Universal Display Corporation (PANL) is scheduled to announce earnings after market close on May 9. Analyst predictions for first quarter net EPS range from -0.16 to -0.04 cents (average: -0.09), but I think that PANL's subsequent movement should not depend primarily on the financial figures reported. As I detailed in the first article of this series, PANL is a difficult stock to value due to a combination of huge opportunities and questions about the current business model. On one end you have Brian Lee of Goldman Sachs, with a $41 price target. On the other, Jagadish Iyer from Piper Jaffray, who says shares are worth $16 each. This article will focus on shorter-term stepping stones (or stumbling blocks) to look for in order to assess which of the above viewpoints is turning out to be closer to reality for UDC.
The Future May Hold Blue Skies, but the Present is Jungle Green
I've already written about how the real opportunity for PHOLEDs, and thus UDC, is in televisions and how blue emitters are the main technological hurdle in the path to their commercialization. The thing is, TVs are just larger (and thus MUCH more profitable) versions of the screens used on mobile devices from Universal's standpoint as a materials supplier. So, we can look at materials usage in current OLED devices to infer what future income might look like for PANL. Their red materials have been in use with Samsung all along. Right now all the questions center on the green materials which are just coming into use.
There are two types of OLED materials being sold. "Emitter" material produces light when electrical current is applied, but it only makes up about 5% of that layer of the screen. "Host" material helps conduct electricity and makes up the rest. While the host material is obviously a higher volume business, it is much lower margin. In fact, Universal didn't even think host materials would be a worthwhile business until they started selling green emitters in 2011 and Samsung found that they could only get acceptable performance with the green host materials UDC was supplying. Host materials accounted for more than 10% of PANL revenue that year. Nonetheless, host materials are easier to make and less protected from an intellectual property standpoint. UDC started breaking down revenue into "material" sales and "royalty" or "licensing" in the last quarter of 2011, after the Samsung deal. When there is significant host material sales, they usually break that out as well. It is important to differentiate between the two, since it would be reasonable to expect host margins to decline or customers to switch suppliers entirely.
The emitters are the more important part. We can be pretty certain that green emitter (and host) material is going into the new Galaxy S IV and probably other high-end screens that Samsung produces. It has been assumed that all of the emitter material comes from UDC, while the green host comes from UDC and another supplier (probably Nippon Steel) but, to my knowledge, this is not actually confirmed. There are other green emitters out there and the rate of adoption for UDC's green is probably the most important thing to look for in the upcoming earnings call. This will most likely be expressed in the relative revenues for each color. I'm arguing that a high percentage (70-80%?) of green to red emitter sales should be far more important to PANL bulls than total revenue or net earnings.
Green adoption will be equally important with other display producers as well, as they ramp up production. LG has begun selling OLED televisions that use a WRGB (white, red, green, and blue pixels with a blue color filter so that the white balances out the weakness in the blue emitter) PHOLED setup. This configuration is also referred to as WOLED-CF. LG has only sold 200 such sets in Korea so far, but they predict availability in the UK in July, and for the US in the latter half of the year. Even if LG were using all UDC material, the LG production so far probably wouldn't show up enough in PANL earnings to infer anything useful. Again, we'll have to look for clues in Q&A sessions, and be alert for any changes to the ramp up plans.
Modeling PANL revenue
|development||1.5||1.7||2.0 a||3.0||2.4||4.4 b||4.2||6.3||4.9||5.9||11.9|
a- minus special payment for discontinuation of Kyocera OLED division
b- minus special payment for expired tech agreement with customer
c - only emitter sales are mentioned
The two tables above show breakdowns of PANL revenue before and after the current Samsung agreement and the associated shift in reporting. The figures are in millions and gleaned from earnings call transcripts, as reported on Seeking Alpha. I use the material sales along with figures on Samsung OLED production to arrive at a very rough estimate of UDC's materials revenue per 4.x" AMOLED display produced. Not all materials are sold to Samsung, but they do have 98% of the OLED display market; I used 90% of material sales for my models. For periods prior to the 4th quarter of 2011, I simply guessed that material revenue associated with end-user products was half of "commercial" revenue. While the latter data is certainly more relevant, using older revenues allows me to exclude development material sales and go further back in matching production figure time frames. Brian Lee has suggested that UDC makes about 20 cents per display. As you can see from the table below, any way you slice it, it's easy to conclude that this figure is completely plausible and possibly conservative.
