Case Study: Cree Investors See the Light

Recently, we snagged a 115% return on Cree (CREE Quote), and how we did so bears close examination.

Durham, N.C.-based Cree was founded in 1987 by CEO Neal Hunter and his brother Eric. The tiny company, then known as Cree Research, was trying to commercialize wafers and devices made from silicon carbide (SiC), an extremely hard substance that performs well as a semiconductor in high-power, high-temperature and short-wavelength applications where lesser materials often melt.

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SiC's very toughness also made it nearly impossible to reliably manufacture. But Cree introduced its first product in October 1989, and over the next decade would learn how to overcome such difficulties in processing the exotic material into economically useful commercial products.

Cree Research soon patented a method to make SiC wafers. From these, blue-light-emitting diodes (LEDs) became the firm's first cash cow, filling a hole in the full-color electronic-display market. (Any electronics buff can tell you, LEDs are superior to small incandescent bulbs, offering energy savings, longer life and smaller space requirements.)

The company went public in 1993, still relying mainly on military contracts and contract-research revenue from large partners to fund much of its own research and development. For years, the work progressed largely unnoticed by Wall Street.

We first became aware of the company from a "Technology on the Cutting Edge" feature on ABC News a few years ago. Noting the massive energy savings LEDs could one day mean for the nation's enormous lighting bill, we looked into Cree.

It turned out that by passing a blue LED's output through a phosphorous material, white light could be produced, offering the eventual promise of vast new efficiencies in indoor lighting. Over the next two years we periodically read the firm's 10-K reports to the Securities and Exchange Commission -- available from such sites as Free Edgar (www.freeedgar.com) -- listened to conference calls and questioned management as to the pace of the technology's commercialization.

By September 1998, Cree introduced its high-performance blue and green LEDs made from indium gallium nitride (InGaN) materials grown on an SiC substrate, and providing a dramatic, 300% improvement in brightness. This finally served to break Cree's stock-price chart upward from its long meandering path.

By May 1999, the company began shipping production quantities of these products as yields increased. White-light LED illumination, full-color video-display signs and green traffic-light signals were among the markets targeted. In March, the company shipped more than 20 million blue and green LEDs, making it the world's low-cost leader and largest producer of nitride-substrate-based LEDs. It had been a long row indeed to hoe. As CEO Hunter observed in the June 14, 1999 issue of Forbes, "It took us three years to get our costs down and yields up."

By July 19, 1999, we were finally convinced, taking the plunge on Cree at a split-adjusted price of 39 11/16. Just over five months later, on Jan. 3, we sold our position for 85 7/16, bagging a nice 115% gain.

Debt free and throwing off lots of cash, Cree's economies of scale were clearly working. For the fiscal years ending June 30, 1996 through 1999, net margins ramped up from 1.6% to 12.2%, to 14.8%, and to 21.2%, respectively. The company's next application for SiC may be blue lasers, whose shorter wavelength promises improved storage capacities for DVDs within the next two years. Going forward, the company's prospects look as bright as its products: The markets for blue and green LEDs and blue-laser opto-electronics products should hit $1 billion and $2 billion, respectively, by 2006.

At the start of the new year, Cree announced its intention to file a secondary offering, and it was then that we exited the stock, fearing earnings dilution, as is so often the case. Did we sell too soon? Yes. The stock has continued to rise past 150. But our triple-digit five-and-a-half-month gain stands as a useful model to follow. By first identifying the company's huge potential through the free media, then backtracking through its history, from that of a small research-driven private firm on through its initial public offering, and at last into its commercialization phase, we were able to score quick, decisive gains.

Investors without a strong science and technology background can get help with prescreening deals -- where they're matched with appropriate investments by venture capitalists -- via a growing number of online sites. Angeltips.com (www.angeltips.com), Nvst.com (www.nvst.com) and OffRoadCapital.com (www.offroadcapital.com) all offer access to private-equity, pre-IPO deals to accredited investors, those with $1 million in assets or $200,000 in annual income ($300,000 for couples).

But you need not be an accredited investor to partake of San Mateo, Calif.-based Technology Funding's (www.technologyfunding.com) closed-end fund or the efforts of MeVC.com (www.mevc.com), now in league with venture capital powerhouse Draper Fisher Jurveston.

Lastly, don't forget to sift through the many intriguing opportunities percolating away innocuously at your local small-business incubator (www.nbia.org). Such incubators often attract the most highly motivated of local entrepreneurs, and investment minimums can often be surprisingly affordable.

It was within the walls of the Arizona Technology Incubator that we spotted tiny LandTech Environmental, a truly fascinating start-up, whose Tiger Densifier machines offer municipal solid-waste landfills a badly needed technical solution to their ever-dwindling supply of airspace. With huge potential, and a pressing industry need waiting to be filled, the company is currently seeking $2 million in first-round financing.

New breakthrough technologies are to be found everywhere, but only if you have the passion to never stop looking and the patience to do watchful waiting. Just remember: Plant seeds early and deep. Good luck!