After Its Recent Rally, Should Investors Sell Wolfspeed Stock?

Key Points

• Wolfspeed stock has seen a massive rally for its stock price in recent weeks.

• However, much of this appears to be related to short covering.

• The company is still headed toward bankruptcy and equity holders are expected to get very little in the reorganized company.

• 10 stocks we like better than Wolfspeed ›

Silicon carbide technologies specialist Wolfspeed's (NYSE: WOLF) stock has staged a huge rally, soaring from $0.40 per share at the end of June to over $3 at one point in just a few trading sessions. That kind of move can make you stop and ask, "What am I missing?"

The answer is nothing and investors should not only proceed with caution on Wolfspeed, they need to stay away from this stock. Wolfspeed is in the middle of a prepackaged bankruptcy process that will leave existing shareholders with very little when all is said and done.

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So, what's behind the rally? More likely than not, Wolfspeed shares have rallied due to a short squeeze currently underway. The stock has a high short interest, and with the company not being liquidated and borrowing costs to short the stock high, this is likely leading to short sellers covering their positions, which means they must buy the stock.

Image source: Getty Images.

The road to bankruptcy

As part of Wolfspeed's bankruptcy, creditors holding more than 97% of senior secured notes and the majority of its convertible note holders have already agreed to the terms that will leave existing shareholders with as little as 3% to 5% of the restructured company. Once the process is complete, Wolfspeed expects to wipe out $4.6 billion in debt, cutting its annual interest expenses by about 60%.

Unfortunately, there is simply no way the math works for this to be a win for current investors. The reorganization is moving forward, and Wolfspeed expects to exit bankruptcy by the end of Q3 2025.

Even if you look past its debt issues, Wolfspeed has still been struggling operationally. The company is a developer and manufacturer of wide-bandgap semiconductors, focused on silicon carbide and gallium nitride materials and devices. These devices are used for power and radio frequency applications such as transportation, power supplies, power inverters, and wireless systems.

Wolfspeed went all-in on silicon carbide, betting big that it would see huge demand from electrical vehicle (EV) makers. At the time, the decision made sense, as silicon carbide has superior thermal conductivity and greater energy efficiency than traditional silicon, which allows silicon carbide components to perform better at high temperatures. This is greatly beneficial in helping EVs travel farther distances. However, the company's execution has been a disaster.

Wolfspeed made the decision to try to control its own destiny and be a fully vertically integrated company that produced both silicon carbide material as well as chips. As such, it took on a massive capex plan that included building the $5 billion John Palmour Materials facility in North Carolina and the Mohawk Valley fab in New York. Both have struggled ramping up.

As a result, Wolfspeed burned through $1.5 billion in cash during the first nine months of its current fiscal year. It ended up with a gross margin of negative 17%. That means the company lost money on every sale, even before operating expenses. At the same time, EV giant Tesla has balked at the high price of silicon carbide components, while hybrid vehicles came more into fashion in the U.S. In addition, the company faced aggressive pricing from Chinese competitors.

Management believes this restructuring will get the company back on track, as Wolfspeed will emerge from bankruptcy with a healthier balance sheet and improved cash flow. It is also betting that its transition to 200mm wafers will help improve its operating results. More chips can fit onto larger wafers, so this will help reduce costs if it can achieve solid yields. However, the last part is key, as moving to bigger wafers is technologically challenging, and there is often a higher rate of defective chips. As such, there is still no guarantee of success.

Last quarter, Wolfspeed said it expects to generate $200 million in unlevered operating cash flow in fiscal year 2026. However, that number excludes interest payments, which remain significant even after bankruptcy. With the company saying it will reduce its interest expense by 60%, it should fall to around $95 million a year, which is still nearly half its unleveraged cash flow estimate. Meanwhile, the company still needs to improve operationally to hit those cash-flow numbers as well.

Don't chase the rally

Some of the recent stock price rally also seems tied to the appointment of Gregor van Issum as CFO. He's a restructuring veteran who has had strong success in the past. However, that doesn't change the math for current shareholders.

Van Issum's job is to clean up the company's capital structure, not to save the stock price. He's trying to position Wolfspeed for long-term growth, but that doesn't change the fact that current equity holders will only get a 3% to 5% stake in the reorganized company.

There is a path forward for Wolfspeed as a business, but current investors will largely be left out. As such, there is no compelling reason to own the stock right now, unless you are betting on a continued short squeeze.

If you believe in the company's long-term potential, the smart move is to wait until after the bankruptcy process is complete before considering a purchase. Until then, avoid this stock. For those already investing, you should sell Wolfspeed stock now.

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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Tesla and Wolfspeed. The Motley Fool has a disclosure policy.