NEW YORK ( TheStreet) -- Sales of core equipment for the LED sector fell in the first quarter of 2011, the first time that MOCVD tool orders have slipped after seven consecutive quarterly increases. China's devouring of LED tools, though, continued unabated to start 2011, according to a first-quarter survey from IMS Research.

The pace of tool orders in the MOCVD market, and the extent to which the market has become reliant on sales to China, are key trading triggers for the LED sector equipment duopoly of Veeco Instruments ( VECO - Get Report) and Aixtron ( AIXG).

Shipments for both Veeco and Aixtron were down quarter over quarter, with MOCVD reactor shipments falling 18%. However, the year-over-year view presents a different picture, with LED equipment orders rising 31%.

China has been the story, and Veeco has been gaining a bigger piece of the China story as the LED markets of Korea and Taiwan move more slowly on capital spending increases.

Shipments of MOCVD tools to China (GaN MOCVD tools, specifically, which represent 97% of the MOCVD market) rose from 64% to 74% in the first quarter, according to IMS Research survey data.

For Veeco, China was 90% of its first quarter shipments, while China accounted for 63% of Aixtron shipments, according to IMS Research. Veeco led in China and Europe while Aixtron led in Korea, Taiwan and the U.S.

In the total MOCVD tool market share race, IMS Research data shows that Veeco gained a point of market share, up from 43% to 44% when measuring total MOCVD shipments, with Aixtron losing a point of share from 53% to 52%.

One of the more important data points in the IMS Research survey is projections for the Chinese market. There has been endless speculation about when the Chinese government stops offering subsidies to MOCVD tool purchasers, and some provinces have already pulled back on subsidies, according to published reports, among them a report from Citigroup analyst Tim Arcuri.

Yet IMS Research shows no slowdown in the Chinese market. "Looking forward, we are not seeing installations being pushed out in China. "We are not seeing installations being pushed out in China. We expected to see some delays, but we have only reduced our 2011 forecast by 8 reactors from 1097 to 1089," IMS Research concluded. The total of 1089 reactors implied significant growth for the MOCVD market from the second quarter through fourth quarter of 2011.

IMS Research estimates that China will account for 820 tools in 2011, up 181%. In terms of MOCVD market share, China is expected to account for 75% of the 2011 MOCVD market, up from 36% in 2010. China is the only region expected to show year over year growth in MOCVD tool order. China's fourth quarter installations alone are expected to be larger than the entire worldwide 2009 market, the consultant noted. Korea has taken the much larger tumbled as compared to No. 2 market Taiwan, down 85% to 33 tools.

Ross Young, senior v.p. at IMS said the strength in the market has been somewhat surprising. The company expected a forecast for MOCVD tool orders at 1,100 to decline, as orders get delayed and China becomes more stringent about subsidies.

IMS Research added that a number of companies provided the consultant with 2012 plans regardless of whether or not there are MOCVD subsidies. Other incentives are proving powerful enough to enable continued investment in LED capacity in China. "We expect significant growth in Q2'11 and Q4'11 resulting in 1089 reactors installed in 2011," the consulting firm said.

While the IMS Research data contradicts some of the bearish reports on MOCVD sales, some analysts view the tool order estimates as one more sign of the looming glut in the LED space.

Mark Miller, analyst at Noble Financial, said the IMS Research 2011 LED tool forecast seems high and adds to his concern about too many tools at too many manufacturers. Miller said the issue isn't how many tools are being ordered by China, but how many tools are needed to meet demand. Several analysts are of the opinion that as tool orders from China continue to rise, it is a reflection of artificial, as opposed to actual, demand for LEDs. "The market is running ahead of itself in capacity additions," Miller said.

A second LED market analyst noted that the IMS Research data can be read as "net bearish" because the only country ordering tools is China. "This benefits Veeco because of the mix, and Veeco was upbeat on the next two quarters, but at some point it ends because China is propping them up," the analyst said.

Veeco's recent earnings were strong and shares of both Veeco and Aixtron have held up well even as the bear case against both companies' remains dedicated.

