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By Melissa Davis

* Author's Note: The StreetSweeper published its original investigative report on Universal Display (NASDAQ:PANL) in October, when it took a close look at key changes in the company's long-term relationship with Samsung (OTC:SSNLF) -- its largest source of commercial revenue by far -- and the flurry of insider sales that surrounded that important top-secret deal. Click here to access that earlier article.

When Universal Display Corporation originally patented the core technology that now ranks as its primary asset, historical records clearly suggest, the company simply combined two existing inventions and then celebrated the resulting “breakthrough” as its own.

For its part, UDC has long proclaimed that its research partners at Princeton University first discovered modern organic light emitting diode ((NASDAQ:OLED)) technology in the late 1990s and then went on to develop the actual OLED materials that now illuminate the display screens of some popular handheld devices found on the market today. In fact, however, outside researchers actually reported similar achievements years before UDC ever arrived on the scene. Armed with evidence of that “prior art,” UDC rivals now hope to severely weaken – if not completely destroy – the broad OLED patents secured by the company.

From the start, UDC has basically relied on two early patents to serve as the foundation for its entire portfolio. The first established the design of its fundamental technology, known as the “OLED stack,” while the second covered the special “emitter” compounds – since limited to iridium by patent authorities overseas – that generate the light in OLED-powered screens. By the time that UDC received (or even requested) those far-reaching patents, however, others had already documented similar breakthroughs in the field.

UDC did not respond to questions for this story.

Phillips Electronics (NYSE:PHG) actually patented a multilevel OLED stack back in the mid-1990s, records show, some two years before UDC followed up by presenting that same type of design. Moreover, when Phillips described the core elements of its invention in 1995, the company used the same kind of language – at times almost identical in nature – that UDC would later include in a related patent issued to the company six years down the road.

Phillips is now challenging a European version of that UDC patent overseas, records show, using its own patent (along with the early research of others) to portray its smaller rival as a glorified copycat. In a nutshell, Phillips argues, UDC secured an unfair patent – based upon technology that “is not new” and “does not involve an inventive step” – that the company arguably should have never received at all.

Similarly, records indicate, UDC followed in the footsteps of others when formulating the “unique” OLED emitter materials – specifically those derived from iridium --covered in its second major patent as well. Long before UDC showcased this development, records show, outsiders had already traveled down that same path by establishing the power of iridium to generate light. Researchers at the University of Southern California-Santa Barbara first highlighted this breakthrough two full decades ago, in fact, with a separate group of scientists further advancing that discovery – using iridium to create light at room temperature this time – that same year.

Notably, experts say, the second study (found in a 1991 edition of Organic Chemistry) includes two key graphics – a chart and a drawing – that clearly expose that early iridium-based compound as the same one that UDC would later present to patent authorities as its very own.

Regardless, UDC has always portrayed itself as a rare trailblazer that – because of its long-ago achievements – gained exclusive control over both the technology and the special light-emitting materials used to power OLED-enabled display screens today. More recently, in an effort to further bolster its argument, UDC has begun pointing to a renewed contract with Samsung (the true powerhouse of the OLED industry) as clear validation of its fundamental patents. Yet other companies have paid hefty fees for patents that proved worthless on down the road, history shows, with Research in Motion (RIMM) – the maker of popular BlackBerry devices -- forking over $600 million for allegedly infringing on patents that later failed to hold up in court.

Meanwhile, as we detailed in a big investigative report two months ago, Samsung has already stopped paying UDC royalties in exchange for use of its technology. Under a new long-term agreement inked by the two parties this summer, Samsung simply offered UDC a flat licensing fee – sweetened with the promise of future orders for its OLED chemicals – instead. By changing key aspects of that important deal, some believe, Samsung expressed only a lukewarm commitment to UDC and the technology that it holds.

“Samsung’s decision to sign on means that, at present, it was easier to use PANL’s materials than litigate by itself or by proxy,” Oppenheimer speculated last month, “especially given that it has had a relationship with the company and used the chemicals since 2005. (So) it has had access to these chemicals” already.