|Period||90% of Material Revenue||/ Displays||= Revenue per Display|
|thru 2012||> $70m||300m||> $0.23|
|June 2011 thru 2012||56.25||200m||$0.28125|
|last 7 months of 2012||~$22.5m||100m||$0.225|
With some minor exceptions, the displays produced contain only red materials. The revenue on the middle line is higher due to the sale of green materials, whose use was then delayed. UDC has confirmed that the pricing and quantities for green emitters are similar to those for the reds, so there is the opportunity to roughly double revenue with green usage, plus hosts as icing on top of that. I figure that Operating Expenses increase at 15% of materials sold, in accordance with the emitter margins that UDC has reported. Where TV material usage comes into play, I guess that licensing will be the same but pricing power will be 25% less due to vastly higher volumes and/or greater efficiency in production usage. Using those assumptions along with the baseline display unit revenue above, here are a range of scenarios and associated valuations for PANL over the next two years:
Worst Case Scenario:
Samsung fails on its intent to ship over 400 million smartphones this year, with production flattening at only 200 million OLED mobile displays. They purchase the minimum amount of green material contractually required. Furthermore, LG's attempted end-run around the blue emitter problem for televisions fails to gain traction as do any other OLED TV entries, so that Samsung's mobile production continues to be UDC's primary revenue source, mostly from red materials.
|Yearly Material Revenue (200m x .28)||$56m|
|+ Licensing Revenue||$40m|
|- Operating Expense (85% emitter margin)||$73.4m|
|= Net Earnings||$22.6m|
|/ 46.2m shares x 20 PE||$9.78/share|
The PE multiple of 20 is chosen to reflect UDC's longer term prospects in general lighting, flexible displays, etc. I do not think this scenario is at all likely, but I also don't feel it's fair to include a best-case projection without an absolute worst-case alternative. For consistency and simplicity, all these scenarios ignore development and other non-primary revenue. That could have a substantial positive impact here, whereas it would be a minor factor in the others.
Samsung stays on track with the ramp up of mobile display production, making 200m this year and 400m next, all fully using UDC green emitters. OLED TV televisions, however, suffer yet another delay to mass market. Thus, Samsung remains the primary revenue source.
|Yearly Material Revenue (300m x .40)||$120m|
|+ Licensing Revenue||$40m|
|- Operating Expense (85% emitter margin)||$83m|
|= Net Earnings||$77m|
|/ 46.2m shares x 25 PE||$41.67/share|
This scenario highlights how important the acceptance of UDC's green emitters is, since their use essentially doubles revenue per device. The validation of the material applies to future device classes as well, and thus warrants the higher PE multiple. I expect that this scenario probably best models the current situation, though we may very well see aspects from two of the scenarios presented here.
LG's televisions use UDC reds and greens and ramp up as expected, selling "substantial numbers" in the next 2 years. In light of the dramatically increased emitter material volume (each 55" TV equals about ~100 mobile displays), LG signs a long-term agreement similar to the one Samsung has in place now. This pushes rival OLED TV producers to commercialize their own TV designs and the competition signals the beginning of a new replacement cycle in television technology where OLED replaces LCD (so-called LED TVs) in terms of market share. Close to 2 million sets are sold by the end of 2014, as predicted by DisplaySearch, which puts OLED TVs on a clear path to sales of ~40m units annually. As a key enabler, UDC would continue to merit a high PE ratio, or, put another way, would continue to be priced on predicted future sales. I have chosen to express the figures the latter way, modeling anticipated future sales and using a 15 P/E ratio typical for a mature high-tech supplier.
|Material Revenue (4 billion x .30)||$1.2 billion|
|+ Licensing Revenue||$80m|
|- Operating Expense (75% margin, 50% increase in base expenses)||$338m|
|= Net Earnings||$942m|
|/ 46.2m shares x 15 PE||$305.84/share|
This scenario illustrates the sheer material volume likely to be associated with OLED televisions. UDC having any piece of the pie would certainly be a game changer, should OLED fulfill its promise to become the dominant technology for large displays. More work probably needs to be done (not necessarily by UDC) for that to happen. Nonetheless, this scenario may well be the most likely path of technological progress in display technology.
These scenarios are meant only to illustrate the relative importance of the factors in play for UDC's current revenue. I have tried to extrapolate available data into best possible estimates for each variable and then done the math, but most estimates involve a degree of guesswork that gives the resultant valuations ballpark validity at best. Keep in mind also that I am not including host or development income and am completely ignoring longer term prospects like general lighting and flexible displays. In light of all this, I believe the data clearly shows that if adoption of UDC's green materials is confirmed, there is significant upside from the current valuation. Investors should be able to gain clarity on this point from the upcoming earnings report, as detailed above. Finally, PANL represents a rare multi-bagger opportunity should the company's materials enable broad commercialization of OLED televisions. The information presented here and in the prior article can be used to assess developments over the next year or so towards that goal.