Photon Dynamics to Benefit From Expected LCD Capex Pickup

Recent results from Photon Dynamics (PHTN) have been uninspiring. PHTN’s revenues have been in a steep downward spiral, declining steadily from $51.7M in Jun 2006 to $13.9M in its most recent Quarter (FQ2, March). PHTN's stock reflects this weakness and is hovering near five year lows. FQ3 guidance is for a pickup in revenues to $15-20M. The Street is at the higher end of this guidance ($19.0M), but this number is unchanged since PHTN reported FQ2 results May 7. Since that report, we have received numerous positive LCD data points.

But the TFT-LCD industry is enjoying a strong upswing. We have seen numerous positive TFT-LCD data points of late, and their strength and frequency seem to be picking up. Four Taiwan TFT-LCD companies reported all-time record revenues, with two more reporting their second all-time highest. Samsung raised its LCD forecast last month. We have been positive on the LCD supply chain since October 10, 2006, with positive views on AU Optronics (AUO), Corning (GLW) and LG Phillips (LPL). We believe industry strength will tighten the LCD supply sooner rather than later, leading to increased Capex investments, which should benefit PHTN and Applied Materials (AMAT).

Press reports suggest that additional capacity expansion is needed. According to these press reports, AU Optronics is seeing order volume exceed its output. AUO’s utilization rate in Q1 was around 80%, with LPL at 90%. On its conference call, PHTN saw 2008 LCD Capex +15-25% Y/Y. Given the recent supply chain data, we believe that upside could be increased and/or pulled in.

As a result, we are adding PHTN to our Stocks To Watch List with a positive bias. PHTN sells yield management solutions to the LCD industry and should benefit from increased CAPEX. It competes with AMAT in this market, but according to the company, it has a market share of 60%+ in Gen 5, 6, 7, and 8 fabs. We have been positive on AMAT since July, and believe it will also benefit, though its exposure to LCDs is far less (~10%).

Disclosure: Author has no position in PHTN

PHTN 1-yr chart