I just returned from a well needed vacation and I am officially back to sleuthing. One of the first items I want to draw attention to is the confidentiality agreement that GT Advanced signed with Apple on August 24, 2012, which was referenced within the Master Development and SOW Agreement between Apple and GT (see image below). While the exact date is not relevant by itself, the date does establish a starting point for the seriousness of Apple and GT’s relationship. I also went back and reviewed the comments made by GT management during the Q3 2012 conference call right after the confidentiality agreement with Apple was signed to see what kind of signs management gave investors related to sapphire screen pricing and expected timing. At this point for those of you who follow my analysis and GT advanced closely it should not come as a surprise to anyone that GT’s management provided a lot of color on the pricing and expected timing during the November 2012 conference call.
Q3 2012 Conference Call Notes (November 2012)
There’s been a lot of discussion regarding the cost of sapphire for cover screens and question as to whether the cost range that we recently published of $10 to $20 above current glass solutions is achievable.
The total cost for sapphire cover screen can be divided into 2 categories: crystal growth and fabrication, with each currently representing about 50% of the total cost.
I’m just saying that, that’s a factor what the throughput of the furnaces might be in terms of cycle time, what the cost of the consumables might be, etc.
There are already a lot of tools in the fabrication area that will have application, that are either depreciated significantly or are already in place and some of those operations that we’ll support.
There are some really innovative technologies that are being developed by ourselves and our fabrication partners that would bring the back end down very substantially in the fabrication area.
I expect that the ratio between the crystal growth side and the fabrication side to change substantially as these technologies get put on-board.
But we’re confident, okay, that we can be inside that box. And we’re also confident that, that’s just the initial box.
And unfortunately, with the big smartphone players, you won’t know until it happens.
We’ll start laying down assets second half of next year, but you won’t see a high-volume phone with sapphire on it, I don’t think, until 2014. And so that’s consistent with the time line that we’ve put in place.
I provided a lot of information that was given during GT’s Q3 2012 conference call, so what right? Well one of the first points I want to draw attention to is the price $10-20 above current glass solutions costs. The number widely used has been $3 per screen for the current glass solution. If we take midpoint of $10-20 it is $15 above the $3 per screen current price. As of November 2012 GT could grow sapphire boules and produce sapphire cover screens for approximately $18 a screen. Add in your 25% margin and they could sell to Apple for $22.50 per screen. GT management also stated that the price was a 50/50 split between crystal growth and fabrication which would be $9 to grown and $9 to fabricate for a total cost per screen of $18.
Eric Virey from Yole Développement early this month modeled the price of sapphire screens. Eric assumed GT would grow the sapphire boules and deliver a sapphire slabs (bricks) for $6.40 per screen and sell for $8.00 per screen (see image below). The sapphire slab end up in China where it would be sliced and polished by Apple subcontractors. The finished screen’s estimated cost is $17 with potential to be as low as $13 per screen in the mid-term future.
May 2013, Eric Virey estimated that the cost of sapphire screen was $22 but could ultimately reach $13 per screen over time (see quote and chart below). What is even more interesting is estimated mix of sapphire growth versus fabrication costs compared to GT guidance of 50/50 split. Virey estimates that the sapphire growth costs as of May 2013, were $9 for crystal growth and $13 for fabrication, which represents a 40/60 split versus 50/50 from GT management. If I bring down the fabrication cost estimate from $13 to $9 the split is now 50/50 and the total cost is estimated at $18, equal to GT management’s guidance.
Today a cell phone cover glass costs around $3. Sapphire will always be more expensive than this. Yole Développement has also produced a detailed cost simulation, showing that today it’s possible to make a sapphire cover for around $22. That must fall. In an aggressive and optimistic yet realistic hypothesis we predict that the cost could go down to below $15 within two years, and ultimately could reach $13.
The wall street analysts have not gotten down to the granular details related to if GT will sell sapphire slabs or if GT will grow the boules, slice the sapphire and polish the screens. Many of them don’t even have a unit or cost estimate per screen that has been published. I think it is very important to know who will be ultimately making the sapphire screens and what GT’s selling price per screen will be to Apple. The cost of the screen will impact Apple’s margins, but will the price of sapphire screens hurt the bottom line as much as some analysts are expecting? The short answer is no and I will explain why.
GT in 2012 was pricing in the cost of sapphire screens using the previous generation ASF furnaces (115 KG) as well as the previous generation diamond wire saw from Meyers Burger. Additionally, the raw materials supply chain for Alumina had not been established. If we fast forward to March 2014, GT is now using a (200 KG+) furnace which represents an improved yield of 74% from the ASF 115 KG Furnace. GT will likely be using the next generation Meyer Burgers diamond wire cutting saws that will substantially reduce kerf loss and improve the fabrication costs to make a sapphire screen. A $80m order was received by Meyer Burger for diamond wire cutting saws in December 2013 and it is widely believed that the order was ultimately headed for Apple’s Mesa, AZ sapphire plant. GT acquired exclusive rights to Intego GmbH sapphire cover inspection tool on March 13, 2013 that is expected to increase the amount yielded (useable portion) from a sapphire boule, which will lower the cost of growing and fabricating sapphire screens. According to GT’s comments (see image below) regarding the LED Intego inspection tool, it provided an improved yield of 20-25% in the lab and I would expect the sapphire cover inspection tool to show similar yield improvement . It has also been evidenced (see image below) that GT has already received several Intego sapphire cover inspection tools so this technology that was in R&D in 2013 is now ready to go in 2014.
So what is the cost of sapphire cover screens? GT’s improvements to the sapphire screen production cost estimates include; sapphire boule is now 74%+ larger than it was in 2012, the inspection tool that improves the yield by 20-25% since 2012 (useable boule), Apple’s negotiations and establishment of the current raw material supply chain may reduce the cost of raw materials by 20-25% from 2012 estimates and lastly the next generation of Meyer Burger diamond wire cutting saws will substantially reduce kerf above and beyond the previous diamond wire saws that were commercially available in 2012. I’ve been modeling out the cost of a sapphire screen at $8 for a final ASP of $10 to Apple. Given the facts at hand, I feel comfortable that my cost estimate for 2014 is reasonable. A $7 increase ($10 cost versus $3 for glass) to Apple’s cost structure will certainly impact Apple’s gross margins, however my estimated sapphire screen incremental cost estimate of $7 per screen is probably half or one-third of what the street is currently modeling for the cost of Apple’s sapphire screens. So yes, sapphire screens will have a negative impact on Apple’s gross margin but sapphire screens will not “tank” the iPhone 6 margin profile by any means. Below are my key points regarding pricing summarized in a chart as well as a repeat of one comment made by TG during the Q3 2012 conference call.
TG’s comment during the November 2012 during the Q3 2012 Conference Call
But we’re confident, okay, that we can be inside that box ($10-20 above current glass solutions). And we’re also confident that, that’s just the initial box.
~Obscure Analyst – 3/29/14
Full Disclosure: I am long GTAT and have no plans to buy or sell any holdings in the next 72 hours