WOLF - Wolfspeed: An Interesting Battleground Stock

2023-12-07 07:16:37 ET

Summary

• Wolfspeed, a supplier of silicon carbide used in EVs, has experienced uncertainty and operating losses, raising concerns.
• The company's sales have been growing (until recently) but are accompanied by significant operating losses and the need for constant capital.
• Despite some positive developments, such as new facility revenues and device design wins, the outlook remains unimpressive with increasing losses and slow revenue growth.

In August, I believed that there was too much uncertainty in the case of Wolfspeed ( WOLF ) amidst a lack of execution and tougher financing markets. The business has seen real uncertainty amidst large operating losses, high financing costs, and a consistent need to raise more (and more expensive) debt.

These conditions remain the same as Wolfspeed has started its fiscal year 2024 with a mixed first-quarter earnings report, creating real concerns, although some green shoots are seen as well. This creates a fluid and uncertain situation, with many dynamics at work here.

A Mega Transition

Wolfspeed, still better known as Cree to some older investors, has been a stock and company which has experienced many boom-bust cycles in the past, leading to many disappointments to investors over time.

In the 2010s, the company sold its lighting business and its LED business, both at not-too-demanding valuations by the way. Following the sale of two of the three business units at the time, only Wolfspeed was left, and the business became a pure play as a supplier of silicon carbide used in EVs, among others.

This resulted in high hopes amidst investors, as a $20 stock in 2017 broke the $100 mark late in 2020, and actually peaked around $140 in the fall of 2021. These hopes and anticipations were not really backed up by operating performance as the Wolfspeed business grew revenues from $471 million in 2020 to $525 million in 2021, although accompanied by a huge operating loss of $314 million, as the nature of the silicon carbide requires massive (upfront) investments.

2022 sales rose 42% to $746 million, which showed solid traction, although still accompanied by a $248 million operating loss and the fact that capital investments massively surpassed depreciation charges. This requires another constant need for capital on top of the losses reported in the meantime.

2023 - Very Tough

After Wolfspeed posted a 55% increase in first-quarter sales to $241 million, it still reported an operating loss of $75 million. Thereafter, progress stalled and, in fact, reversed. Second-quarter sales fell to $216 million, as operating losses increased to $91 million. Third-quarter sales were coming in flattish at $229 million, with operating losses topping the hundred million mark, at $102 million.

While the $236 million number for the fourth quarter of 2023 was not too impressive either (accompanied by an operating loss of $112 million), it was the guidance for 2024 which was the real issue. This guidance called for sales of just $1.0-$1.1 billion, suggesting that stagnation was seen for the year to come.

While the company held $2.2 billion in cash as of the third quarter, it had $3.0 billion in (convertible) notes outstanding, as losses and net investments into the business triggered the company into reaching a $2 billion funding deal with Apollo Global Management over the past summer, although it came at the expense of coupons which carried a payout near 10%! With more interest expenses added to the bottom line, I was a bit cautious as Wolfspeed still was a $55 stock following this announcement back in June.

As the company guided for first-quarter sales in the fiscal year 2024 at just $220-$240 million, with GAAP losses set to widen to $145-169 million, I was very cautious at $43 per share. It is the lack of execution, higher losses, added interest expenses, and continued capital investments required, which create a very tricky proposition for investors. I feel that the current risk-reward frankly is unappealing, despite the long-term growth of its end markets.

And Now?

Since August, a $43 stock has actually fallen to lows of $27 in recent weeks, before now recovering to $39 and change.

Later in August, Wolfspeed sold its RF business to MACOM Technology Solutions Holdings ( MTSI ) in a $125 million deal, in which the buyer clearly looked like the winner. Obtaining some proceeds obviously was nice given the financial state of the business, but proceeds are just sufficient to finance losses for about a quarter, while some activities will leave the door as well.

In October, the company appointed Thomas Werner as the Chairman of the board, an industry veteran who worked and has a network within the company's industry, which looks comforting.

On the final day of October, the company reported first-quarter sales of just $197 million, coming way down compared to the outlook, although operating losses ticked down to $95 million on the back of lower factory start-up costs.

There were some positives to be found in the numbers as well, as the new Mohawk facility generated $4 million in quarterly revenues, but more importantly, could run at 20% of capacity by the summer and has the potential to generate $2 billion in sales, if and once full capacity has been achieved. More important is that the company won $1 billion in device design wins, equal to over one year of revenues at this moment in time, although the backlog has already grown to a very substantial $20 billion number.

For the second quarter, sales are seen between $192 and $222 million, including an estimated $12.5 million revenue contribution from the Mohawk facility, with GAAP losses seen between $131 and $153 million. This is hardly an inspiring outlook, although sales are seen up a bit from a very soft first quarter. Some improvements are badly needed as net debt ticked up to $1.8 billion, with the 125 million shares of the business now valuing equity of the company at around $5 billion here.

What Now?

The truth is that despite some green shoots seen in the first quarter, and shares on a net basis continuing to come down, I fail to have great conviction to get too upbeat here. Losses continue to increase rapidly, and with that come higher interest expenses, as the revenue build-out is painfully slow.

Moreover, despite the rosy long-term prospects for the business in terms of demand, it is the question of how competitive the industry will become over time, as it certainly is Wolfspeed's ambition to obtain a huge presence in this market, as it is making preparations to open new facilities already.

Despite the long-term potential of the industry, the question is how big the industry will become, but moreover how competitive (read profitable) this business will become, and if and how much dilution will be incurred along the road. The debate continues to rage on here, but I fail to have conviction yet on either side.

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