NEW YORK ( TheStreet) -- LED lighting sector lightning rod Cree ( CREE - Get Report) provided its shareholders with another "gut check" day on Wednesday. An inventory glut in the LED market that is lasting longer than expected, and steep pricing declines, forced Cree to lower its existing top line and gross margin guidance.

The trading action after the Cree pre-announcement seemed to suggest that a good number of investors had run out of patience, with more than 19 million shares traded on Wednesday when Cree shares fell by more than 12%, and notably, fell to a new 52-week low, below the $43 mark (Cree shares would finished the week at $44.85).

Just about a year ago, in the middle of April 2010, Cree shares were above the $80 mark. It's been up and down, and then up and down again, since that year-ago high mark for Cree shares. Even before Wednesday, Cree shares took a big hit since its January earnings, when it first reported the excess inventory in the LED market. Cree shares had been as high as $72 in December 2010.

So has the death knell been sounded for Cree in the LED lighting sector? Some headlines seemed to insinuate that on Wednesday.

Another way to ask this question -- the more important way, actually -- reaches to the heart of the debate that has long raged about the Cree outlook: is the latest stumble for Cree a sign of structural weakness in the long-term bullish LED sector thesis, or a short-term supply/demand hiccup in a high growth sector that is distinct from the Cree long-term story? After all, visibility is notoriously dim in the LED space and it's possible that Cree was simply overaggressive in expectations about recovery from the inventory glut it already told investors was taking place last quarter.

Cree now expects third-quarter fiscal 2011 revenue of $215 million to $220 million, versus a previous guidance range of $245 million to $265 million. Gross margin guidance was lowered to 43% from 46%. Cree expects a rebound in the June quarter, however, the rebound will still results in revenue lower than Street expectations.

Hans Mosesmann, analyst at Raymond James, put it this way in his latest note on the volatile Cree story on Wednesday: "Cree's miss is likely to set up the debate on the nature of the company's current struggle: merely a LED inventory blip or structural. Count us on the structural view in terms of LEDs."

Raymond James's Mosesmann recommended investors avoid Cree shares, but that's nothing new for the Raymond James analyst, who can rightly be dubbed the "Dean" of the Cree bears.

An investor can look back to the debate after the last Cree earnings in January, when the company first uttered the words "inventory glut." The primary points of debate have not changed. Even at that time, when Cree predicted a quick inventory work-through, analysts said that predicting how long an inventory work-through takes is far from a perfect science.

There were some reports in the press, including from Barron's, that seemed to indicate Wall Street was betting against a Cree recovery. Barron's provided what it said was a "random" sampling of analysts indicating that negativity about Cree was pervasive. Yet while Cree has its bears, and always had, and some analysts became more negative on Cree -- and many analysts had to take down price targets and earnings models -- there are plenty of bulls left on the Cree story. Since the bears seemed to be dancing on Cree's grave this week, let's at least consider the opposing argument.

Oppenheimer & Co. wrote on Wednesday that the Cree earnings pre-announcement showed that conditions in the LED market were worse than Oppenheimer and Cree had believed. However, Oppenheimer analysts concluded, "we believe Cree's difficulties are primarily cyclical rather than structural, and that pricing and margins will improve as the cycle turns."

Andy Abrams, analyst at Avian Securities, said the Cree disappointment isn't the sign of a market share shift or structural change in the market. "This is not a big change from where we were before with Cree," Abrams said. The analyst added that the weakness in the spot market for LED chips has a ripple effect through the space and there have been signs all along that the conditions have not been good in the past quarter. The Avian analyst said the mistake that he made, in retrospect, was not taking down Cree numbers as information filtered in that a rebound from the inventory glut wasn't occurring quickly.

Even as lead times remain short -- an indication that pricing on the spot market is still weak -- the situation has been improving in the past three to four weeks, the Avian analyst said. Cree was overaggressive in its target for when the previously reported inventory glut would reverse, and that has to make an investor cautious when Cree now says that in the past few weeks the conditions have been improving, especially since Cree conceded lead times are still short. Yet the Avian analyst said Cree's more positive tone has been corroborated by channel checks in the LED space.

"We are hearing that demand at the chip level is coming back and that will immediately slow the decline in pricing," Abrams said. The analyst concluded conditions will improve in the LED market in the back-end of the June quarter and throughout the second half of the year.

Andrew Huang, analyst at Sterne Agee, took the short-term hiccup view as well. "Revenue growth should be back in the June quarter, though pricing will still be very aggressive."

Ross Young, LED market analyst at IMS Research, said three of the major themes in the LED story are more or less unchanged.
  • LED chip sales are soft.
  • It is no surprise that Cree LED chip sales are soft with the LED backlighting market suffering from an overbuild in the second half of 2010 along with seasonal weakness in the first quarter 2011 and the continued trend toward fewer LEDs per panel. The IMS Research analyst expects a larger jump in LED penetration in the second quarter of 2011 when companies launch their 2011 models. Yet this doesn't mean problems for Cree disappear.

    Most of the panel suppliers are increasingly sourcing internally or with affiliated companies, making it more difficult for Cree to maintain its backlighting chip business.

    IMS Research's Young said the same situation is likely occurring in other consumer segments as well, along with growing competition from other players in Asia who have rapidly expanded capacity in 2010.

    Additionally, the chip business has become an increasingly smaller part of the Cree revenue mix, which should be no surprise to anyone who follows the company as that revenue decline has occurred quarter after quarter. However, it can't entirely explain the pre-announced revenue miss, either.
  • Weakness in the component business which represents packaged LEDs primarily for lighting is a big part of the equation for a Cree rebound, and the rate of adoption in the general lighting market predicated on lower pricing of LED components is still a moving target. Yet again, this is an old, as opposed to new theme, in the LED space.
  • "Surely the lighting revenue will come as prices fall, but hard to pinpoint exactly what quarter it will surge. In the residential space, $40 is too high for a 60W bulb. As prices fall below $20, I would expect it to rapidly increase," IMS Research's Young said.
  • Over dependence on the China street lighting market is a concern, but not a new one either.
  • The China lighting market will certainly look domestically for sourcing given all the subsidies and incentives provided to manufacturers to build in China, Young said. The Chinese government wants the companies it is supporting to succeed, so one would expect growing domestic content requirements over time. "It is probably too early for that now as they are just beginning to ramp production, but will be a concern eventually. So, it is likely that China street lighting was also weaker than expected in Q1 as it is likely Cree still has a large share in that space," the IMS Research analyst added.

    The opinion of Mark Miller, analyst at Noble Financial, who has been among the more bullishly inclined analysts in the LED space, is notable given the Cree miss since Miller recently went down from a buy to a hold on LED equipment maker Veeco Instruments ( VECO - Get Report), and is now more cautious on his overall view of the LED market.

    "Are we ahead of curve both for Cree and Veeco? My model is showing me that we are ahead. Some of the growth projections are turning out to be aggressive and ahead of the curve for both LED lighting and equipment," Miller said.

    In any semiconductor-linked space, there are always going to be cycles that shift suddenly, and unexpectedly, and recovery times that are shifted out based on a lack of supply/demand visibility. For investors in the LED space, then, the question is not just when the rebound occurs, but whether Cree is still in a strong position to benefit when it does.

    So what do you think: Is it time to turn out the lights on Cree, or just dim the lights before the wattage again increases? Take our poll below to see what TheStreet has to say....

    Is it time to turn out the lights on Cree, or just dim the lights before the wattage again increases?

    Cree is a buy.
    Cree is still a sell.

    -- Written by Eric Rosenbaum from New York.

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