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Universal Display Corp (PANL) is not a stock for those prone to motion sickness. After spending a decade of trading between $10 and $20 per share, it began to rise in 2010, eventually peaking at over $60. Single day price moves over 5% are not uncommon, and the stock sports a 1.3 beta, meaning it is 30% more volatile than the market as a whole. Furthermore, with $30 price tag and associated PE of ~150, PANL shares are clearly not being valued on the basis of the current business, but rather on future prospects. Nonetheless, even if we limit our assessment to the current revenue-producing aspects, the prospects look very enticing: DisplaySearch expects revenues for this market to exceed $11.3B in 2013, up from $6.9B last year, and further predicts that the market will reach $44B by 2019.

This article will give a brief overview of UDC's display technology and then go on to discuss medium-term technological and business points, along with associated risk factors, that I believe are still missing in order for PANL to realize its full potential. A subsequent article will discuss key points to look for in the next earnings call, due in early May, in order to assess the ongoing business. Universal Display has other, longer-term development projects, such as general lighting, with enormous potential. This article will not discuss those, though a future one may.

OLED Displays: a technology which has yet to see optimal use

Universal Display develops organic light emitting diode (OLED) technologies and materials. The company's revenue comes from the licensing of these patented technologies and the sale of associated OLED materials. With the acquisition of patents from Fujifilm last July, UDC owns or has exclusive rights to more than 3000 patents worldwide, and is far and away the purest stock play on OLED technology. The technology has two primary applications, displays and general lighting, with the former being more advanced in terms of commercialization. Consequently, UDC derives the virtually all of its current revenue from the small screens used in smart-phones, media players, tablets, etc.

One reason OLED first gained traction in small, mobile (battery-operated) devices is because of its lower power consumption. Yet OLED is even better suited for televisions. since it is essentially plastic and can be more easily manufactured into large sheets than the crystals used in LCDs. To see a more important reason why OLED is better suited to TVs, take an OLED smart-phone out into the sunlight along with an LCD one. The OLED screen will seem to wash out more than its LCD competitor. The reason is that LCD makes a picture by filtering light emanating from behind the screen (it is "back-lit"). OLED emits light directly from the pixels, which is why it is more power efficient, particularly with dark images. Thus the OLED pixels have to compete with external light, whereas the filtering LCD pixels reflect or absorb it. Televisions are typically used indoors, so this issue goes away. Furthermore, OLED gives far more vibrant color, better contrast viewing angles, and faster switching (no blur even with fast moving images, as with a ball in sports). This article provides some nice detail on the differences in technology, and to quote from it:

The 55-Inch OLEDs shown at the 2012 attracted attendees like moths to a light bulb on a summer night.

If you look closely, however, you'll see that the article was written over a year ago, and predicts:

In just a few months we expect the first large screen OLED HDTVs to be offered for sale in the US.

In fact, OLED TVs were demoed at CES in 2010, which is part what caused the stock to take off then. With all of those advantages, why haven't OLED TVs taken over? The answer is our first puzzle piece...

Technology Puzzle Piece: Blue emitters

You might recall from science class that you can make any color by combining various amounts of red, green and blue light. The (O)LED materials that emit light gradually wear out as current is passed through them (the more current, the faster they wear out). The organic versions of these materials typically have better power-efficiency and thus longer lifetimes than their non-organic counterparts. For a mobile device to have its screen on 3 hours a day for 8 years requires 10,000 hours of material lifetime. The materials that emit red have lifetimes of 50,000 hours without noticeable degradation (95% of initial brightness), more than good enough. UDC's green material lifetimes have also improved to 18,000 hours, and have started to come into use over the last year. The latest OLED light blue emitter materials at UDC currently have equivalent lifetimes of 700 hours (and even less for the deep blue that would be most suitable for displays), which is obviously not usable. Consequently, current OLED displays use traditional fluorescent systems for their blue light, which have a fraction of the lifetimes mentioned for red and green.

While noticeable color degradation and/or the need to replace after a few years might be acceptable to most consumers with a several hundred dollar smart-phone, that is unlikely to be the case for a high-end television costing ten times as much. TV replacement cycles have been shortening, but they should still be expected to last 7-10 years. Figuring for an 8 year lifespan at 6hours/day, we would need to see blue emitters with 20,000 hour lifetime. While UDC is certainly working on this problem, it's important to note that they do not necessarily need to be the developer of a commercially viable blue emitter in order to profit from the advance. A 55" television has roughly 100 times the display area of 5 inch phone screen; while producers' material efficiencies will no doubt continue to improve, it is still safe to assume that PANL's material sales will increase by an order of magnitude once OLED TVs are produced in volume. Last June, Dupont announced a blue emitter material with a lifetime of 33,000 hours to 50% of initial luminosity (not the 95% for the figures above). While Dupont claims this is good enough for TVs, it's probably borderline at best, and the latest OLED TV delay from LG seems to support that assessment. The technology is certainly getting close, though.

