(Cree earnings story updated for analyst comment, Wednesday trading)

NEW YORK ( TheStreet) -- LED bellwether Cree ( CREE) is losing some of its support, and this isn't a direct reference to the heavy selling action on Wednesday, but the shifting Wall Street view of the LED sector darling.

More than 13 million Cree shares were traded on Wednesday -- four times its average -- as the LED stock declined by 3%, and hit a new 52-week low during intraday trading at $38.22. The Cree decline carried over from Tuesday's after-hours weak earnings report and guidance that remained short of the Wall Street view for the coming quarter.

Long-time bears on the Cree story had said headed into earnings that shorts might still apply more pressure on shares. While the Wednesday decline of 3% was less than the after-hours decline on Tuesday that had peaked at a 7% drop, the more compelling story on Wednesday for Cree bearishness was the frustration on the part of analysts who haven't been long-time Cree bears.

"At this point, even bulls are going to pause and really wonder about Cree and question how quickly does the lighting business really take off," Brigantine Advisors and long-time Cree bear Ramesh Misra said on Tuesday.

By Wednesday, there were indications this reconsideration of Cree among non-bears was taking place, though the short-term and long-term view of the company remained a point of bifurcation for Wall Street.

Jeff Bencik, analyst at Kaufman Brothers, lowered his rating on Cree from a hold to a sell and lowered his price target to $29, a bet that even after Cree's big drop since it pre-reported a weak quarter, there is still 25% downside to shares.

"CREE continues to stress that driving current LED adoption levels will be the key to growing revenue and earnings. While this may be true in the long run, we are uncertain about the company's ability in the short run to cut costs as quickly as pricing is declining. The company continues to be a technology leader, but there is still considerable uncertainty surrounding the stock and its end markets," the Kaufman Brothers analyst wrote.

Theodore O'Neill, analyst at Wunderlich Securities, reduced his rating on Cree from a buy to a hold, and lowered his price target from $80 to $40. While the Wunderlich analyst doesn't see as much downside in Cree's share price from this level, his commentary on Cree did sound alarm bells about the long-term, secular growth story for LEDs, and for Cree, which has always been taken for granted among the bulls. O'Neill's comments don't discount the chance that in the long-term Cree is still a leader in the space, but he conceded that his call for $3 core earnings from Cree could take a "few extra years to get there."

The Wunderlich analyst also evinced the frustration among Cree bull with the Cree management team, writing, "CREE is now a 'show-me' story with no near-term catalysts. The company's gross profit margin peaked in fiscal 4Q10 and is now on track to hit 40%, or 10 percentage points below where it was four quarters ago. Management has offered up in succession: pricing pressure from the backlighting market where it isn't supposed to have much exposure; China street lamp delays; inventory buildup in the channel; and softened demand as reasons for margin declines. Yet at the same time it is claiming to have ever better components. What's next, a tsunami?"

Indeed, the Wunderlich analyst provided Cree with a left-handed compliment in his reevaluation of the company that invoked a tsunami of another kind, saying that its strategy of promoting adoption of general lighting is clearly working, but too well. "Instead of getting the market to adopt the products CREE designed, it pulled in every potential copycat on the planet. CREE's components, which we believe are objectively the best in the world on multiple fronts, have inspired a tsunami of competition. All the competition is hiding under the CREE pricing umbrella, and as CREE spurs new markets with its lighting products, more copycats join in, keeping pricing on a downward path. When does this end?"

O'Neill also pointed to a near-term issue that goes beyond the gross margin and earnings weakness: the potential need for Cree to write off inventory, which is an issue that other Cree analysts noted has increased as a financial risk for the company.

O'Neill wrote, "The inventory that might normally have ended up with CREE's distributors and hidden from view is now on the books at 119 days, right at the end of the fiscal year. The auditors are likely going to take a hard look at it and we cannot rule out the risk of a write-down -- 119-days-old inventory is roughly an entire product cycle in this business."

The weak earnings in Cree's third fiscal quarter were not a surprise, but its revenue and gross margin guidance for the coming quarter leave room open for the bearishness that remained in Cree shares on Wednesday as they hit a new 52-week low.