Adopting a more critical tone than some other notable names on Wall Street, Oppenheimer describes UDC as a “very tight-lipped company” with a “tendency to portray itself as (the) only game in town” despite the “constant patent fights” that it keeps facing. Clearly distancing itself from the enthusiastic bull camp, Oppenheimer remains on the sidelines with the equivalent of a hold recommendation on the stock and (at last check) no projected price target on the volatile shares at all.

UDC has won over plenty of loyal fans at this point, however, with even Goldman Sachs joining the pack after managing a lucrative secondary offering for the company earlier this year. Since resuming its bullish coverage of UDC last month, Goldman Sachs has repeatedly urged investors to buy the stock – currently below the $40 mark -- ahead of a projected run toward $70 a share.

But Peter Cohan, a Massachusetts-based investment strategist who doubles as an advisor to technology firms, suspects that both UDC and Goldman have misled investors about the future potential of the company. He, for one, assigns little value to the OLED patents trumpeted by UDC and its followers – predicting that, if challenged in court, those patents would fail to survive – and portrays the company as a master of “smoke screens” instead.

“It’s interesting that Goldman is touting this stock,” says Cohan, who holds no financial position in UDC himself. “It’s just another example of Goldman assuming that investors are incredibly stupid. They did the same thing with subprime mortgages, when they convinced investors to go long on a big pile of garbage …

“This is how Goldman makes money,” he insists. “They prey on the ignorance of investors.”

For now, at least, UDC boasts a generous market capitalization of $1.76 billion – an astounding 34 times its prior-year sales – based entirely upon the perceived value of the OLED patents secured by the company. UDC facesmultiple challenges to those patents, however, which could pose real threats to the company and its future success.

Colorful Spin

A few years ago, with UDC banking on monopoly-like control over the OLED market, rival Merck (NYSE:MRK) bluntly dismissed that possibility.

Like UDC itself, records indicate, Merck had by then invested sizable resources in the development of OLED materials that promised to revolutionize the entire display industry. While Merck had successfully cornered a huge chunk of the market for chemicals used in traditional liquid crystal display (LCD) screens, however, the company saw little chance that any player would ever achieve similar power in the developing OLED space.

“It will not be one dominating supplier in OLED,” Merck assured Reuters at the time. “Not a single supplier will have such a strong position as we have in liquid crystals. There will be different companies with different materials, and we will be one of them.”

To help ensure that competition, records indicate, Merck took direct aim at UDC by challenging the broad OLED patent protection long trumpeted by the smaller company. With the help of giant BASF and Sumation (a joint venture between Sumitomo and Cambridge Display Technology), records indicate, Merck recently weakened a key OLED patent secured by UDC overseas. By presenting evidence of similar technology that surfaced decades ago,records show, that trio managed to invalidate most of the claims included in a European version of the “universal” OLED patents that UDC counts as its most valuable assets of all.

Notably, legal experts have indicated in the past, foreign rulings can influence future reviews of related U.S. patents on down the road.

“When considering the value of a patent, it is also important to consider what has happened to foreign counterpart patents and applications in the various patent offices around the world,” a pair of patent attorneys wrote in the New York Law Journal a few years ago.

Although the findings of these proceedings are not binding under U.S. law, as a matter of practicality, an adverse determination in a foreign tribunal may diminish the value of a U.S. patent because of the risk that a U.S. court or the USPTO (United States Patent & Trade Office) will analyze the subject matter in the same way that the foreign tribunal did.

Nevertheless, UDC has boldly presented the recent decision in Europe as an outright victory for the company. Although the European Patent Office struck down 18 of the 30 claims originally included in that fundamental patent, records indicate, UDC has chosen to focus on the dozen claims that remain intact – specifically those covering iridium materials found in commercial devices today – while curiously proclaiming that the rest somehow fall “outside the OLED world.”

While UDC retained some control over phosphorescent OLED (PHOLED) materials derived from iridium, however, other companies have apparently developed similar chemicals of their own. When Oppenheimer performed a “cursory” search of available databases, in fact, the firm located more than 900 patents and patent applications for iridium-based OLED materials here in the U.S. alone. M-CAM, a Virginia-based firm that focuses on technology companies and their respective inventions, also found hundreds of related patents in a more meticulous review of its own.

