Questions Answered After Cree's Acquisition Of Ruud Lighting

Aug.22.11 | About: Cree, Inc. (CREE)

Alan Ruud, founder of Ruud Lighting along with its BetaLED brand and new Cree (NASDAQ:CREE) board member and Chuck Swoboda, Chairman and CEO, Cree, Inc. sat down for an interview with the EdisonReport, the day after Cree acquired Ruud Lighting.

Ed: Has Warren Buffett called to invite you to play bridge now that you are in his ranks?

Al: (laughter) No, I am not a billionaire yet, with emphasis on the word yet. Remember, about 40% of the value is in stock and I am now a large shareholder of Cree. This is a powerful combination that I believe is going to dramatically improve the value of Cree over time. Remember, I am not doing this and walking away. This isn’t just a cash deal; it was for the stock as well, and I am personally expecting big things out of the stock.

Ed: Full disclosure. I own a few shares in most public lighting companies as it helps keep me informed, and I, too, am a Cree shareholder.

Chuck: Great, then basically I work for both of you.

Ed: Al, why now?

Al: A number of reasons. I am not a patient person. I see the opportunity out there. We have some products set for introduction next year, but we need to do more. Being a private company, we can only do so much. The opportunities are huge, and we need to bring more products to the market faster. We have capital, and that dictates how much can go through the development pipeline. With Cree, we can go further, faster than we could do on our own.

Ed: Have you always been a Cree customer?

Al: In LED, yes. We used Cree because they are the best. Recently they launched a great indoor product line, which is very different from what we do. Our businesses are totally complementary. If I deliberately tried five years ago to put together a plan to bring the two companies together, I could not have planned it this well. If we tried to set a strategy to go our own way originally and then get together now, we cold not have done a better job. The two companies complement each other in regards to products, people, service, and culture.

Chuck: We bet the company on LED. Our culture is about technology and products that people don’t expect. We try to solve the unsolvable. There are lots of synergies between the two companies, and the cultures between Ruud and Cree are very similar. Most M&A does not work because of culture. Having a similar culture is why we believe this combination can work.

Ed: Was it a coincidence that Cree launched an indoor luminaire or was it a deliberate decision not to compete with Ruud? I saw the CR Series at LIGHTFAIR, and it is a great product. As I recall the tagline said “It’s Payback Time!” Most companies understand the tagline reflects the quick ROI, but some think the tagline has a bit of a sinister double meaning in that it is payback time for the OEMs who have not launched LED as fast as Cree would like. Some think you are paying the OEMs back by competing against them.

Chuck: No. The product has a very short payback, and that was the only intention of the tagline. It is a catchy line, and the product is doing great. We are focused on driving a revolution to change everything to LED. You can have the best technical story, but in the end, nothing grows in a big way unless there is a financial payback. Without a payback, we don’t believe the technology will have wide scale adoption.

Ed: Al, how is it that you jumped in first? What did you see that the conglomerates did not?

Al: I did jump in first, but I don’t know if I saw it first. The conglomerates probably saw it too, but they have such an asset base that a rapid transformation is a threat. For a private company, the best time to leapfrog competition is during a technology shift. It was a once-in-a-lifetime opportunity to make our point in the market place. We did take a hit in margins early on as we began to ramp. Public companies would not have been able to stand that, but we did not have the luxury of time to be a me-too. Think about it, how often does a new technology come along in lighting?

Ed: Let me tell you both that EdisonReport had no prior notice of this acquisition. Usually, during due diligence, we’ll hear a little chatter; a few anonymous messages come in. We heard none. But, Al, over the years we have heard that you talked to various people some formally and other informally. We are told that Cree approached you and that you did not solicit any other offers.

Al: That is correct.

Ed: Cree paid a multiplier on revenue anywhere between 3 and 3.6 depending on how you account for the taxes. In 2008, Philips paid about a 1.6X multiplier for Genlyte—and those were great times. The economy was at its peak. Did you pay too much?

Chuck: We don’t believe so, because we did not buy a traditional fixture company. We purchased an LED company, and have now combined two system companies dedicated to only LED: Cree and Ruud. We believe an integrated approach is how you best move the market. Ruud is not an old-line fixture company. Since 2007, Ruud Lighting is the only company we have seen make the transformation to a majority of their products being LED.

Al: Let me add that we have not spent one dime on R&D on anything except LED in the last five years.

Ed: I am aware of that.

