Trade Update – $GTAT: Closing Protection

by CC September 9, 2014 2:22 pm • Commentary

So the AAPL iPhone 6 event has started, and so far, we know that there is probably no sapphire in the iPhone 6 screen.  GTAT is down about 12% as a result of this news. But it appears it’s in the new watch, both on the screen and on the sensors.

Our initial trade on GTAT was premised on the sapphire in the iWatch, and a small possibility of sapphire in the iPhone 6, with a possible eventual move to using sapphire in the future iPhones.  We still like the long-term prospects for GTAT given AAPL’s support, so we are going to sell the weekly put that we owned as a hedge for a profit and remain long GTAT from a lower cost base, though still in a losing position at the moment.  

Action:  GTAT (15.08)  Sell the Sept12th 16 put to close at 1.20 for a .71 offset against losses in the stock.
Remaining position:  Long GTAT with a $16.80 cost basis



New Trade – Take $GTAT

Last week we looked at GTAT stock and talked about its potential move based on exactly what Apple announces on its product release September 9th. Here’s the background:

GT Advanced Technologies (GTAT) has caught the iPhone 6 fever.  The supplier of Sapphire, the material that goes into LED screens is expected to someday displace Corning’s (GLW) Gorilla Glass in new larger iPhone(s) and maybe iWatch. The stock is up 105% year to date as investors expect the company’s manufacturing partnership with Apple to yield massive supply/demand opportunities. In fact, analysts have back-end loaded 2014 sales in anticipation of GTAT being a main supplier.  In the first two quarters of this year, GTAT booked $80 million in sales, and analysts expect them to book $143 million in the current quarter and $407 million in Q4.  The risk to the story at this point is that GTAT is NOT the exclusive supplier to Apple, or that sapphire will not be used in the new phone’s screen at all. (it is currently used in small quantities on the camera and thumb button.)

Vol is creeping higher in the name as the Apple event is essentially a GTAT event as well. The at-the-money $17.50 strike straddle in Sept (the put plus the call) is offered at $2.70 and is 75 vol. You can see where that is historically on this chart (IV30 in red):

Screen Shot 2014-08-29 at 10.05.42 AM
1 yr IV30 vs HV30 from LiveVol Pro

As we said in the preview last week, we believe any selling pressure in GTAT based on less than baseline assumptions on Apple integration are probably a longer term buying opportunity as the most likely future is one where GTAT glass is in more and more Apple products.

Since GTAT’s stock is so closely linked to Apple’s product cycle, analysts have been speculating for months about the potential total demand for sapphire for the iPhone 6 and the iWatch.  This Wall Street Journal article from 2 weeks ago wrote in depth about the issue:

GT and Apple are producing synthetic sapphire, designed to replicate the properties of one of the hardest minerals on earth. Sapphire doesn’t crack or scratch as easily as glass. It withstands high temperatures and resists chemical corrosion.

Manufacturing synthetic sapphire is costly, so the material has been used sparingly, in airplane windows and armored vehicles to protect against extreme conditions or as a scratch-resistant cover for expensive watches.

Apple already uses sapphire to cover the iPhone’s camera lens and fingerprint reader. But broader use of the material could ease another big headache: damaged phone screens.

While much of the analyst community has been most focused on whether the iPhone 6 screen is going to be Gorilla Glass (what was used in prior models, produced by Corning) or sapphire, our view is that Apple’s big bet on sapphire initially had the iWatch in mind.  Sapphire’s biggest benefit for watches is that it’s scratch resistant, and it is already used for expensive watch faces as the article states.

However, the real question is whether Apple’s decision to invest heavily in sapphire also had a longer-term plan of potentially using it for phone screens as well.  Considering that GTAT is unlikely to have the plant fully running until early next year, we don’t think sapphire is going to be used for the iPhone 6 screen, except for possibly a small number of high-end models.  Even if sapphire were used in only a few models, we’d view that quite positively given that it would be an initial test run for the future possibility of using sapphire in most new iPhone models.

Analysts are projecting revenues to ramp up in the fourth quarter as the new product cycle gets under way.  Full 2014 revenue is estimated at $625 million, with 2015 revenue projected at $1.15 billion, and 2016 revenue projected at around $1.8 billion.  That’s assuming of course that sapphire is in the iWatch and at least a portion of iPhones over the next few years.

Which brings us to this question – how many iWatches will AAPL sell?  It’s a difficult question to answer since the smart watch market is quite novel.  Morgan Stanley estimated 30 to 60 million watches sold in the first year, but pricing will likely make a big difference.  A lower priced watch ($100-$250) would move more volume, which would be positive for GTAT.  A higher end, higher margin watch could mean more like 15-30 million watches sold, and that could hurt GTAT’s total sapphire sales.

The final risk that we see in GTAT is meeting production targets.  In other words, execution.  AAPL is clearly the main buyer, and Apple’s investment in building the plant is a good indication that the company is confident that it will need plenty of sapphire for its products.  But if GTAT runs into production delays or manufacturing hiccups, the potential revenues modeled for 2015 and 2016 could take a major hit.

But that’s a discussion for a later date.  In the short-term, this is how we see the potential scenarios:

1)  AAPL announces sapphire in the iWatch, but no sapphire in any of the iPhone 6 models

2)  AAPL announces sapphire in the iWatch, and sapphire in the high end iPhone 6 models.

3)  AAPL announces sapphire in the iWatch, and sapphire in the standard and high end iPhone 6 models.

4) AAPL doesn’t announce an iWatch (or does but it doesn’t have sapphire) and no sapphire in any of the iPhone 6 models.

As we state in scenario 4, there is a possibility that sapphire is not even in the iWatch or the iPhone (or this event has no iWatch), but that would be strange because why would AAPL have invested in sapphire in the first place? So we don’t really consider that a plausible scenario.

We view scenario 3  and 4 as unlikely, scenario 2 as possible, and scenario 1 as the worst case, but possible outcome for the Sept 9th announcement for GTAT.  Having said that, there are 2 main reasons why we want to buy GTAT in the short-term.  First, even if the AAPL event in 10 days leads to a move lower in GTAT, the long-term partnership with AAPL is clearly focused on incorporating sapphire into more AAPL products, so we don’t see a major selloff (greater than 25%) in GTAT as likely.  Second, while implied volatility is higher recently, we think the Sept12th weekly options are actually under-priced given the importance of the event to GTAT.  As a result, we are going to buy stock and buy a Sept12th 16 put to protect against a greater-than-12% fall in GTAT between now and Sept12th expiration.

TRADE – Buying to Open GTAT for $17.51
Hedge:  GTAT ($17.51) Buy the Sept12th 16 Put for $0.49

– Buy 1 Sept12th 16 Put for $0.49 vs long stock for 17.51

Hedge Break-Even on Sept12th Weekly Expiration:

Profits:  below $15.51

Losses:  Between $15.51 and $16, lose up to 0.49, lose the full 0.49 at $16 or above

Rationale:  By buying the weekly put, we limit our maximum potential loss to 12% in the short-term, if the news on sapphire disappoints.  However, we give ourselves unlimited upside in the case of good news, and are only risking 3% in premium if the stock is unchanged by Sept 12th.  Finally, short interest in GTAT has reached 43% of the float, so the possibility of a significant squeeze on good news is there as well. If the event does disappoint we see that as mostly a near term problem for GTAT and the purchase of the put allows us to be able to add deltas lower in that scenario.