RealMoney Silver - LED Update Is Not Good for CREE

LED Update Is Not Good for CREE
By Chris Versace
RealMoney Contributor
12/28/2007 4:36 PM EST

Since talking about Cree (CREE) in early October, the shares fell 16% compared to a 4.7% pullback for the S&P 500 early this week. Since then, CREE shares have rebounded as some on the Street have touted the name as a lighting play in 2008. I still like LEDs in general, but new data points suggest otherwise in my opinion for CREE.

Slowing LED Growth in Mobile Phones

One of the driving factors of the LED market over the last few years has been the uptake of LEDs in the mobile-phone market for a few applications, such as camera flashes, but the primary application has been backlighting. However, as adoption has soared over the last few years, the technology has taken share and now accounts for nearly 95% of handset backlighting.

As such, mobile phones are not likely to be the strong volume driver that they were in recent years, and related volume is likely to be more in line with mobile-phone industry trends -- from both a seasonal perspective, as well as an annual shipment one.

Even though the mobile-phone market has continued to deliver year-on-year shipment growth for the last several years, the seasonal pattern -- which consists of sequential declines in the March quarter, followed by modest increases the next two quarters, and then the all-important fourth quarter -- has remained intact.

Aside from volume concerns, pricing compression will likely be an issue, as well as its impact on margins. Conversations with a few LED vendors suggest that pricing for handset-use LEDs has been under pressure.

Other reports, like the recent one quoted by Digitimes, suggests the overall production value of the handset LED market will decrease over the next two years, with related price quotes falling by about 30%.

Will there be other applications -- LCD TVs, portable computer backlighting and general lighting -- that will be volume drivers for LEDs? Sure there will, particularly as average selling prices for them continues to come down. The problem is the real volume for these applications are not in the near term -- that is, in the next few quarters.

In the near term, with a measurable percentage of CREE's revenue derived from the mobile-phone market, I have to question if CREE can live up to Street expectations that call for 23% top-line growth and 33% EPS growth in calendar-year 2008 over calendar-year 2007, per First Call. Note the math on this: With all things being equal, margins will have to expand in calendar-year 2008 to deliver faster EPS growth compared to top-line growth.

Growing Competition

In October, I addressed the fact that semiconductor capital equipment companies were seeing good orders for equipment used in the manufacturing of LED chips.

Well, it seems that industry capacity will continue to grow, as AU Optronics (AUO) is looking to set up an LED chip company in Taiwan and has reportedly booked equipment from equipment makers.

This is but the latest and follows a number of others -- Epistar, LumiLeds, Harvatek, Formosa Epitaxy, Opto Tech, Arima Optoelectronics, Lumi Micro and some larger players, including Samsung , Osram, scattered across the U.S. and Asia -- that have been adding capacity in recent quarters.

In my view, many of the risks I described about CREE remain and the latest developments touched on above only exacerbate them.