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Earnings Summary
FYE Jun 2010E 2011E 2012E
Important Disclosures regarding Price Target Risks, Valuation Methodology, Regulation Analyst Certification,
Investment Banking, Ratings Definitions, and potential conflicts of interest begin on Page I of the Appendix Section.
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CREE INC. (NNM: CREE) July 8, 2010
INVESTMENT THESIS
We are initiating coverage of Cree with a Buy rating and a $112 target price. Our thesis
is simple. By year 2015, we believe that 22% of the market for lighting products will be
based on LED, which is far more conservative than the 50% estimate from Philips
Lighting. Based on our analysis, at that level of market adoption, we believe global
lighting socket penetration will reach 13% or 5.8 billion sockets out of 44.3 billion
worldwide. Our 2009 base case assumes a mere 0.35% penetration, which highlights not
only how early it is in the cycle, but also how much longer there is to go.
To achieve the 13% penetration by 2015 for general lighting implies a significant ramp in
LED unit volumes. Given our view that Cree is the market share and technology leader
in LEDs used in general lighting, we believe Cree should be able to grow its earnings in
the range of 30%-40% over the next five years, which is consistent with its five-year
historical average multiple of 36X forward 12 month EPS.
We believe that 18 months from now (the end of 2011), the stock will be trading at 35x
our CY12 EPS estimate of $3.19, implying a price target of $112. As is the case with any
high multiple stock, it is unlikely that it will straight-line to our target. Rather than
attempt to predict precise entry and exit points, we feel comfortable taking the long-term
view and believe that Cree’s leadership position in a secular growth industry will bring
the stock to our target and beyond.
INVESTMENT POSITIVES
General Lighting Presents Significant Volume Opportunities Over the Next 5 Years.
Based on our general lighting model shown in Exhibit 1 below, we believe LED unit
volumes for general lighting will grow at a 5-year CAGR of more than 90% between
2010 and 2015. Assuming ASP erosion of 20%-25% per year, this should translate to
industry revenue growth of 47% per year. As the market share leader for LEDs in
general lighting (we estimate Cree’s share at 25%-30%), we believe Cree has enormous
potential for revenue growth.
Dominant Share In General Lighting. We often hear bears talk about the competition
out of Asia taking share from Cree. At the 2010 Light + Building Show in Frankfurt, we
estimate that Cree had 35% share of the LED products on display. At the 2010 Lightfair
Show in Las Vegas, we estimate that Cree had 50% share of the LED products on
display. At the 2010 Guangzhou International Lighting Exhibition, we would not be
surprised if Cree had 30% share of the LED products on display. We believe Cree is
selling its LED products to all the major lighting companies around the world, whether it
is selling LED chips, LED components, or even, LED fixtures. We also believe Cree is
also selling its LED products to small startups seeking to enter the market. By selling to
both the established incumbents and new startups using LED technology to enter the
lighting market, Cree will benefit in either scenario.
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CREE INC. (NNM: CREE) July 8, 2010
Success in General Lighting Driven By Technology Leadership. Over the past three
years, Cree has made significant progress not only increasing the light output of its LEDs
but also improving its efficacy. The implication of higher efficacy is that an LED can
generate more light with less power, which results in greater energy savings. As recently
as 2006, the most common complaint about LED lighting was that the LEDs were still
not bright enough and that color stability was inconsistent. Today, we believe there are
few who would attempt to make that argument. We believe Cree’s pace of innovation
relative to its peers has enabled it to take share in general lighting. As an example,
Cree’s closest competitors are shipping LEDs with efficacies in the range of 100 lumens
per watt while Cree already has products commercially available at 130 lumens per watt.
Assuming LED brightness increases by about 15% a year, this implies that Cree is
about 2 years ahead of the industry average. As a result of this technology lead, as
shown in Exhibit 2 below, general lighting as a percentage of its sales has been steadily
increasing.
Other
30%
Other
50% Lighting
50%
Lighting
70%
Other
90%
Secular Growth Offers Some Resistance to Recession. Despite the impact of a global
recession, Cree’s LED revenue increased 30% in 2008 (the stock dropped 42% versus the
NASDAQ down 40%) and 20% in 2009 (the stock increased 250% versus the NASDAQ
up 48%). We believe the revenue growth in those two difficult years is evidence that
LED adoption is secular.
