GT Advanced Technologies, Inc.(GTAT) a public technology company servicing the solar, LED and electronics industries worldwide, filed for Chapter 11 bankruptcy in early October 2014 to the shock and surprise of many investors. The bankruptcy is still in the court of law, but back when the bankruptcy filing was first announced, shares dropped a staggering 93% in one day. Looking back two years before the default, the red flags were evident.
On the surface, GTAT was an investor’s dream, having secured a $578m prepayment loan from Apple Inc (AAPL) in late 2013. This prepayment loan was issued to allow GTAT to acquire the raw materials and manufacturing equipment necessary to produce synthetic sapphire. Though Apple never publicly said what they intended to use the synthetic sapphire for, it is believed to have been planned for use as the iPhone 6 screen under the assumption that it would be tough and scratch-resistant. Reportedly, GTAT was so invested in this deal that they even went as far as bringing a halt to what had previously been their largest business of supplying materials and equipment for solar panels and chips.
With the release of the iPhone 6 in September 2014, Apple ultimately used Corning’s Gorilla Glass. After repeated failed drop test were administered to the sapphire produced by GTAT, it was apparent this deal was a bad bet for Apple. However, using S&P Capital IQ’s proprietary tool called Probability of Default Fundamentals (PDFN) – which uses financials to derive a percentage chance of default - we actually see GTAT’s problems started long before the broken glass.
On Dec 31, 2012 PDFN jumped from 0.63% (mapped to a lower case score of bb+) to 1.31% (dropping one notch to a score of bb). This meant that GTAT, even two years before bankruptcy, had a mapped score which was below sub-investment score (i.e. it was already in a high risk category). The PDFN continued to grow higher and the mapped lower-case score continued it’s descent until the default on 6th October 2014 as you can see from the graph below.
Source: S&P Capital IQ
Though hindsight is 20/20, this is still a very interesting case study as we identified early warning signs of deteriorating credit, from multiple perspectives, two years before the default. We continued the analysis using S&P Capital IQ’s proprietary Probability Of Default Market Signal (PDMS) model, which is driven by equity prices and shows the market’s perception of credit risk denoted by a percentage chance of default. We also took a look at the share buybacks and key business development.
To hear the full case study, please register for our GARP presentation, Broken Glass, Warning Signs and Defaults: A Credit Risk Mystery taking place February 24th at 7:30 am.
What exactly happened in the business negotiations between GTAT and Apple is unclear, and in fact this is still being disputed in the court of law as I write this. But make no mistake, from our analysis of the fundamentals and equity markets; GTAT was showing signs of financial distress more than 2 years before the bankruptcy and before the Apple deal. This supports a fundamental point in the art of counterparty risk analysis: credit surveillance of the supply chain, using various metrics to attain a holistic perspective, is not a ‘nice to have’ but a paramount.