Al: We still do have some other legacy products, and we make money off those legacy products. We will continue to sell them until we are successful with an LED replacement and customers choose to change their buying habits. When we stepped in five years ago, there was no question that we were going to transform our business. We jumped in, and this is the future here today. HID is the 20th century.

Ed: Do you anticipate losing any of your OEM business as you now compete against your customers?

Chuck: At LIGHTFAIR New York, 2007, there were three companies talking about LED: Cree, Ruud Lighting and LLF, which was a small company building LED downlights. We acquired LLF in 2008, and we have grown their business while growing our LED components business. So we believe you can do both.

Early on, we thought general illumination would convert to LEDs. Most in the industry thought we were crazy. We thought it was possible to drive the market, and we tried selling lighting-class LEDs to everyone in the industry. We learned that even if we had the best components in the world—we could not drive the market as a source company. We bought LLF because we wanted to push the demand side of the market faster.

Buying LLF, and now Ruud, accelerates the adoption of LED, which creates a bigger market. Not just for Cree, but for the entire LED industry. This is an important point. We are not just growing demand for Cree, we are growing LED demand period and many lighting companies will benefit. In addition, society as a whole benefits because of the energy reduction, the maintenance savings, and the improved quality of light.

Ed: Ok, I respect your answer Chuck, but that is your standard answer that you used on the conference call. Let’s really discuss this. Our industry is a people-industry and these people have long memories. Many don’t like Ruud Lighting. Ruud evokes a certain emotion from their competitors. Do you sincerely believe that all of your customers ignore the fact that you compete against them?

Chuck: We expect that luminaire manufacturers will make the best decision for their business. We will keep working very hard to deliver value to those customers and ensure that we have the best value proposition for LED components. Every other LED components company is in the system business, and this is the nature of our industry. Vertical integration allows us to accelerate the rate of innovation, and we are here to drive adoption. Remember, I am a guy who at one time had 100% of a market that was zero. I believe most successful businesses will figure out how to make the best products for their customers. They may not like Al because he is pushing them to do things faster, but long term, this will drive the industry to deliver better LED lighting.

Al: Let me add to that. First, midlevel people may feel as you mentioned. But very sharp business people run the businesses. They will put their bottom line ahead of emotion. Do you really think they will buy a lower quality LED and pay a higher price because of emotion? They run their companies based on facts. Look at GE, SYLVANIA and Philips—all are source companies and all are fixture companies. This is the state of our industry. Any company that would move away from Cree because they don’t like what we have done and buy an inferior product at a higher price is not a smart businessperson.

Ed: Al, when Philips (NYSE:PHG) purchased Genlyte, did you shift any of your business away from Philips or Advance?

Al: No. Was I going to buy a more expensive ballast or a lower quality lamp? It wouldn’t have been a good business decision.

Ed: One of the benefits to LED Lighting is the superior uniformity. We find that typically a parking lot may be designed with half-a-footcandle minimum. With HID, there may be five footcandles under the pole, then three footcandles, and the darkest portion of the lot is half-a-footcandle. I teach my daughter to park under that hotspot. Now, everything is being designed to the lowest common denominator. I agree that there is superior uniformity, but the parking lots are uniformly dark.

Al: But remember these IES Recommended Practices were written around the legacy technology. At the time, those practices were the best that technology allowed. There need to be new standards, and there will be.

Chuck: Maybe half-a-footcandle is no longer the right number. Tell us what you want. The beauty of LED technology is that it does not matter. Tell us the amount of light you need, and we can give it to you. It will be more uniform, substantially more energy savings, less maintenance cost, and even a better of quality of light. LED allows for much for flexibility; it should not be a compromise. It should be better in all aspects.

Ed: Al, will you keep the plane? I understand that you pick up people and fly them to various sites. Sometimes, they think you are a hired pilot and don’t grasp the fact that you are the CEO initially.

Al: Yes, we are keeping the jet, and it has been a great tool. Seeing is believing, and we have closed many orders once our customer can know exactly what to expect.

Ed: Will there be rep changes?

Al: We have people working on that. I won’t say there won’t be any changes. We had sales teams in here today working on this issue. The deal is only 24 hours old, so it’s just too early to make any statement.

We signed the agreement and closed the deal at the same time. This is helpful as it allows us to work on our synergies immediately. Sometimes there is a 30-day or 60-day gap before the closing, and it becomes hard on the employees. The first binding agreement was at the closing. I really like the fact that the deal is already closed.

At $525,000,000, I bet he does.

Disclosure: I am long CREE, GE, PHG.