For its part, UDC has tried to downplay the recent decision in Europe – along with similar cases pending in key markets of Asia -- by emphasizing that the company faces no similar challenges to its treasured OLED patents here at home. Last month, for example, CFO Sidney Rosenblatt portrayed the setback in Europe as a mere nuisance (at worst) that posed no risk of spreading to this side of the globe.

Since then, however, M-CAM Chairman David Martin has blasted UDC in general – and its CFO in particular – for allegedly tricking investors with “fanciful” spin.

“Sidney is lying in this wonderfully calculating way,” Martin told TheStreetSweeper earlier this month. “He is misleading the public. And the last time I checked, that’s a (securities) violation.”

UDC cannot face any opposition proceedings in its home country, Martin declared, because the U.S. system (which differs from those in both Europe and Asia) does not allow it. However, Martin said, UDC has already seen a new U.S. patent effectively derailed – and could hit similar roadblocks in the future -- as a direct result of the ruling that invalidated the bulk of its claims in a key patent that it held overseas.

The week after that setback, Martin explained, UDC suddenly cancelled 90 claims – resembling the same broad claims struck down in Europe – contained in a patent application filed right here at home. After that, he said, UDC replaced those claims with a much narrower set – focused specifically on iridium – which the USPTO then promptly rejected (for so-called “double-patenting”) on its own.

Going forward, Martin cautioned, UDC could also encounter threats to the U.S. patents that the company already holds. By pursuing a formal “re-examination” under the USPTO process (a challenge that the current system allows), he predicted, a third party could expose clear flaws in the U.S. patents secured by UDC and effectively “blow this company to bits.”

If history serves as any guide, UDC should fear this type of review. In 2009, The Record newspaper observed, the USPTO completely nullified 41% of the patents that it re-examined through the so-called “inter-parties” process and – with only 8% of those patents left unchanged -- clearly weakened most of the rest.

Even if UDC manages to avoid that particular threat, Martin indicated, the company still faces other big challenges ahead. Specifically, he predicted, UDC could soon find itself competing against rivals that obtained similar OLED patents – which also cover iridium-based materials – and then waited on the sidelines for a real market to build. With demand for OLED materials finally starting to mount, he said, those competitors will now look to make a big splash on the field.

“You let the market develop, and that’s when you drop the bomb,” Martin explained. “You don’t go after anyone until there’s an economic argument to do so … We are probably a quarter (three months) away from that right now.”

Faded Glory

UDC has long relied on Samsung, a Korean powerhouse that ranks as the only major adopter of OLED technology to date, as its primary customer and its largest source of commercial revenue by far. While UDC regularly touts the growing popularity of OLED-enabled cell phones marketed by Samsung, however, the company recently startled the market with a weak outlook for its upcoming sales.

Despite soaring demand for Samsung cell phones that utilize OLED technology – and that promise to become hot Christmas presents this year – UDC has warned of a sequential decline in its own revenue during the busy holiday season. For its part, UDC blamed the expected downturn on a “seasonal” dip in fourth-quarter orders that the company “always” encounters as a matter of routine. Just last year, however, UDC reported the exact opposite trend instead.

“Commercial and development revenues for the fourth quarter of 2010 were up both sequentially and year-over-year, as our PHOLED technology gains increased market adoption,” Rosenblatt boasted at the time. “The sequential growth of our commercial chemical sales in the fourth quarter was driven primarily by our penetration of the handheld device market …

“We are very pleased to see products in the market,” he concluded, “with displays powered by our technology and materials proving to be a commercial success.”

Samsung has since gone on to flood the market with millions of Galaxy cell phones featuring OLED technology, records indicate, toppling mighty Apple (NASDAQ:AAPL) as the industry leader along the way. Even so, last quarter, UDC posted a remarkably modest uptick in commercials sales of its patented OLED materials. With revenue generated from patented chemicals sold to commercial customers inching up just $600,000 in the third quarter, records show, UDC relied on so-called “host” chemicals – commodity materials sold by other suppliers as well – for much of its blockbuster growth instead.

