Taking a contrarian position in a stock comes with risks, sometimes substantial ones. That's because you're effectively going against the market, and are willing to believe that the company can do the opposite of what it's widely expected to do. A good example is a stock that's in a tailspin and which faces a lot of adversity. It's easy to get down on that type of investment and assume it'll just go lower. But by taking a contrarian position, you're expecting it will turn things around. And if that happens, you could stand to generate significant gains from investing in it.
Wolfspeed (WOLF -5.71%) is a semiconductor stock that many people don't have a lot of hope for. As of Wednesday's close, it had lost 80% of its value since the start of the year. The business, which makes silicon carbide, faces an uncertain future as it recently filed for bankruptcy protection. There's undoubtedly a ton of risk that comes with investing in the stock.
But the company is working on turning its business around, and it even brought on a key executive recently with experience in doing just that. If it's able to emerge from bankruptcy protection successfully and become a profitable business, it could be positioned for some excellent growth opportunities. Could it be a good contrarian stock to buy?
Image source: Getty Images.
Is a turnaround possible for Wolfspeed?
Wolfspeed's financials need a lot of work. Over the nine-month period ending March 30, the company incurred an operating loss totaling $748 million, which was higher than the $561 million it generated in revenue. The company's gross margins are incredibly low and sometimes even negative. On top of this, the business has long-term debt and convertible notes totaling a whopping $6.5 billion. While those are long-term liabilities, they are staggering amounts for a business that isn't even profitable.
Getting out from under such a debt load likely wasn't going to happen over the course of Wolfspeed's day-to-day operating activities. But through a bankruptcy filing, the company believes it can slash its debt by close to 70%.
And to help with its efforts to transform its business, the company has brought on a seasoned executive with experience in turnarounds in the tech sector -- Gregor Van Issum, who will take over as the company's chief financial officer as of Sept. 1. With 20 years of experience in technology, Van Issum says a key priority will be to improve profitability for the business. It won't be an easy task, however, given how poor the company's margins are and the significant operating expenses it incurs.
I'm skeptical about how likely it will be for Wolfspeed to get out of the red. It may successfully emerge from bankruptcy, but that doesn't mean the business will be able to transform into a healthy and profitable business.
Why a turnaround may not matter
The bigger problem for investors is that even if Wolfspeed emerges from bankruptcy protection, they may not have much to show for it. That's because under the restructuring, existing equity in the company will be cancelled, and current shareholders will receive between 3% and 5% of the new restructured business.
That means generating big gains for investors who own shares today may not be all that likely, even if the company's turnaround efforts work. With a much smaller position, it'll be more difficult to generate large gains from any increase in the company's value. Meanwhile, there are still no guarantees that the business will be able to successfully execute a turnaround. As a result, there may be limited upside from investing in Wolfspeed's stock today.
Wolfspeed isn't worth the risk
Even if you are a contrarian investor, Wolfspeed may not be a stock worth investing in today. The potential gains from a turnaround may be limited given how much shareholders will be left with in the restructured business. A safer option would be to invest in a company that at least isn't in the midst of bankruptcy, and which has a clearer path forward.