The analyst added that Veeco is inexpensively valued relative to Aixtron, therefore, even with a longer-term bearish view of Chinese orders, Veeco shares are fairly valued. For Aixtron, the current issue is that Korea and Taiwan remain weak markets, and Aixtron does not have enough China business relative to Veeco. Until China grinds to a halt and Korea and Taiwan start spending again on LED orders Aixtron will continue to lose market share, the analyst said.

IMS Research's Young said, "We're not seeing that yet for calendar year 2011. The good news is that it still looks good for MOCVD tools, and it seems like it could be a record year for the MOCVD guys."

Last week, in another sign of recent LED market strength supported by the tool orders, Rubicon Technology reported another beat and raise quarter. Rubicon provides the sapphire substrate used in LED production.

Ultimately, the issue is what drives orders for Veeco and Aixtron one year from now. Reports from LED manufacturers Cree ( CREE - Get Report) and SemiLEDs ( LEDS - Get Report) have shown the weak pricing environment and inventory glut. Cree shares are down 40% this year, and the reaction to its recent earnings was fear that things get worse before they get better. SemiLEDs is down 60% this year.

"The problem with LED tools is that all that capacity is really fueling incremental buyers as opposed to the installed base plus new guys," the LED analyst said, asking, "Is this problematic today or year from now? That's the issue facing the LED supply chain overall."

Analysts say that even as China speeds ahead with its LED tool orders, figuring out what will drive new orders for Aixtron and Veeco with installed capacity able to meet existing demand is the question. "Veeco and Aixtron say the market has to buy new tools because the new tools will be much more efficient and make better LEDs and there is logic there, but the demand side has to continue to grow at a strong clip," the LED analyst said.

Noble Financial Miller's added that IMS Research data on LED market growth shows a more moderate growth profile than Noble Financial's model through 2014. IMS Research has projected about 84 billion LEDs in 2011, 108 billion in 2012, 130 billion in 2013, and 158 billion in 2014.

Noble Financial projects 106 billion LEDs in 2011, 146 billion in 2012, 185 billion in 2013, and 240 billion in 2014. Miller said the continued growth in MOCVD tools in 2011 can't be squared with the LED demand outlook, especially as IMS Research expects more moderate growth than Noble, and Noble believes the market is headed for a glut.

Indeed, IMS Research's Young said that additional supply after 2011 MOCVD tool installs is not required until 2014 to meet demand.

"We believe around 450 rather than 800 tools should have been installed in 2010 and only an additional 700 tools in 2011 and 2012 combined are necessary to keep up with demand. But rather than 1150 tools from 2010 - 2012, we are showing nearly 1900 tools in 2010 and 2011. So the big question is, where do orders come from after 2011?" Young asked.

The IMS Research senior v.p. said in answer to this question that new entrants in China as well as existing players in China who didn't invest much from 2010 to 2011 have plans to add a healthy amount of capacity in 2012. IMS also expects companies who expect to win significant lighting business to invest as that market will start to accelerate in 2013. Other companies with plans to boost their market share will continue to invest as will companies looking to take advantage of the most advanced tools to lower their costs.

On the demand side of the equation, the impact of all the low cost supply coming on is lower costs and prices in LED backlighting and general lighting,which should accelerate those markets beyond the existing IMS demand forecast, by enabling alternative approaches for backlighting to be used which consume more LEDs and boost contrast and power performance over the conventional edge LED, and also with growing 3D volumes boosting LED consumption.

Yet even with the potential for new demand, IMS Research sees a bubble. "Consolidation may be inevitable as the bubble that continues to grow may burst eventually. There are just too many players in this space today with 3-5 new companies jumping in every quarter, it is truly amazing. It is most likely unsustainable unless new markets are created we aren't aware of," Young concluded.

Veeco Instruments and Aixtron were both close to flat in trading on Monday. Veeco shares were recently trading at $50.97. The $50 to $51 range has served as a the upper level for Veeco share action recently.

-- Written by Eric Rosenbaum from New York.


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