We’re supposed to be living in the golden age of green technology and … Wait a minute! We just used that intro in our article on EnerSys, an energy storage company that specializes in innovative lead-acid battery technology. The lead paragraph of that story alluded to the ongoing weakness in the green tech sector, particularly for solar companies, which puts pressure on adjacent industries like energy storage.
However, EnerSys stock (ENS) has been trending up for a while. Investors appear bullish based on the company’s strategy to develop and adopt advanced battery technologies like lithium-ion. The pivot away from older tech is causing some short-term pain as it shutters facilities and shifts production, but revenues are steady even while gross margins are temporarily taking a hit. The company’s diversification across different markets is another selling point, even as it starts to lean more heavily into green tech applications such as electric vehicles. Our biggest concern is that EnerSys plans to rely heavily on government tax breaks and subsidies to execute parts of its business strategy.
Is Wolfspeed Stock the Same Old Story?
This is pretty much the same story we’re about to tell you about Wolfspeed (WOLF), a heavy metal band semiconductor manufacturer that specializes in wafers made from silicon carbide (SiC), a material more efficient and energy dense than conventional silicon. The company is investing $6.5 billion to expand its SiC manufacturing capacity and restructuring its business as it chases a $20 billion total addressable market (TAM) by 2030 (or so they say). There are headwinds: Its newest facility out of New Yawk is slow to ramp, resulting in significant short-term losses and some ugly gross margins. Like EnerSys, Wolfspeed plans to fund part of its expansion by tapping a U.S. government slush fund, also known as the CHIPS and Science Act. And, like EnerSys, Wolfspeed offers investors exposure to a number of different markets but especially green tech industries.
We’re particularly interested in Wolfspeed stock as a pick-and-shovel play on electric vehicles. Last month, we took a serious look at whether we wanted to invest in China’s BYD (1211.HK), the largest manufacturer of EVs on the planet (yes, even more than Tesla). While the MBA jury is still out on whether we add a position in BYD, the article inspired a recent video on investing in EV chips as a potentially lower risk way to play the growth of electric vehicles. Wolfspeed is the first name on our list, coming just days after the company released its Q2-2024 results that eventually drove the stock down 25% (more on that later). Sporting a simple valuation ratio ($4 billion market cap/$833 million annualized revenue) of just 4, Wolfspeed stock is sitting at a pretty attractive price if we can find enough compelling reasons to buy into the company.
How Does Wolfspeed Make Money?
First things first: How much exposure does Wolfspeed stock offer to our EV chip investment theme? This is not an easy question to answer. The company does not break out its revenues by specific market applications. Instead, it splits revenues between Power Products and Materials Products. The former represents actual silicon carbide devices, things like schlocky dildoes Schottky Diodes, that are used in various applications, while the latter are the raw materials that are used to manufacture those devices.
Until recently, Wolfspeed also had a third revenue line consisting of radio frequency (RF) products that use gallium nitride on SiC (GaN–on–SiC). We’d tell you more but it no longer matters because the company offloaded the business at the end of last year to MACOM Technology Solutions, which develops radio, microwave, and millimeter-wave semiconductor devices and components.The deal netted Wolfspeed $75 million in cash and about $60 million in MACOM stock at the time of the transaction. Wolfspeed now bills itself as the world’s only pure-play, vertically integrated silicon carbide company, claiming more than 60% share of the SiC market.
Is Wolfspeed a Pure-Play EV Chip Stock?
But that still doesn’t answer our original question: Is Wolfspeed a pure-play on EV chip? We need to engage in a bit more backstory before we finally give you an answer. Specifically, we need to understand Wolfspeed speak for how it describes its customer pipeline (design-ins) and future revenue (design-wins). Design-ins represent customer commitments to purchase products, like a letter of intent or pinky swear, which is what we would call a pipeline (and sometimes a pipedream). Wolfspeed claims a pipeline of more than $22 billion in potential work. A design-in becomes a design-win when a customer issues a purchase order for at least 20% of the expected first-year revenue. While the design-win on paper reflects each project’s entire commitment, actual revenue may never hit the total potential value. Clear as mud, right?
While it’s difficult to determine how much of current revenue is related to SiC products for EVs, the future is pretty clearly rooted in electric vehicles based on the above chart. The company had a record of $2.9 billion in design-wins, with more than 80% related to EVs. Those numbers represent 28 different vehicle models, according to management, which said that over the next five years (based on the pipeline/pipedream) the number of EVs leveraging Wolfspeed devices will increase to nearly 120 different models across 30 different OEMs.
Multi-Billion-Dollar Expansion Plans
The company is certainly ramping up manufacturing capacity as if it believes those billions in handshakes are the real deal. In 2022, it opened what was billed as the “world’s first, largest, and only 200mm silicon carbide fabrication facility” in upstate New Yawk. Why is that a big deal? Previously, Wolfspeed’s largest silicon wafer size was 150mm The larger substrate allows for more chips per wafer, which reduces manufacturing costs and makes SiC chips more cost competitive with conventional silicon-based wafers (more on that later).
