WOLF - Wolfspeed: Too Uncertain Amidst Lack Of Execution And Tougher Financing Markets

2023-08-20 05:50:45 ET

Summary

• Wolfspeed's situation is causing concerns due to large operating losses, high financing costs, and the need to raise more debt.
• The company's transition to focus on the Wolfspeed business has resulted in disappointing results and a soft outlook.
• Despite new supply contracts and a potential funding deal, the company's execution and financing markets remain risky, making the risk-reward unfavorable.

In June, I called the situation surrounding shares of Wolfspeed ( WOLF ) uncertain. This came after the company has used strong conditions in financing markets in recent years in order to raise a lot of cheap convertible debt to pursue a capital intensive strategy change.

More debt must be raised given the continued losses and the fact that recent financing carried near 10% coupons. The combination of large operating losses, high financing costs, and net capital investments being required caused real concerns given the changes in the financing markets.

Forwarding two months in time, the company announced another big supply contract, and another set of disappointing results, accompanied by another soft outlook, making the situation too uncertain to get involved.

The Business

Wolfspeed, still known to many investors as Cree, has been a stock which has caused many disappointments to investors following many boom-bust cycles, despite generally rosy prospects. In recent years, the company has undergone a massive transition, which involved a $310 million sale of the lighting business, fetching a mere 0.5 times sales multiple of $569 million.

Following that divestment, the company was left with the Wolfspeed business and the LED business, as that letter segment was subsequently divested as well. Investors liked the strategy as the whole on Wolfspeed was awarded higher valuations over time, with a $20 stock in 2017 trading at $50 pre-pandemic, to peak around $140 in the fall of 2021 when the market and certainly technology and semiconductor names were booming. This boom followed multiple other booms with shares of the company trading above the $50 mark during the dotcom bubble, in 2010 and 2013.

In August 2020, the company posted 2020 sales of $908 million on which a large $209 million operating loss was reported, with the Wolfspeed segment being responsible for half of sales and the yet to be divested LED business responsible for the remainder of sales. After this business was divested to Smart Global Holdings (SGH) , the company focused on Wolfspeed as a premier supplier of silicon carbide to EV OEMs, subsequently changing its name as well, reflective of its new focus.

2021 revenues rose from $471 million (on a pro forma basis in 2020) to $525 million, yet now accompanied by a huge $314 million operating loss. In August 2022, the company posted a 42% increase in sales to $746 million, as operating losses of $248 million were very large. Moreover, capital investments of $600 million surpassed depreciation charges by around half a billion.

To finance these losses, the company raised convertible debt and raised half a billion in a deal with BorgWarner ( BWA ) as well.

Cash Flow Concerns

Wolfspeed posted a 55% increase in first quarter sales for the fiscal year 2023, with revenues reported at $241 million, although accompanied by a $75 million operating loss. Second quarter sales fell back to $216 million, on which a $91 million loss was reported. Third quarter sales stabilized at $229 million, with operating losses increasing further to $102 million.

The company guided for $222 million in fourth quarter sales, yet the issue was that of the 2024 guidance, which called for sales of $1.0-$1.1 billion, implying that revenues are not really increasing on a sequential basis. With cash holdings posted a $2.2 billion at the third quarter, that looked comfortable, but the business had $3.0 billion in (convertible) notes outstanding, typically carrying some lower coupons.

To obtain more financing, the company reached a $2 billion funding deal with Apollo Global Management in June, including a $1.25 billion 2030 note which carried a huge coupon of 9.875%, with another option of $750 million in debt potentially provided later.

With the market reacting positively in response to the deal in June, question marks on that move could be posed. After all, the company added another $125 million in interest expenses per annum to the bottom line. Given the new reality and poor performance, I was cautious to get too upbeat on Wolfspeed at $55 by the end of June.

Another Disappointment

Since June, shares of Wolfspeed actually rose to the high-sixties in July but ever since shares have sold off to just $42 per share. The boom in July was driven by the fact that the company cut a $2 billion wafer supply agreement with Renesas to provide silicon carbide in the coming decade.

The issue was the fourth quarter results , but, moreover, the 2024 outlook. Fourth quarter sales of $236 million came in ahead of the guidance, and up a little bit year-over-year, but gross margins collapsed 8 points to 27% of sales. Operating losses rose further to nearly $112 million, as the company posted a full year operating loss of $380 million on $922 million in sales. Net debt ticked up to $1.22 billion as the first tranche of the Apollo deal closed.

The issue is the guidance, with first quarter sales seen at just $220-$240 million, with GAAP losses set to widen further to $145-$169 million, up from $113 million in the past quarter. This comes even as the company sees lower factory start-up costs for the coming quarter, due to a change in the accounting recognition of start-up and underutilization expenses.

With 125 million shares now trading at $43, the market value of $5.4 billion reveals that investors clearly have real questions on the strategy.

Reiterating My Caution

After I definitely saw the potential in June, behind this risky strategy, the issue is that the company continues to disappoint. While the fourth quarter results were soft already (on the bottom line), the outlook for the first quarter is highly disappointing.

Execution remains an issue, which makes that continued operating losses are seen, and are actually increasing, as more funding is needed amidst higher interest rate expenses and capital investment requirements.

This is very tricky as execution is needed to obtain financing and confidence from investors and lenders, as the business requires a lot of capital. With debt being very expensive, the low share price makes dilution of the shares not very appealing here as well, and thus not a viable option.

Despite the sell-off since June, and the new supply contracts being signed, I am still not convinced enough on the shares, but moreover, the risk-reward here. Real execution and strong financing markets are badly needed to make the transition and ramp-up work, as I have questions on both those pre-conditions for a success.

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