The buzz about LEDs among investors, government agencies, companies, and even end-users of lighting and display products have soared in recent years. According to Pennwell, the revenue for packaged LEDs reached $13.7 billion in 2012, up from $12.5 billion in 2011 (link here) when it surpassed the laser market for the first time. They expect the overall CAGR (although uneven during some sequential years ahead) for LEDs in lighting to be approximately 12% through 2017, making the space attractive for public and private investors alike since such growth is rare in this current global economy that will be challenged to produce even 3.2%, expected for next year.
But where can investors and companies find money in the LED industry? My research and analysis show that some opportunities are fairly predictable while others are not. The predictable domains are those companies that will drive their profits through high sales volume, which will require substantially increasing the market penetration for LED lighting. According to Digitimes Research, the global LED lighting market will be $44.2 billion in 2015, supporting a market penetration of 38.6% (up from 18.6% predicted for 2013), primarily driven by Japan, South Korea, and China. But which companies will possess the winning approaches beyond incremental improvements of LED technologies and manufacturing platforms?
Success from Invention and innovation
LEDs have come a long way since they were initially used as indicator lights and in calculators made by Texas Instruments (NYSE:TXN) and Hewlett Packard (NYSE:HPQ). LED or solid-state lighting success has been possible because of a number of key inventions, which includes first the blue LED in 1993 by Nichia, the white LED later in the decade produced by mixing blue LEDs with yellow phosphors (also by Nichia), and a slew of technology improvements in the past several years in such areas as light module design, material, and packaging - leading to sharp increases in light extraction efficiency. Energy efficient LED lighting has become crucial in the wake of rising global energy consumption, global warming connected to high energy usage, and shortage of natural resources.
Sector Revenues and Expected Changes
Thus far, LEDs' notable revenue remains in the display market and not in the lighting market. [The same is true for the OLED revenue, although LEDs and OLEDs are significantly different in terms of technology and applications (see here)]. LEDs are used in two different ways for display applications: (1) for TVs and electronic gadgets including computer monitors, white high-brightness LEDs (HBLEDs) are used to provide backlighting LCD screens, and (2) for electronic message displays viewed from larger distances than those in (1), discrete red/green/blue (RGB) LEDs are used as pixels to create displays to show media-based or other content for general public viewing. For the first application, major companies like Samsung (OTC:SSNLF), Apple (NASDAQ:AAPL), Dell (NASDAQ:DELL), LG, and Nokia (NYSE:NOK) utilize LEDs for many of their personal computers or mobile devices; OLEDs already play a role here and will take away some market share in this space, starting with gadgets of screen sizes around nominal 7'' or smaller.
The size of the market share swing will depend on how much better the AMOLED-based screens actually are compared to LED-lit LCD screens and whether the price between the categories remain in the same ballpark. Currently it's the latter, although a considerably thicker display produces quite high quality pictures that are almost on par with those created by the AMOLED technology. Areas where AMOLED devices could win big with further technology improvements in the future are, 1) foldable screens that could perhaps allow the whole gadget to be reduced to a size storable in a wallet, and 2) significantly higher color quality providing true black and broader color gamut through saturated RGBs, and 3) significantly higher brightness for easier reading in the sun. These enhancements are several years out and it is not surprising that UBI research predicts that the flexible OLED market will soar in 2018 to $15 billion from the current $714 million expected for 2014.
For the second LED display application, a large number of companies play different supply chain roles to produce a variety of electronic boards seen in highways, smaller roads, and such public premises as NYC's 7th Avenue and Broadway junction, university and hospital campuses, arenas, railway stations, churches, and local market plazas. Many of these companies are either private or from China, or both, making it difficult for investors to seek profit opportunities despite the huge market associated with the media advertising and such giant corporations as CBS and Lamar. However, Daktronics (NASDAQ:DAKT) is one organically-grown US company that produces and services many of the billboards in US highways, sports arenas, and in other major locations including those in the NYC's Broadway attraction site.
What to Expect for LED Lighting
Although LEDs are well-suited for viewing applications which includes displays and decoration lights, they aren't yet favorable for large-scale general-illumination purposes. The reasons are mainly twofold: 1) LEDs' high wall-plug efficiency doesn't scale for bigger lamps that require more LED chips and higher chip density requiring more sophisticated thermal management, and 2) inherently, LEDs' light output largely remains just in front of it, thereby being much less effective in illuminating large volumetric space such as those in ballrooms, lecture halls, warehouses, etc. Both of these challenges can be resolved with innovative designs that utilize add-on components as discussed in my book or via other solutions.
And the Money is in…
While it will still be several years before the LED industry resolves the above inherent challenges in a cost-effective manner, there are still opportunities for investors in the near term. Finding such prospects involve understanding the LED supply chain and the dreadful binning issue that can actually add opportunities for making money. Inorganic LEDs, in particular blue and white, suffer from the chip yield issue because they are made from nitride-based compound semiconductors that inherently have higher wafer defect densities. For high-end applications, the manufacturers sort the better chips and sell them at premium prices to customers in the higher supply chain that produce very high end modules used in premier display and lighting products.
Discrete RGB LEDs used in billboards made by reputable manufacturers use high-end LED chips and modules. I suspect quality computers and gadgets from AAPL and DELL, for example, also use premium white HBLEDs in their LED-lit LCD screens. The remaining 100s and sometimes 1000s of LED chips from a batch run eventually end up with a large number of lighting suppliers at much lower cost. While this isn't good news for consumers who expect the LED bulbs to last even through heavy usage, a number of suppliers stand to make money from them. Lights made from low-performance chips are likely to not last long or maintain their initial quality after some time due to thermal issues.
The high-end LED chips aside, the LED lamp or module industry essentially is similar to the large-scale electronics industry with regards to money that can be made with surrounding components, materials, and packaging. Cree (NASDAQ:CREE), being convinced of this, became more vertically integrated in the recent years. One of the key components in an LED lamp or luminaire is the electronic driver chip, for which many established electronic chip companies jumped to the opportunities that could be potentially huge. These include such vertically integrated companies as Samsung and LG, as well as others such as STMicroelectronics (NYSE:STM), Renesas Electronics (trades in Japan), Cirrus Logic (NASDAQ:CRUS), Fujitsu (OTCPK:FJTSY), and Dialog Semiconductors (OTC:DLGNF) which trades in Germany and France.
Aside from driver chips and drivers, among others, that make up the periphery of the hardware ensemble are optical components including lenses, reflectors, light guides, as well as metallic heat-sinks and plastics, adhesives, sealants, and coatings for packaging. All these are usually mature technologies and some profits may come from a few differentiating, unique and more efficient designs; but by and large, the bulk of the profits will come from very large volumes because there are too many companies in the landscape facing price pressures. Material and equipment companies such as Rubicon (NASDAQ:RBCN) and Veeco (NASDAQ:VECO) will also need the volume to work in their favors.
It is important to differentiate between the display and high-quality lighting segments of the LED industry because high-quality chips are in high-demand and low supply and without them, the popular end-user products cannot be realized; therefore, companies higher up in the supply chain, such as AAPL and DAKT, are in dire need to grab them at premium prices. As long as LED chip yield remains an issue which will very likely be the case for about 5 years, vertically integrated companies such as Samsung making its own chips will have an edge with display parts (see here). As the LED chip industry matures, vertically integrated lighting and display companies with a concentration in the higher end of the supply chain will still fare better because the majority of the profits are going to come from packaging and fixtures.
Disclosure: I am long CRUS, DAKT, NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.