Skywater Technology: U.S. Foundry Riding the On-Shoring Trend

One of the most significant trends in the global economy over the past 3+ years has been the move by leading countries like the U.S., Japan, Europe, and China to "on-shore" the manufacturing of semiconductor chips.

Today, Taiwan produces 60% of the world's semiconductors, and over 90% of the most advanced chips, primarily through one company - TSMC (TSM). South Korea (mostly Samsung and SK Hynix) produces another 20%. That means 80% of the world's supply comes from these 2 critical locales.

Semiconductors are a critical component in almost all industries, from data centers to automobiles to communication devices to military equipment. Disruptions like COVID exposed how fragile the semiconductor supply chain is, causing shortages in several of these critical industries. Clearly, it also spooked governments, exposing a key national security weakness.

In response, we've seen several initiatives to "on-shore" chip manufacturing. The U.S. CHIPS Act of 2022 allocated $53 billion to bolster the U.S. semiconductor industry, and the E.U. followed with a €43B incentive of its own. Japan and India introduced similar government programs.

In this Green Screen stock review, we're going to take a look at a virtually unknown but very relevant player in this phenomenon: Skywater Technology (SKYT). Let's dig in...

What Skywater Does

Put simply, Skywater is a U.S.-based semiconductor foundry. It takes designs from clients and builds the chips at its two fabs in Bloomington, MN and Kissimmee, FL, with a third fab in Austin, TX coming online soon.

Skywater focuses on mature production nodes (65-130nm). This is not TSMC or Samsung, who are pushing the bleeding edge of technology at 3-5nm. While the advanced nodes are key for applications like the latest smartphones or AI-focused data centers, older nodes are still used for a lot of applications, particularly in aerospace, automotive, industrial, medical, and less advanced consumer devices. Over 50% of semiconductors produced still fall into this older, cheaper, more customizable, and reliable category.

The company also has developed what it calls its "Advanced Technology Services", or ATS, model. This involves close collaboration with customers to quickly customize and bring to market tailored semiconductor solutions. Unlike TSMC or GlobalFoundries, which are basically contract manufacturers, Skywater aims to create deeper and more collaborative relationships with its customers in areas like quantum computer chips and biomedical devices.

79% of revenue comes from ATS collaborations, while the rest comes from what it calls "Wafer Services", which is more like the contract manufacturing model used by most foundries.

Growth and Recurrence of Revenue

Skywater delivered a 23% CAGR between 2021 and 2024, and most forecasts have the firm growing revenue 10-15% annually over the next 5 years.

Given the focus towards on-shoring, and still-robust worldwide semiconductor growth of 6-8% annually, I think these targets are plenty achievable. Skywater has also made two big recent moves to increase its capacity, expanding its Bloomington facility via a $2 billion CHIPS act grant, and purchasing Infineon's former fab in Austin to build out its capabilities in automotive and aerospace. The company is smartly looking to capitalize on the current political sentiment.

As for recurrence, well, this is not a great example of a recurring revenue business model. Skywater, like all fabs, is largely a contract manufacturer, and will have to continually compete for projects. It isn't totally transactional, though - production runs (particularly at these older nodes) can last for months or years, and the ATS model should help maintain customer relationships based on more than just technology or price leadership.

Is There A Moat?

Two factors point to a "narrow" moat for Skywater: its customer relationships, and the fact that it is fully U.S.-based. These fall into our categories of SWITCHING COSTS and LOCATION.

Skywater's customer relationships, as we've touched on already, go deeper than just "hand off and build". They involve long-term, multi-year contracts in which both Skywater and the customer invest substantial time and capital co-developing customized solutions in areas like defense, aerospace, or quantum computing. Often this relationship goes even deeper, with customers funding tools and other capital expenditures to make their designs a reality. Once established, these are very difficult relationships to move to a competitor.

The U.S.-based advantage is pretty self explanatory. It is key to winning sensitive defense work in applications like radiation-proof chips for spacecraft, or missile guidance systems, etc. Skywater has the DoD's Trusted Foundry accreditation, one of only a handful of foundries to earn it. This gives the company a clear edge in securing this type of sensitive work.

Investors should recognize, though, that the moat here is only for certain applications. These are mostly low-volume, high-customization chip applications. In the more high volume, consumer focused market, it does not really have many (or any) real economic moat factors.

Management and Finances

Skywater was created in 2017 when private equity firm Oxbow Industries purchased the Minnesota fab from Cypress Semiconductor and spun the company out into its own entity.

As such, there is no real "founder" figure, but CEO Thomas Sonderman has been leading the operation since the beginning. He is an industry veteran with decades of experience at big names like AMD and GlobalFoundries. While not a founder in the traditional sense, Sonderman is sort of like Elon Musk or Howard Schultz, men who did not technically found the companies they are synonymous with (Tesla and Starbucks, respectively), but nevertheless have been the driving force behind their success.

Obviously, Sonderman does not slot into the elevated heights of those two business legends, but Skywater has been successful under his watch. The company has steadily grown revenues at 20-25% annually, while slowly but surely improving its profitability and cash flow generation. The company achieved positive free cash flow (barely) in 2024. Additionally, despite a business with a LOT of capital expenditure requirements, Skywater's debt is reasonable at just 55% of equity. It has been well-managed and is financially healthy.

Risks

I would place Skywater into the "medium-high" risk rating basket among our universe of stocks.

Given the nature of the business, it is reasonable to infer that Skywater relies on a dozen or so key accounts—primarily defense contractors and select tech developers—for the bulk of its revenue. Infineon will also be a major customer given it has contracted supply from the Austin fab.

While we've touched on the sticky nature of these relationships, they also create risk. A very large chunk of them rely on government funding, and we all know how that is trending right now. In fact, Skywater is actually forecasting a revenue *decline* for 2025. Government-reliant business models make me uneasy - government is just too volatile, with substantial turnover and priority changes every 4-8 years, and policy changes seemingly daily.

Skywater doesn't have a strong history of cash generation, either. In 3 of the last 4 years, it has been substantially cash negative, and only barely crossed into positive territory for 2024.

Finally, with such a big focus on on-shoring chip fabrication, I think there's a good chance competition is going to bloom in this space over the next 2-3 years. That will test Skywater's already narrow margins.

Conclusion

Skywater Technologies is well-positioned in an area of important strategic focus right now. The stock also looks pretty substantially undervalued to me - I peg its fair value close to $13, while it trades under $7. Investors who like the story could possibly see some good returns from this one.

As for me though, I'm passing. Skywater doesn't really fit into the prototype of a "green dot" company. The growth runway to me is unclear - is this essentially just a subcontractor for defense contractors? Or are there larger opportunities in more organic markets? How will it fare once larger and more advanced foundries come online in the U.S.? Can the company actually generate substantial free cash flows on its own, or does it rely on customer-purchased equipment to stay afloat? A lot of important questions... too many for me to consider it for the Watch List.