After Cree's Industry Changing Acquisition of BetaLED, Still Many Unknowns

| About: Cree, Inc. (CREE)

Tuesday, 16 AUG, we were working on a story about Cree (NASDAQ:CREE) steamrolling the OEMs and selling direct. Our source was a Tier 1 OEM who complained that at the July SSL conference in Seattle, Cree presented a giant steamroller on the first slide. The implied message, we were told, was that Cree was going to steamroll the OEMs and sell direct.

We contacted Cree and had full access to their team that presented in Seattle. The presenter explained that the steamroller metaphor was meant to show how the semiconductor industry can rapidly drive cost through performance increases and aggressive cost reduction. Further, Cree sent us a copy of the presentation and it was clear that nothing in the PowerPoint indicated they were going to steamroll the OEMs.

Late Tuesday we notified Cree that we were not pursuing the story. Wednesday, 17 AUG, we learned that Cree purchased Ruud and the crown jewel of the LED industry, BetaLED. The lighting world has changed.

The deal cost Cree $525M between cash and stock. We ran the numbers past a prominent Silicon Valley lighting CEO who gave us insight on the sales price. One benefit for Cree is that it helps them escape the semi conductor label which typically has a value multiplier of 1X sales. Semiconductor companies typically receive low evaluations because they are cyclical and capital intensive. Owning a luminaire company may allow them to trade at 2X revenue. At a $525M price, it is likely that Cree paid approximately 3X the 2011 forecasted revenue. Another benefit to Cree is that margins on LEDs are declining rapidly and there will be higher gross margin dollars on luminaires fixture than on LEDs by themselves.

We are told that BetaLED and Cree struck a deal years ago which gave favorable pricing to BetaLED in exchange for volume. This deal would protect Ruud from other competitors—as well as from Cree—so long as Ruud developed the market, which they did very well.

The benefit to Ruud is obvious—half a billion dollars. There may be one other benefit and that has to do with pending patent litigation between Cooper and Ruud over Illumination Management Solutions, Inc., a company on whose Board of Directors Al Ruud sat, and which Cooper acquired in 2009. This could be quite expensive to defend.

One of the most important issues of the acquisition is whether Cree can keep and expand their base of OEM business or if they will choose, or be forced, to go it alone. The industry has wrestled this issue for decades with various results.

GE sells sources to luminaire manufacturers who compete against GE’s luminaire division in Hendersonville, NC. This has caused very few problems for GE.

The opposite happened to Venture Lighting in January 1998, when their parent company, ADLT acquired Ruud Lighting. At the time, we at EdisonReport wrote that the deal reminded us of the acquisition of Taco Bell by Pepsico (NYSE:PEP), where Coca-Cola (NYSE:KO) ran ads asking the fast food industry if their supplier (Pepsi) reminded them of their competition (TacoBell, KFC, etc.). Pepsico eventually spun off their restaurant business and ADLT sold Ruud back to Al Ruud.

The Philips (NYSE:PHG) Genlyte deal is much closer to the GE deal in that Philips has been able to keep most of its luminaire manufacturers happy. It did not happen by accident. Philips has managed, and continues to manage, these relationships and sometimes make great sacrifices to keep the OEMs feeling they are being treated fairly.

Most luminaire companies don’t like each other, but they even like BetaLED less. Part of the resentment is historic. Ruud Lighting sold direct and bypassed electrical distributors, giving Ruud a clear price advantage to the end user over its competitors. Over time, as Ruud grew and they became world-class, some of those bypassed distributors began to actually buy from Ruud. This was due to Ruud’s efficient service and exceptional quality, related in part to their Delta Guard Finish which was regarded as superior to the industry-standard powder coat finishing. Recently, with the success of BetaLED, the entire outdoor lighting industry has been jarred. In addition, the tier 1 reps complain very loudly about losing street lighting business to BetaLED—in some cases, decade-long contracts.

What will happen to Cree’s existing OEM outdoor business? Street lighting has until recently been dominated by GE Lighting Systems, Cooper (CBE), and Acuity Brands (NYSE:AYI) (American Electric and Holophane.) We would expect GE to continue buying from Cree, but obviously, there will be less collaboration. Presently, GE purchases LEDs from Cree and populates the Printed Circuit Boards for fixtures.

We would expect Cooper to shift some of their business away from Cree because of the aforementioned litigation.

We have no idea what the luminaire companies of Philips will do. These companies do purchase a significant portion of their LEDs from Cree. Approximately two years ago, Philips set up a roadway division that competes head-to-head with BetaLED.

One luminaire manufacturer told us that being a part of a public company, he would expect to see BetaLED focus on their return on investment and not take jobs at gutter pricing. Recently, he said BetaLED has not been the price leader and has been slightly less aggressive in the market place.

There are many unknowns after this industry changing acquisition. The question is, will Cree steamroll forward?

Disclosure: I am long CREE, GE, PHG.