Here's a lesson for any prospective Apple (NASDAQ:AAPL) suppliers: Don't bet your entire company and capital structure on transforming your business model for the sake of the Cupertino giant. GT Advanced Technology and its shareholders had to learn that the hard way when the company shocked the market with a Chapter 11 bankruptcy filing earlier this month, one that no one saw coming.
Since the initial announcement, GT has been in bankruptcy court hearings trying to adhere to its confidentiality agreements with Apple while also attempting to provide much-needed answers to investors -- stuck between a rock and Apple's $50 million penalties.
GT has been trying to relieve itself of its iPartnership, hoping for an "amicable parting of the ways," after calling the deal "oppressive and burdensome" and noting that its cash burn from the sapphire-material operations were "not sustainable."
Well, GT has now officially settled its differences with Apple, and the two companies are now going their separate ways.
GT to Apple: "It's not you, it's me."
GT has announced that it will wind down its sapphire material production operations in Arizona and Massachusetts, laying off 650 employees in Arizona in the process. The company also expects additional layoffs in Massachusetts and Asia. In doing so, it plans to exit the sapphire material business that it had hoped to enter, and go back to simply producing sapphire furnaces and growth equipment (its previous business model for addressing the sapphire market).
If approved by the bankruptcy court, GT will be released from its exclusivity obligations (the original deal included provisions that GT could only supply sapphire material to Apple for consumer electronics). GT owns all of the equipment and inventory assets in those facilities, but plans to sell those assets to repay Apple the $439 million it owes. The company has four years to pay back that loan (without interest).
Apple and GT plan to continue a "technical exchange" of developing next-generation sapphire production processes.
What it means for GT Advanced
For GT, it is now free to go back to the way things were, selling furnaces while focusing on its Merlin and Hyperion opportunities. Merlin is a new solar module metallization and interconnect technology, which can lower costs, improve reliability, and drive efficiency gains in the solar market. Hyperion is an ion implanting technology that GT acquired from Twin Creeks in 2012 that can produce paper-thin sheets of sapphire, which could potentially be used as a display laminate.
GT had been planning on supplying sapphire material to Apple to pay back what it owed, in a way counting its chickens before they hatched (or even before the chicken coop was built and operational). The company even went as far as recording deferred revenue based on this expectation. That's why the total prepayment obligation recorded on its balance sheet was only $350.6 million, less than the $439 million it had received in prepayments. The rest was being recorded as deferred revenue based on current sapphire material prices. With the partnership being dissolved, it now has to pay all that back in cash.
That's for the company. As far as GT equity holders are concerned, it's unclear if there will be any residual value once the company emerges from bankruptcy, particularly since Apple is now GT's largest creditor.
What it means for Apple
This deal was inherently structured far in Apple's favor. For example, GT had been required to supply a minimum quantity, but Apple was not required to purchase any minimum quantity, among other aspects. As such, Apple bore very little financial risk, other than the possibility of GT having trouble repaying what it owes.
That risk is even less since its loan is secured by certain GT assets (sapphire furnaces). This isn't like an unsecured loan where Apple was simply taking GT's word. Now all Apple has to do is wait until GT can pay it back in the coming years, but it's not as if Apple is hurting for cash right about now.
Of course, widespread speculation was that Apple was planning on using sapphire in iPhones at some point, even if the material wasn't included in this year's models. No one outside of GT and Apple know for sure what Apple was planning, but it's possible that GT's troubles could put Apple's long-term product plans in jeopardy.
Additionally, sapphire is already very common in watch faces, so it should have no problem finding alternative sapphire suppliers for its upcoming Apple Watch. Presumably, Apple had something else in mind for the $578 million in sapphire material that it had effectively preordered through 2020. At least it has plenty of time to figure out an alternative.
Evan Niu, CFA owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.