitability until Q3 or Q4 of this year, but if they execute on the Apple agreement and start building an order book in any of the above incremental technologies, that rocky ride will transition to simply rocking, on the upside. Matt Margolis expects at least $64 per share and I wouldn’t be surprised.