Cree is guiding to gross margin of "40%+/-." Long-time bears on the Cree story were looking for gross margin to dip into the high 30s. Cree's target of "40%+/-" avoids the worst-case scenario. However, Cree management guidance has been questioned after three consecutive quarterly misses and investors may doubt the certainty with which Cree is making the 40% gross margin guidance call, said Mark Heller, analyst at CLSA Securities.

The CLSA analyst also noted that Cree's fiscal fourth quarter revenue guidance implies a range of 3% to 12% growth. Cree is guiding to revenue of $225 to $245 million. When Cree pre-reported its third quarter, the LED company guided to revenue growth of between 10% and 12%.

Ramesh Misra, analyst at Brigantine Advisors and a bear on Cree shares, said the Cree guidance makes it look as if conditions in the market have worsened since it pre-reported on March 23. "There are no concerns about the just-passed quarter, but now Cree seems to be hedging its bets on the revenue guidance it just gave on March 23, and the implication is that things became dramatically worse," the analyst said.

Wall Street had been looking for earnings in the fiscal fourth quarter of 36 cents, though Cree guided down to a range of 25 cents to 31 cents.

For Cree's just-reported fiscal third quarter, revenue was in line with Cree's recently lowered guidance, at $219.2 million.

Earnings in Cree's fiscal third quarter of 27 cents were short of the Wall Street consensus view of 29 cents earnings, though Cree's recent commentary about an inventory glut and pricing pressure were expected to weigh on quarterly earnings and gross margin. Gross margin of 42.4% was slightly below Cree's target of 43%.

The earnings per share miss could have been skewed by Wall Street analysts who had not lowered their guidance in line with the recent Cree pre-report. While most analysts did take down numbers, one Cree analyst was still calling for earnings of 44 cents in the fiscal third quarter, according to Yahoo!Finance, an earnings expectation that has not been possible since Cree pre-reported.

Given the bad news coming into the Cree earnings, the CLSA analyst Heller tried to give Cree some measure of limited support, saying, "Cree is not out of the woods yet. I'm cautiously optimistic they can get better from here, but obviously visibility is still limited and Cree management still has to earn back investor confidence."

Brigantine's Misra said, "At this point, management needs to do something to get back credibility."

Misra noted that Cree has never specified if its gross margin guidance is GAAP or non-GAAP, as one example of a bone of contention with investors. Cree reported gross margin of 42.4% on a non-GAAP basis, but 41.7% on a GAAP basis, which is a bigger miss over its target of 43%.

"They've shied away from being specific with numbers, and with gross margin coming down again, it would have been better if Cree management reset expectations and lowered the bar on gross margin if they really wanted to clear the deck," the analyst said. "In a market where people are hyper-focused on gross margin, Cree can't afford to play fast and loose with the numbers, and I think there was still some hope amongst analysts and investors that the March quarter would hit them but then they would recover."

Cree CEO Chuck Swoboda, said in the earnings release, "Q3 results were in-line with our revised lower targets for the quarter. The results reflect both our continued success in LED lighting and the challenges of managing the LED chip and components business through a business cycle with short lead-times and low order visibility."

Explaining his bearish turn on Cree to TheStreet, Wunderlich's O'Neill noted, "I am very bearish on this name but not permanently. It's likely to take more than two quarters before we see a glimmer of hope."

The analyst stressed that unlike the Cree perma-bears, he is far from capitulating on the argument over Cree gross margins. Cree perma-bears see Cree gross margins as having only a downward trajectory due to the commoditization of the LED business, and the LED space ultimately resembling semiconductors.

"By our calculation, capacity utilization represents half the fall in gross profit margins from peak. Cree is backing off capex and if the market grows and Cree gets the transition to larger wafers right, we may well see margins defy expectations but it won't happen overnight. It's a wait-and-see story now," O'Neill wrote.

He added in comments to TheStreet, "I can almost guarantee you that if CREE gets back to 100% capacity utilization, this will be a $70-$80 stock."

-- Written by Eric Rosenbaum from New York.

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