BWA - Wolfspeed Stock: Uncertain Situation

2023-06-28 16:54:15 ET

Summary

• Wolfspeed, Inc. has used strong financing markets to raise a lot of cheap convertible debt in recent years after a capital-intensive strategic change.
• More debt needs to be issued to fund losses and large capital investments, this time near 10% coupons.
• The combination of large operating losses, huge net capital investments, and an underwhelming 2024 outlook causes real concerns, amidst changed financing markets.

Shares of Wolfspeed, Inc. ( WOLF ) have seen some real interesting action in recent years. In fact, my last take on the business was the summer of 2019, when Wolfspeed was still known as Cree, as I concluded that Cree was seeing continued struggles. Forwarding four years in time, I basically have to draw that same conclusion today with regard to shares of Wolfspeed.

A Recap

Back in 2019, I thought that Wolfspeed (at the time still called Cree) would see continued disappointments, despite great prospects. The company was undergoing a massive transition at the time.

Early in 2019, the company sold its lighting business in a $310 million deal to Ideal Industries, fetching a mere 0.5 times sales multiple (with sales reported at $569 million in the fiscal year 2018), at the time responsible for nearly 40% of sales of the overall business.

Following this divestment, Cree was focused on two businesses: Wolfspeed and a LED business. Moreover, the company operated with a pro forma net cash deal just in excess of half a billion dollars post the lighting divestment, while the company commanded a $4.9 billion equity valuation based on 103 million shares outstanding trading at $47 at the time. This means that operating assets were valued at around $4.4 billion.

This was applied to a business: consisting of Wolfspeed and the LED operations, with sales trending around $1.1 billion. However, the issue was that realistic earnings only were very low, barely coming in above breakeven levels. While Wolfspeed was posting solid revenue growth (with revenues trending just over half a billion), that was not enough to offset weakness at the LED business. With no realistic earnings for the overall business, it was hard to get upbeat from a fundamental point of view.

A Massive Boom-Bust

Shares of Wolfspeed have seen a huge boom post the pandemic with shares hitting a high at $140 in 2021, as shares still traded at $120 in September of last year. Unlike many other technology and semiconductor names, Wolfspeed has been a massive underperformer as of recent, as shares fell to the $40 mark in May of this year, although they have recovered to $56 at this point in time.

In the end, the company posted 2019 sales at $1.08 billion in 2019, split exactly 50-50 between the remaining businesses. In August 2020, the company posted 2020 revenues at just $908 million, on which a $209 million operating loss was reported. LED was still responsible for 48% of sales that year, and a few months later the company divested these assets to SMART Global Holdings ( SGH ) in a mere $300 million deal, with relative few upfront proceeds.

Following this move, the company was a business with only remaining activity: Wolfspeed as a premier supplier of silicon carbide to electric vehicle ("EV") OEMs.

2021 revenues recovered in a modest fashion, up from $471 million in 2020 to $525 million in 2021. The company incurred a huge $314 million operating loss, only in a small part explained by a $74 million asset abandonment charge. Moreover, the company made huge investments into the business resulting in dilution of the share count.

By August 2022, Wolfspeed announced a 42% increase in full year sales to $746 million which again was about the good news as operating losses of $248 million were huge. Moreover, capital investments surpassed $600 million, the second year in a row in which they came in over half a billion dollars, all while depreciation charges barely surpassed the hundred million mark.

All this results in continued dilution as well as a build-up in (convertible) debt. This prompted the company into raising more convertible debt with the market, and in fact the company reached a half a billion dollar deal with BorgWarner Inc. ( BWA ) to establish financing as well to drive BorgWarner's transition into the wider EV space, all as the company is seeing capital spending requirements boom in 2023 and 2024.

And Now?

Wolfspeed, Inc. continued to grow and bleed a lot of money in the fiscal year 2023. First quarter sales rose 55% to $241 million, although still accompanied by a $75 million operating loss. At the start of the year, the company announced a massive deal with Mercedes-Benz (MBGAF) to which it will supply carbides.

Second quarter sales fell back to $216 million, a disappointing result with operating losses increasing to $91 million. In February, the company announced its plans to create an even larger plant in German-located Saarland, in an effort to generate up to $4 billion in revenues from silicon carbide in 2027.

Third quarter sales stabilized around $229 million, with operating losses topping the $100 million mark at $102 million as continued dilution made that the share count rose to 124 million shares. Cash holdings stood at $2.2 billion which is more comfortable than it looks as the company has $3.0 billion in convertible notes outstanding, for an $800 million net debt load, which typically carry low interest coupons, badly needed to fund losses and capital spending which trends at roughly $700 million a year here.

With fourth quarter sales seen around a midpoint of $222 million, more losses are in sight which made investors nervous. This furthermore is the case as the company outlined a 2024 guidance, calling for sales of only $1.0-$1.1 billion in the upcoming fiscal year, with quarterly revenue trending at $250-$275 million.

The combination of very limited sequential revenue growth, big losses and huge net capital investments, all driven by an underwhelming 2024 outlook made investors cautious, and this is why a $100 stock in 2022 fell to $40 in May. At these levels, the business is awarded a $6 billion enterprise valuation (despite the huge investments made into the business).

A Rebound

By the end of June, shares of Wolfspeed have seen a massive rebound as the company has reached a deal with Apollo Global Management, Inc. ( APO ) to obtain $2 billion in funding. Apollo will fetch $1.25 billion in secured notes upfront, with an option to provide another $750 million down the road.

These 2030 notes come at a huge cost, as the coupon of 9.875% is in a different league versus the low coupons offered on the convertible debt issued in recent times. Apparently the lenders take comfort with the situation, although at a price, as investors react positively to this, with shares having risen some 10% in response to the financing agreement. This move added well over half a billion dollars in value on the back of the news (of the expensive borrowings).

The fact that Wolfspeed, Inc. investors are enthusiastic about the new Apollo Global financing, while nearly $125 million in interest expense will be added in year one, is telling, with financing badly needed as the scaling-up is lagging compared to expectation. Given this new reality, and the cold, hard performance, I am curious to learn about the ramp-up, but I do not see compelling reason to get involved with Wolfspeed, Inc. here.

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