Business Puzzle Piece: Customer Diversity

If the blue-emitter problem can be solved, then I believe the other puzzle piece will fall into place on its own. Nonetheless, it would be hard to overstate the danger represented by this piece as things currently stand. I said above that UDC currently derives virtually all of its current revenue from small OLED screens. Samsung Mobile Display (SMD) dominates the production of these screens with 98% market share and accounts for the vast majority of UDC's revenues. While Universal Display also has agreements with a host of other companies, it's important to realize that these are development agreements made so that these companies can assess UDC technology and products in the hope that they will eventually utilize them in production of consumer products. Doing that would require a commercial agreement, like the one (and only) in place with SMD.

I believe the market completely underestimates the importance of this piece of the equation. The implications go far beyond simple pricing power; they affect information flow, all aspects of negotiation, and even general decision-making. Years ago, I spoke directly with a member of Universal's executive management and it seemed very clear to me just how tied their hands are with SMD. At the time, a 3 year development contract between the two had just expired, yet UDC confirmed that Samsung was continuing PHOLED development as usual. This situation dragged on for months before they eventually announced a series of extensions to that agreement, and then finally the current commercial one, which is heavily redacted and full of loopholes for SMD. If nothing else, multiple commercial customers would give investors additional data for comparison and analysis.

The bigger picture, though, is that UDC gaining multiple commercial agreements has the potential to completely transform future OLED development. Paula Doe from SEMI Emerging Markets says:

Anxious to avoid another experience like the commoditization of the LCD sector, display makers intend to keep their processes and complex OLEDs materials stacks to themselves this time, which makes process integration of different materials and equipment difficult.

Yet some integration is almost certainly necessary for OLEDs to advance at all. The Korean government seems to recognize this already, and UDC, as the leading developer in the field, and one of the only ones not in competition with the other end-marketers of displays, could eventually take a role in further integration.

Risk Factors

Predicting technological advance is always difficult and therefore risky. While Universal Display need not provide the entire OLED solution in order to succeed, there is always the possibility of a competing technology decreasing the relative value of what OLED can do. As an example, LCD displays (including the latest so-called LED TVs, which are really LED-backlit LCDs) have been tweaked to provide increasing levels of efficiency and image quality, which has in turn, slowed OLED adoption. Ironically, this particular development has also spurred OLED producers to push forward in using UDC's green emitters in order to improve power consumption and remain competitive. Even so, while OLED seems intrinsically better than LCD for displays, not all OLED technologies and processes are compatible, and UDC could be sidelined even as OLED becomes successful. An example would be Polymer-OLED (P-OLED), an alternative to the small-molecule phosphorescent (PHOLED) approach favored by UDC, which might just rise from the dead.

Assessing all of these risks tends to be made a little more difficult by UDC management, which is not always as conservative as it could be. This may be largely due to the missing Business Puzzle Piece described above. An example would be their projections on the use of their green emitters, which caused earnings disappointment. UDC makes such projections based on the information they get from their customer, and clearly, that situation represented a tangible risk to PANL investors. Similarly, while UDC seems to be out of the woods for the time being on patent challenges, intellectual property is always a concern for any emerging technology, and one has to wonder how well the company would publicly assess the risk for its investors.

Finally, I must emphasize again the danger of relying on a single customer for revenue. If you need this illustrated graphically, look at a 5 year chart of American Superconductor (AMSC) and see what happened when things went bad with their primary customer, Sinovel, in 2011. Korea is not China when it comes to intellectual property, but doing business with the chaebol is not a warm and chummy prospect. In short, Samsung should be regarded as more of a "frenemy" than a partner.

Summary

PANL is a stock with great potential, but execution risks to their current primary business remain. The best way to be ahead of the curve on these is to understand PHOLED technology, but this is a highly complicated and uncertain endeavor. The surest indicator of success will be further commercial contracts with OLED producers. Look for LG as the leading candidate for a second such contract, and follow me for the next article on what to look for in the next earnings report in early May.

Source: 2 Remaining Puzzle Pieces For Universal Display's Success