Do you have the nerve to put $778 million on black at a roulette wheel in Vegas? Investors in GT Advanced Technologies (NASDAQ: GTAT) may be doing just that, but without knowing it. Could the Apple (NASDAQ: AAPL) deal crush GT Advanced Technologies as it tries to shift from being a tools supplier to a component supplier?
GT entered into a deal with Apple in October to co-develop sapphire glass device screens. Initially, it sent the stock soaring. When reading the press release, everybody locked in on the $578 million prepayment and may have overlooked that Apple is not guaranteeing volume. As additional details filter out, investors should be wondering if GT has made a deal with the devil.
GT used to sit on the sidelines, making the production equipment to create sapphire glass, rather than making the glass itself. That approach worked well enough when the company was making furnaces for polysilicon production. It allowed GT to shift the risk of production levels and quality hurdles onto the producer of the panels. In the world of solar panels, where there are numerous competitors, this worked well. In the world of handset manufacturers, where the screens aren't price-competitive yet, not so much.
Apple was interested in getting access to sapphire glass at a specific price point and quality level, but didn't want to get into the manufacturing business. So, to close the deal, GT committed to providing a certain amount of capacity at specified (but unannounced) quality levels. All of this was with the expectation that Apple would buy the components.
GT needed the deal
Despite resurgence in the solar market in recent years, the commoditization of raw materials dramatically pushed price points lower. Google and Samsung had access to the technology, but Apple's focus on quality over price made it the natural fit. Corning (NYSE: GLW) manufactures Gorilla Glass, which has performed admirably, but has not been able to eliminate scratches or even breakage, and as wearable computing becomes more prevalent, the stakes are raised.
Units are right around the corner. According to AppleInsider, Foxconn has already finished assembly testing for the sapphire-covered iPhone, and the GT website is advertising jobs for the Arizona Plant, which is rumored to have openings for 700 people. In addition, a China-based analyst is now claiming that Apple has two iPhones in trial production with screen sizes of 4.7 inches and 5.7 inches. If this analyst is right about testing runs beginning now, with mass production in May, this would indicate a possible June launch.
The penalty for failure is bankruptcy
GT needs a substantial hit on its hands, and to capitalize on this hit by expanding beyond device screens. Sapphire coatings could be used for everything from sports glasses to body armor, if the costs can come down enough. But, if yield or quality doesn't live up to expectations, GT will not exist. To get the order and get the deal signed, GT needed to build out a production facility in Arizona. To facilitate this buildout, GT issued 3% convertible debt that will need to be paid back, regardless of whether the deal with Apple is fruitful. If it isn't, GT is on the hook for the repayment of its $578 million debt to Apple, as well as the $190 million of convertible debt, at a time when its product failed. The actual wording from the Risk section of the bond prospectus is:
If the repayment of the Prepayment Amount were to be accelerated, it would likely produce a cross-default under our 3.00% Convertible Senior Notes due 2017, or the 2017 notes, and the notes offered concurrently with this offering (correspondingly, an acceleration of the 2017 notes and the notes offered concurrently with this offering would likely produce a cross-default under the Prepayment Agreement), and we may not have sufficient resources at such time to satisfy these obligations.
I love the idea of sapphire glass, but can't count Corning out of the game. The company has existed for over 100 years by reinventing itself after other manufacturers started producing light bulbs. Keep in mind that Steve Jobs initially contracted Corning to develop the screen for the iPhone.
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