Wolfspeed (WOLF -58.95%) was trading around $0.97 per share at 10 a.m. Wednesday. Shares had dropped 69% from Tuesday's close after a Wall Street Journal report Tuesday evening that the company is considering filing a "prepackaged" Chapter 11 bankruptcy plan. Shares of the semiconductor company are down roughly 96% over the past year.
The company in May noted a "going concern warning" in its quarterly filing. That means its auditor expressed substantial doubt that the company would be able to continue to operate over the next year, and it could go bankrupt. That rattled investors, as did the Wall Street Journal report, but it does not necessarily mean the end is near for the company. For example, online used car company Carvana issued a "going concern warning" back in 2020, only to see its stock skyrocket from $30 (split-adjusted) to over $300 at one point this year. One of the big catalysts for Carvana was its debtors restructuring its debt, which is something Wolfspeed's management is currently looking to do.
The Wall Street Journal reported on Tuesday after markets closed that the company is considering filing a prepackaged Chapter 11 bankruptcy plan, which is a streamlined bankruptcy process where a company negotiates a plan of reorganization with its creditors before filing for bankruptcy protection. Wolfspeed management has already rejected several out-of-court debt restructuring proposals from its creditors, according to the report.
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What went wrong, and can it be fixed?
Wolfspeed designs and manufactures semiconductors based on silicon carbide and gallium nitride, which are used in power and radio-frequency (RF) applications, respectively. The company is vertically integrated, also producing the underlying silicon carbide and gallium nitride materials used in these components. It was originally a part of LED lighting company Cree.
Wolfspeed's main focus has been on its silicon carbide business. Silicon carbide has superior thermal conductivity and greater energy efficiency than traditional silicon, which allows silicon carbide components to perform better at high temperatures. This is particularly beneficial for use in electric vehicles (EVs) and helps extend their driving range.
Seeing strong growth and with projections of robust EV growth ahead, Wolfspeed went all-in on silicon carbide, looking to rapidly expand its business. This included building a colossal silicon carbide materials plant in North Carolina and a large fabrication facility (fab) in New York. This is where the company's problems began.
The $5 billion John Palmour facility in North Carolina was meant to supply Wolfspeed with the bulk of its silicon carbide material and wafers. However, the project encountered delays and is still not fully operational, while the start-up cost has stressed its balance sheet. Silicon carbide is grown from crystals, and wafer production is complex, which has led to challenges. At the same time, its Mohawk Valley fab in New York has had weak utilization. Fabs generally need to run near full capacity to be profitable.
At the same time, the company has faced increased competition from cheaper Chinese manufacturers, such as Sicc Co. and Epiworld. While it has many benefits, silicon carbide is more expensive than traditional silicon, and EV customers can be price-sensitive as a result. Meanwhile, EV demand, while still growing, has slowed. This led several vehicle manufacturers to delay product launches.
This has left Wolfspeed with $5.2 billion in net debt. Meanwhile, it had burned through $1.5 billion in cash through the first nine months of its fiscal year that ends in June and has had a gross margin of negative 17%. That means Wolfspeed is selling its components and materials for less than it costs it to make them. It's also seeing its sales decline, including an 8% drop last quarter.
The company initiated a restructuring plan and forecast $200 million in annual cash savings. It also expects to generate $200 million in unlevered operational cash flow in fiscal 2026. However, the unlevered part means that interest expense is not taken into account.
Wolfspeed is currently negotiating with its creditors, including Apollo Global Management, to restructure its debt. In particular, it needs to restructure its convertible notes to be able to access up $750 million in direct funding from the CHIPS Act. While this could be done out of court, it looks like management may prefer to do it as part of a prepackaged bankruptcy filing.
Can Wolfspeed shares rally?
Wolfspeed finds itself in a precarious position given its high debt load and lack of free cash flow. While it's made some progress, there are still no clear signs that its manufacturing issues have been fully resolved.
The company is banking on its transition to 200-millimeter wafers, which it has been working toward since 2019, to improve efficiency. Larger wafers allow for more silicon carbide components per wafer, increasing output without significantly raising production costs. Its Mohawk Valley fab, meanwhile, was specifically designed to support 200 mm wafers, which should improve its utilization. The company has previously said that it has $13 billion of design-in wins from customers, so if it can scale production, the demand appears to still be there.
There is a path for Wolfspeed to avoid bankruptcy and its stock to recover, but right now that path appears to be extremely narrow, and management does not look like it even wants to attempt it. If the WSJ report is correct and the company files for prepackaged bankruptcy protection, it is highly unlikely that equity investors will be left with anything. As such, investors should avoid the stock.