By suddenly expanding into this commodity business, records indicate, UDC managed to dramatically boost its third-quarter revenue – with host materials accounting for roughly one-third of its $21.8 million in overall sales – and blow past Wall Street estimates in the process. But even UDC management, often wildly optimistic by nature, seemed reluctant to count on that competitive business as a lasting vehicle for future growth.

After all, an otherwise bullish report on UDC indicates, the company sells even those lower-margin commodity materials at premium prices – charging three times more than Korean suppliers – that can be easily undercut by foreign rivals.

“It is a business that is new for us, and the question is going to be whether it is sustainable,” Rosenblatt confessedat a UBS conference last month, when the stock – previously flying high on record third-quarter results – began to lose some of its steam and spiral back toward earth. “We believe it will be. But because it is a new business for us, it is one that we really are going to be a little cautious about how much we think it will grow.”

Either way, records indicate, that detour – especially when coupled with a revised Samsung agreement – has effectively reshaped the company. Under its original business model, records suggest, UDC expected to achieve sky-high margins (well above 90%) by simply pocketing fat royalty payments and generous licensing fees from the companies that utilize its technology. When UDC inked a new long-term agreement with Samsung earlier this year, however, the company stopped receiving royalties from its largest customer and started counting on big orders of its patented materials (sold at an 85% margin) to drive its profitability instead. Faced with a meager rise in sales of its patented chemicals last quarter, records indicate, UDC then further adapted its business strategy by expanding into the crowded market for host materials that carry even lower margins (estimated at 60%) still.

When Goldman Sachs resumed its upbeat coverage of UDC last month, however, the firm somehow overlooked those negative trends. Although UDC relied heavily on sales of host materials to drive its third-quarter growth – and warned about competitive threats to this business going forward – Goldman boldly predicted that the company would post a steep rise in chemical revenues (of 60% annually) over the course of the next several years, anyway. Moreover, while UDC accepted a hit to its margins when it began peddling commodity materials, Goldman continued to forecast hefty margins (of 80% to 85%) for the company as well.

Based upon those lofty expectations, Goldman established a Street-high target price for UDC -- well above the $50 mean -- of $68 a share.

Meanwhile, UDC has dropped additional hints about potential deterioration in its core business. Last month, for example, the CFO reported that UDC could soon begin shopping for additional OLED technology to bolster its current portfolio.

Until now, records indicate, UDC has banked primarily on OLED technology developed by its own research partners at Princeton and the University of Southern California to guarantee its future success. While UDC estimates that it has spent more than $60 million on research and development over the past several years, however, the company has committed just one-fourth of that total to the university-based studies that actually led to the patents covering its OLED technology. At the same time, industry news coverage reveals, some deep-pocketed UDC rivals – including Merck, BASF and Sumitomo – have shelled out mountains of cash in an effort to secure leadership positions in the promising OLED field.

As a marginally profitable company (with a history of losses that stretches back a decade or more), records show, UDC has long relied on the proceeds of stock sales to fund its operations. After raising $250 million in a big secondary offering managed by Goldman Sachs this spring – with investors buying UDC stock based on faith in its current technology – the company now looks eager to splurge on some new assets that will supplement those that it already owns.

“We will use that money to acquire intellectual property either in the OLED space that we’re specifically working on -- the emissive materials -- or in other areas in the OLED stack, if we think it makes some sense,” Rosenblatt told investors at the UBS presentation last month. “So we’re actively looking right now to see if there is IP that we can acquire.”

By expanding beyond its original strategy (first through the sale of commodity materials and next through the hunt for IP developed by others), some feel, UDC has at least hinted at serious threats to its core OLED business. Byreporting weak demand for its patented OLED chemicals in the third quarter (and warning of an inexplicable slowdown in the fourth), they further suggest, UDC has in fact effectively signaled that the company already faces some of those headwinds right now.

‘Empty Shell’

Indeed, last month, UDC basically conceded that rivals in China – a country with a notorious disregard for patent restrictions – could slice into its market share.

