GT Advanced Technologies Inc fka GTAT

[lecorb]

GT Advanced Technologies: What Went Wrong And What Investors Need To Know About The Bankruptcy Process



Oct. 9, 2014 11:51 AM ET | 1 comment | About: GT Advanced Technologies, Inc. (GTAT)



Disclosure: The author is long GTA
Summary
•We believe the management has been blindsided and do not believe the management misled or otherwise committed any fraud.
•The management can certainly be accused of ineptitude and poor risk management.
•There are many unknowns and the management owes investors some candid answers to the fullest extent possible within the limits of the Apple NDA.

We are believers in several of GT Advanced Technologies (NASDAQ:GTAT) product lines but, as our series of articles about GTAT clearly state, we have always viewed the GTAT's Apple (NASDAQ:AAPL) business as a risky one. The contract with Apple obligated GTAT to produce but did not guarantee any sapphire revenues. We took that risk to be real and modeled different scenarios that are likely to play out depending on Apple adoption. In various articles and discussions on Seeking Alpha, we even suggested that readers should assume that Apple business going to zero in the worst case scenario.

We believed, based on our reading of the Apple contract, that Apple loan was secured by the assets of LLC setup by GTAT for this business and not GT Advanced Technologies Inc. We saw that construct as a fair risk given the potential for a large return. What we did not foresee is a catastrophic cash drain situation that landed the Company where it is today.

Whatever it is that drove the company into bankruptcy was a surprise catastrophic event. The management appears to have been blindsided as they were forecasting in August that the Company had sufficient cash for the foreseeable future. Readers can see the following exchanges in GTAT's Q2 earnings call transcript:

“
Brian Lee - Goldman Sachs

Hey guys, thanks for taking the questions. Just from, first off, how should we think about the level of cash burn for 3Q and 4Q and do you see the need to raise additional capital to get Arizona scaled up to targeted operational efficiency. And then I have a follow-up.

Tom Gutierrez - President and CEO

As our guidance for the year suggests I mean we are expecting to end the year with approximately $400 million of cash on the balance sheet. And as you know from prior history, this business really starts to generate the cash once the order flow and the revenue flow starts to move. So at the moment, okay, we don't expect need to go out into the marketplace to raise additional capital.

Stephen Chin - UBS

Okay and may be a follow-on to that. If the final prepayment does not come through by that October timeframe is there an extension possible to that or is there a scenario where you then might need to raise more cash, if you don't get that prepayment?

Tom Gutierrez - President and CEO

I would say that these are milestone based, right and so when you reached a milestone, you get paid, they are not cliffs per se. And so I feel very confident based on the progress that we are making that we will achieve the milestone in that timeframe but as I indicated with the projection of having close to $400 million in the bank at the end of the year, it's not a world-ending event, if it slides although again I don't anticipate that it will slide.

It should be clear to readers from the above exchange that the management did not see a reason for additional capital in the near term, let alone be concerned about bankruptcy. Unless one is prone to conspiracy theories, whatever happened in the last two months was catastrophic and was far outside of management expectations. This development has also blindsided the street. To the best of our knowledge, the worst case scenario in many analysts' thinking was the need to raise additional capital in 2015. In spite of the predictable Monday morning quarterbacking on the subject, no analyst that we are aware of even uttered the word "bankruptcy" in GTAT context prior to the actual event.

While the bankruptcy is clearly distressing to stockholders, the Company seems to have enough equity to cover the debt and there seems to be some equity left for the stockholders. Per the bankruptcy press release, the Company has assets of about $1.5B and liabilities of $1.3B as of June 28. However, much of the liabilities are to a single customer, Apple. Apple's loan is collateralized by the Company's assets at Mesa. The heavy redactions of the Apple agreement make it difficult to predict how the collateralization would work. However, we expect that the net effect of any settlement with Apple is likely to lead to a carve out of the Mesa facility which would result in the Apple loan being offset by the equipment and working capital at Mesa. In effect, the balance sheet would become substantially lighter with likely superior debt to asset ratio. There is another factor that may skew the numbers further in GTAT stockholders favor. While we are no accounting experts, we believe the Mesa assets are currently being held on GTAT's books at cost (we invite accounting experts to comment below if they see it differently). In the event of transfer of these assets, we find it likely that the transfer would occur at a price consistent with the MDSA, which would give GTAT a significant margin on the sale. Such onetime event would substantially boost the book value of the Company. It is hard to put numbers on any of this due to the secrecy of the Apple deal but suffice it to say, this is in no way a typical bankruptcy.

As of September 29, the Company also has a cash position of $85M which it plans to use for ongoing operations. While this is not a huge cushion, it gives the Company a runway to operate as it negotiates through the process. And the runway is especially useful given the ramp up of many significant products at GTAT. The Company's Merlin, Hyperion, ASF, HiCz, and Polysilicon products are about to experience a strong growth spurt. These are high margin products and as these devices start selling in the Q4 timeframe, the Company's balance sheet will start to recover. However, the bankruptcy is likely to disrupt the product sales and we would not be surprised if some of the equipment sales get delayed or cancelled.