Just six months after opening the new Mohawk Valley Silicon Carbide fabrication facility, Wolfspeed announced a $6.5 billion plan to further expand production. Some of the money will be spent to install additional tools at its $1.2 billion Mohawk Valley fab that only started production last year (yeah, more on that later, too). Wolfspeed is also constructing a 445-acre silicon carbide materials facility in North Carolina, which will expand the company’s existing materials capacity by more than tenfold. The materials generated at that facility will be used to supply the facility in upstate New Yawk. Phase-one construction is expected to wrap this year at a cost of $1.3 billion. And, just this month, Wolfspeed announced plans to (once again) build the world’s largest, most advanced silicon carbide device manufacturing facility – this time in Germany.
Multi-Billion-Dollar Financing Plans
That’s a lot of money going out. How does Wolfspeed plan to fund all of this? And when does all that funding result in a sizable return on investment?
There are investors, such as BorgWarner, a global automotive components supplier that is pivoting into e-mobility. The Michigan firm agreed back in November 2022 to invest $500 million in Wolfspeed, which will entitle BorgWarner to purchase up to $650 million of SiC products annually as its requirements increase. In July 2023, Renesas Electronics Corporation made a $2 billion deposit to secure a 10-year supply commitment of SiC hardware. The Japanese corporation is reputedly the world’s third-largest automotive semiconductor company and the largest microcontroller supplier. Management also said it is finalizing plans to secure funding through the U.S. CHIPS Act and other government sources.
And, of course, there’s debt. We’ll spare you the details on the $1.5 billion in convertible notes or the $1.25 billion in secured notes or whatever other financing the company has engaged in the last couple of years. It all comes down to this. Wolfspeed is a $3.2 billion company with $2.6 billion in cash and $5.2 billion in debt pursuing a TAM of $20 billion by the end of the decade.
New Factory Falls Flat
You might construe from our last comment that we’re a bit skeptical about this ginormous spending spree to expand SiC material and device production capacity at breakneck (and break-the-bank) speeds. That brings us to the recent nosedive in Wolfspeed stock after the company reported a 20% year-over-year increase in revenue. It was certainly the best news from the Q2-2024 earnings report. The whiz-bang factory in upstate New Yawk is not ramping up as quickly as expected, incurring $70 million in “underutilization costs” through the first half of the 2024 fiscal year, and more is expected on that front.
Management is putting some spin on this fastball that it is trying to pitch it past investors, but the bottom line is that execution has not been flawless. Yet Wolfspeed is on full steam ahead before it apparently fully solves the current factory problems.
Of course, not everything is in the company’s control. A global slowdown in EV adoption has been well documented at this point. The lack of a comprehensive charging infrastructure, higher interest rates, and lack of subsidies in some markets are among the reasons that supply is outstripping demand. That’s causing companies to pull back on production and other expansion. For instance, investors penalized Tesla after Sir Elon Musk announced a sharp slowdown in sales and shrinking margins as the company competes with the likes of BYD. Meanwhile, Wolfspeed insists that EV revenue is still on the rise, despite guiding to flat revenues in Q3-2024. Instead, management is blaming uncertainty in the industrial energy markets in China and across Asia for its lackluster upcoming quarter. Still, we have to wonder if the pullback on EV production will eventually catch up to silicon carbide chips.
Costs and Customer Concentration
That’s especially relevant given the disparity in cost between SiC chips and conventional silicon chips. A review by researchers last year found that while silicon carbide is considered the “next evolutionary step for future electric drives,” its cost is still about three to five times more expensive. For instance, the increased cost of a 200mm SiC substrate is estimated to be about $1,300 to $1,800 compared with about $800 cost for 150mm wafers. However, the study noted that SiC chips can “lead to overall cost savings in the long term due to their increased efficiency and durability, especially in applications like electric vehicles and industrial power systems.” For example, EV components made with SiC transistors can be reduced in size.
Of course, it will take some time for EV manufacturers to design and integrate these new efficiencies. And, as we just discussed, the industry has hit a few speed bumps. For its part, Wolfspeed is also still figuring it all out. The struggles at the Mohawk Valley fab facility caused gross margins to drop from 34.3% the prior year to just 12.9% in the most recent quarter. We can probably expect more of the same in the near term, especially as the company continues to spend heavily on capex projects. Finally, a brief note on customer concentration: Just two customers accounted for 35% of revenues last year. Maybe this number goes down as more OEMs get onboard, or maybe it goes up as just a small handful of distributors become responsible for getting Wolfspeed hardware into the market.
Conclusion
If you’re an investor who believes that silicon carbide is the future for EV chips and other applications that require efficient, energy dense hardware, then Wolfspeed is one pure-play option on SiC. The company has adopted a build-it-and-they-will come mentality, something we generally shy away from. The strategy appears to be paying off to some extent, with $2.5 billion in investments from a couple of major players in the EV supply chain. But at what cost? Heavy debt, heavy losses, and a heavy drop in gross margin. It’s hard to see any of that improving any time soon as Wolfspeed charges ahead with more multi-billion-dollar factory buildouts as it boldly tries to capture and consolidate the SiC market. While the current customer pipeline does suggest the demand is there, Wolfspeed would not be the first company to see demand leak away due to competition, cost, and other factors.
Next up, we’re going to step back and take a broader look at the SiC thesis with a focus on other companies going after the same opportunity Wolfspeed is. And is there really a $20 billion pot of gold at the end of the 2023 rainbow? Stay tuned.