According to the Alliance for Economic Stability, Chinese suppliers have rushed to capitalize on this opportunity already by peddling cheap OLED materials of their own. For example, the AES claims, Jilin Optical – whichpublished research that served as evidence of prior art in the European patent trial – currently sells PHOLED chemicals at one-third of the price charged by UDC itself.

UDC actually faces numerous challenges in Asia, records indicate, a crucial market that provides the company with more than 90% of its total revenue. UDC weathered a string of damaging legal setbacks there earlier this year, theKorea Times reported, when the Japanese Patent Office invalidated “all three critical PHOLED material patents” secured by the company in that country. Since then, the newspaper added, UDC has seen two similar patents in Korea – home to Samsung and, as such, the most important OLED market of all – come under attack as well.

Like other players in the young OLED space, records indicate, UDC relies on Samsung for most of its business and obviously treasures that vital relationship. But Samsung has forged similar deals with other companies as well, a new comprehensive “white paper” on the developing industry shows, and has regularly indicated that – whenever possible – it prefers to conduct business with OLED suppliers located in its home country instead.

Take Duksan Hi-Metal, for example. That Korean company already serves as the sole vendor of at least two active-matrix OLED (AMOLED) materials used by Samsung, records indicate, and soon hopes to add PHOLED materials to the mix by challenging a pair of broad UDC patents that block the company from selling those chemicals right now.

“Some studies show that phosphorescent materials were being widely used even before the technology was patented” by UDC, Duksan Hi-Metal told The Wall Street Journal back in June. “And as the technology isn’t something new, their patent ownership should be invalidated.”

If UDC ever loses control of those patents, critics warn, the company will likely lose most of its $1.76 billion market value as well.

“It is our opinion that, unless UDC is able to string together a series of legal victories, there will be no material royalty revenue opportunity for the company,” cautioned Liam Mulcahy, a professional trader whose hedge fund held a short position in UDC at the time that he issued a bearish report on the company earlier this year. “Additionally, many of UDC’s original core patents are approaching their expiration dates, including UDC’s ‘key PHOLED technology patent,’ which expires in 2017 …

“While management of UDC is quick to point out that they have numerous other patents and that the patents in the U.S. have not been impacted (by setbacks overseas), this defense misses the point entirely,” Mulcahy continued. “The Street’s valuation of UDC is predicated on one thing: assumed control of the OLED industry through IP protection.”

Without that power, Mulcahy warned, UDC will likely find itself competing against “dozens” of other chemical suppliers in a crowded market for commodity materials instead. Under that scenario, he predicted, UDC would see its premium valuation disappear to render a stock price – currently near $40 even after a big fall -- of no more than $10 a share.

As the founding chairman of a firm that closely monitors patent developments, uncovering bright red flags at UDC in the process, Martin foresees the potential for an even steeper decline. In a nutshell, Martin views UDC as a vulnerable company – sitting on flimsy patents covering technology developed by others – that could one day sink into penny-stock territory as a result.

“This whole thing is a really unfortunate situation, where shareholders are being duped,” Martin proclaimed. “The company doesn’t have what it says that it has.

“Then you’ve got analyst coverage that’s just beating the drum to say that there’s real value there. Any time that happens, you have this helium effect on something that’s basically an empty shell. So it floats for a while …

“The weirdest thing about this whole thing is that it’s all hidden in plain sight. It’s a racket,” he concluded. “And it’s as big of a mess as these things come.”

Disclosure: Prior to the publication of this article, TheStreetSweeper (through its members) established a short position in Universal Display with the intention of profiting on future declines in the share price. It began establishing its current position on Dec. 5, when it sold 13,900 shares of PANL short at $42.36 a share. It continued to increase its short position over the course of the next week, selling additional shares at prices ranging from a high of $41.85 a share to a low of $39.67 a share. At press time, TheStreetSweeper had sold a total of 55,200 shares of PANL short at an average price of $41.24 a share. Going forward, TheStreetSweeper may choose to adjust the size of this investment – by increasing, decreasing or covering its short position in the stock – and will fully disclose the details of any future transactions in PANL as those trades occur.

As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in any of the companies that they cover.

Source: Universal Display: A Real Work Of (Prior) Art?