On Monday, October 6, 2014, GT Advanced Technologies (GTAT) filed for bankruptcy, and the stock dropped more than 90 percent. The filing came by surprise as indicated in the headlines:
- “Investors Stunned as GT Advanced Filing Cuts $1.4 Billion” - Bloomberg
- “Apple supplier GT Advanced shocks with bankruptcy filings” - Reuters
- “Bankruptcy Filing Surprise From GT Advance Technologies” - 24/7 Wall St.
GT Advanced is the sapphire glass supplier to Apple (AAPL). The stock was on a tear with the news that its glass will be used in new Apple products. The stock climbed 136 percent from its close of $8.72 on 12/31/2014 to its peak of $20.54 on 7/2/2014. Investors were speculating that the company’s sapphire glass will be used for the new iPhone’s display. It turns out that was not the case, and the glass was only being used in the camera and the fingerprint reader. It is said that it will also be used in the new Apple Watch that will begin selling in early 2015. Investor disappointment based on speculations is not reason enough for the company to declare bankruptcy, although the bankruptcy is most certainly related to its agreements with Apple. A risk factor in the 2013 10-k was listed as:
“We are required to maintain significant inventory of sapphire material under our agreements with Apple, although Apple has no commitment or obligation to purchase any sapphire material from us. If Apple does not purchase sapphire materials in the amounts we expect, it would have a material adverse effect on our cash flows, results of operations and financial condition. In addition, due to certain restrictions in our supply agreement on the sale of sapphire material, we may not be able to sell that material to other parties, which would result in increases in our inventory that we cannot otherwise sell and would have a negative impact on our margins and our operations and may require that we take a charge for that inventory if it becomes excess or obsolete.”
Although the bankruptcy took many by surprise, there were plenty of warning signs that were being displayed prior to the filing. GuruFocus’ website can help spot these signs before it is too late.
Severe Warning Signs
Prior to the filing, GuruFocus indicated five severe warnings and zero good signs. Today, three good signs are showing, but the automated system is basing that on the stock’s historical low valuations according to its second quarter earnings and its low stock price after dropping more than 90 percent. The warning signs are conducted with a thorough checkup using a checklist of 32 items that cover the areas of financial strength, profitability, growth and valuation of each company. Here are the following severe warning signs for GT Advanced that were displayed prior to bankruptcy:
- Piotroski F-Score: Low – Piotroski F-Score of 2 is low, which usually implies poor business operation.
- Per Share Revenue: Declined – GT Advanced Technologies' revenue has been in decline for the last 5 years.
- Gross Margin: Declined – GT Advance Technologies' gross margin has been in long term decline. The average rate of decline per year is -1.6%.
- Short Percentage of Float: High – GT Advanced Technologies' short interest is high. 48.55% of the float is shorted.
- Days Inventory: Building Up – If a company builds up inventory, it may mean it is having difficulties selling its goods.
Altman Z-Score
The Z-Score model developed by Edward Altman is an accurate forecaster of failure up to two years prior to distress. It can be considered the assessment of the distress of industrial corporations. Be aware that the Z-Score does not apply to financial companies. When the Z-Score is less than 1.81, it is in the Distress Zone. A study by Altman found that companies in the Distress Zone have more than an 80 percent chance of bankruptcy in the next two years. GT Technologies’ Z-score is -0.35, placed it in the Distress Zone.
Insider Trade Patterns
Insiders are executives and directors of the company and also include control persons holding at least 10 percent of the outstanding shares. Who else is there to know more about a company than its own senior management? One thing that stands out is that none of the insiders were buying. As Peter Lynch said in One Up On Wall Street, “When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months." A pattern that I found interesting was the pattern of insider selling. Insiders sell for many reasons to raise cash, and the stock could likely be coming from compensation and not actively purchased. What I noticed is that selling was common in 2011 and 2012, but completely stopped in 2013 leading up to the agreement that was entered with Apple on October 31 of that year. Once the agreement occurred, insider selling picked up again and continued all the way through to its bankruptcy filing. The lack of selling in 2013 indicates that management believed the stock’s price will increase, most likely due to the upcoming agreement with Apple. Once the agreement was made and the stock’s price shot up, profits were taken and confidence in any further gains seemed to have evaporated.
Low F-Score
Joseph D. Piotroski developed the F-Score based on fundamental analysis. The binary scoring system ranges from 0 to 9. While back-testing his system, he found that companies with the highest scores tended to outperform the market. His back-testing results also showed that shorting the companies with the lowest F-Scores outperformed the market. GT Technologies has an F-Score of 2, which usually implies poor business operations.
Cash Balances and Cash Flows
A simple test of mine is to check on the company’s cash balance and match it up against it cash flows. At the end of the second quarter, GT Technologies reported a cash balance of $333.1 million dollars. This can be seen by looking at its financial statements (10-Y Financials). Free cash flow from operations was at $217.7 million for 2012 and quickly reversed to $-159.1 million in 2013 and was on pace to lose even more in 2014. Overall free cash flow followed a similar pattern, but at a more extreme drop to the downside. Free cash flow for the second quarter of 2013 was $-22.9 million and jumped to an enormous $-277.4 million in the second quarter of 2014. Unless some changes were made, the high losses in cash flow were completely unsustainable at those levels. In its bankruptcy filing, GT Technologies stated that it had $85 million in cash as of September 29. The company could not reverse its free cash flow losses and was soon going to run out of cash.
Conclusion
While GT Technologies’ bankruptcy filing took many by surprise, there were plenty of warning signs that could have provided an advanced notice of such financial troubles. Tools available at GuruFocus, such as the warnings signs, Z-Score, F-Score, Insider Trades, and 10-year financials can help detect these issues. The All-In-One Screener can also be used to find companies with similar characteristics to GT Technologies.