It is important to understand that the Company's outcome in the bankruptcy process is not defined by the balance sheet alone but the perception of value of various business units from the creditors view point. In this context, readers may be interested in our articles about the sum of parts valuation of the Company. We believe the creditors are likely to look at the Company in a similar way to determine how they should proceed to protect their interests. Note that majority of the Company's debt, outside of Apple debt, is in the form of convertibles. These holders have in the past viewed the equity of the Company as being potentially valuable. If the stockholders interests can be preserved through this liquidity crisis, we believe the Company has great products that are likely to deliver in spades over the next three years. We have considerable conviction in saying that the sum-of-parts of GTAT far exceeds GTAT's stock price before the bankruptcy. Whether the debt holders accept or recognize this view is speculative. And, even more speculative is how the recognition value, or the lack there of, would affect the management's negotiations with the creditors.

In other words, this bankruptcy is caused by liquidity crisis and stockholder interests may survive depending on the Company's next steps. Unfortunately, there is scant information available and it is unclear what effect the bankruptcy process can have on the equity going forward.

With the current publicly available information we do not suspect that management has mislead the investors and we do not believe the management committed any fraud. However, we are highly skeptical of the Company's risk management discipline. We do not understand how the management can take a risk of this scale and how the board of directors can approve such a risk without sufficient risk mitigation.

There are also some intriguing aspects of the bankruptcy that raise considerable risk for the stockholders. According to recent Wall Street Journal article:

“
"On Wednesday, Apple called the bankruptcy filing "a surprising decision." A person familiar with the matter said Apple had been working with GT to keep it solvent. In addition, Apple hadn't demanded repayment of loans as it could have, based on GT's weak cash position, people familiar with the matter said."

Per a separate Reuters article, Apple spokesman Chris Gaither said in an email that "We are focused on preserving jobs in Arizona following GT's surprising decision and we will continue to work with state and local officials as we consider our next steps"

These statements to us indicate a troubled relationships between the companies and raises more questions than they answer. While the details may not be known until the bankruptcy hearing, and may be not even then due to Apple confidentiality reasons, the most likely culprit that got GTAT to this situation is the relationship with Apple. Regardless of the exact reason, some key questions for investors to ask, and the management to answer, are:

- What exactly did GTAT fail to deliver that led to this situation? Was it yields? Cost? Schedule? Material performance such as breakage? Something else? It is critical that management address this issue. Investors need to understand the failure mechanism that led to this disaster.

- Is the relationship with Apple salvageable?

- Given the current state of the Apple relationship, how much of the Company's 2014 guidance still remains intact?

- Can GTAT hand over the keys to the Mesa facility to Apple and write off the assets and debt from its balance sheet? (this was our worst case assumption)

- Can the cross defaults on convertible notes and other debt be cured without inflicting substantial pain on the common stockholders?

- Does GTAT need concessions from any lenders other than Apple?

- And, last but not the least, was the Company aware of what could go wrong with the contract? Why was such a catastrophic risk not managed? Why did the Company not raise cash in Q1 or Q2 or even Q3?

Management owes its investors an open and honest communication in this regard so that investors can make a reasonable assessment of the Company's stock value. We understand that the Apple NDA prevents disclosure and holds the Company accountable to a tune of $50M per violation. However, the Company has to push the limits of the NDA to the extent possible to give the investors as much information as possible.

Can the current shareholders survive or get wiped out by the Chapter 11 process? The unfortunate answer to is that there is no certainty in the Chapter 11 process. Investors will get a better idea of the equity as the process plays out and the stock is bound to oscillate at a penny stock or near penny stock level based on speculation.

While the equity in GTAT currently is speculative, the bond market may provide an interesting opportunities for aggressive investors. Bond investors should note that GTAT bonds CUSIP ID GTAT3908991 and GTAT4078167 are trading by traditional bankruptcy metrics assuming the worst for the company. We believe the assumptions behind this pricing are flawed. GTAT is in a rapidly growing markets with great products. The problem here is liquidity and an aggressive bet on a single customer in one of Company's markets. Considering the underlying dynamics, especially with Apple's debt being secured by Mesa assets, these bonds are severely mispriced. We currently see a decent potential for the equity to survive. Which, in turn implies that debt holders are likely to come out of the process nearly unscathed. Given the Company's on balance sheet assets as well as off-balance sheet prospects, we believe the bond investors have a lot to gain by purchasing these securities at the current levels.

Regardless of the outcome, the management team and the board should be held accountable.

http://seekingalpha.com/article/2550985-gt-advanced-technologies-what-went-wrong-and-what-investors-need-to-know-about-the-bankruptcy-process?app=1&uprof=44