INVESTMENT CONCERNS
Technology – Will Cree Be Able To Sustain Its Leadership Position in General
Lighting? With several major electronics companies already committed to entering the
LED market (Samsung LED, LG Innotek, AUO, and Chi-Mei) and several others
currently evaluating the LED market (Panasonic, Toshiba, and Sharp), many investors
think that Cree will not be able to sustain its leadership position in general lighting. In
particular, we believe Samsung LED and Toshiba present the greatest risk to Cree, given
their substantial balance sheets and years of semiconductor manufacturing experience.
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CREE INC. (NNM: CREE) July 8, 2010
Our view is that this is a valid concern but not for another 3-5 years. We believe that: 1)
over the next three years, these competitors will be focused primarily on LEDs for
backlighting; 2) from the perspective of technology, it is significantly more difficult to
make an LED for general lighting than for backlighting (we estimate that Cree currently
has a 2 year technology advantage over its peers for general lighting); and 3) the lighting
market is much more fragmented than the computer or TV markets.
Margins – Can Cree Sustain Its Margins as a Tsunami of New Capacity Comes On
Line? With Aixtron and Veeco estimated to ship between 700 and 800 tools in 2010,
there is a significant amount of new capacity coming on-line in 2011. Will Cree be able
to sustain its margins? This is a valid concern, but we think the answer is yes, because
while lower than normal ASP erosion clearly helps everyone in the industry, we think
Cree’s gross margin improvement has been driven by favorable mix shift, improving
yields, higher volumes, the transition from 3” to 4” wafers (which is now complete), and
to a lesser extent by more favorable pricing. Looking ahead, given that Cree’s gross
margins of 48% in the Mar-10 quarter are at the high end of its targeted range (mid- to
upper-40s), we think gross and operating margins could tick down over time. Our model
currently reflects operating income growth of 49% in FY11, and more than 30% in FY12
and FY13.
VALUATION
Over the past five years, Cree’s historical average P/E on NTM EPS is 36X, ranging from
20X at the low end to over 66X at the high end. Given our view that the lighting market
is at only 0.45% penetration in 2010, heading to 13% in 2015, we believe it is too early to
consider sustainable multiple compression. Instead, we would argue that the stock’s
current multiple on forward 12 month EPS is actually depressed and presents an excellent
entry point.
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CREE INC. (NNM: CREE) July 8, 2010
At $66, the stock is currently trading at 29X consensus EPS of $2.26 for FY11 (ending
June). Our target P/E multiple of 35X is consistent with our view that Cree should be
able to grow its earnings in the range of 30%-40% over the next five years. By the end of
2011, we believe the stock will be trading at 35X our CY12 EPS estimate of $3.19, which
suggests an 18 month target price of $112.
As is the case with any high multiple stock, it is unlikely that it will straight-line to our
target. Rather than attempt to predict precise entry and exit points, we feel comfortable
taking the long-term view and believe that Cree’s leadership position in a secular growth
industry will lead the stock to our price target and beyond.
Longer term, we see further upside to EPS as LED adoption in general lighting continues
along its multi-year upgrade cycle. By FY15, we do not think that EPS of more than
$7.00 is unreasonable (30%-35% growth on FY11 consensus EPS of $2.30), which
should translate to a stock price of over $200 by mid-2014. We believe the biggest risk
to our price target is general macro weakness. In 2008, the global recession
compressed multiples across the board. Fundamentals played out accordingly, with
Cree’s Mar-09 quarter revenue down Q/Q, the first down quarter in two years. Since
then, sequential revenue growth has resumed, with March-10 quarter revenue up 78%
Y/Y.
COMPANY OVERVIEW
As shown above, Cree is the most vertically integrated LED company in the industry,
making its own MOCVD tools, substrates, LED chips, LED components, and LED bulbs
and luminaires – everything but its own chip and packaging tools. Cree is also unique in
that it is the only LED chip company to grow its epi on silicon carbide – every other
company in the industry uses sapphire.
Cree started in the late 80s as a materials company focused on the development of silicon
carbide (SiC). Cree’s industry-leading blue and green LED chips are based on its
expertise in growing Gallium Nitride (GaN) and other materials on silicon carbide
substrates. In the 1990s, Cree sold its chips to LED packagers and benefited from the
adoption of LEDs in mobile phones and automobile dashboards. In 2004, Cree started its
XLamp product line, which used its LED chips in Cree’s own proprietary package. In
April 2007, Cree acquired COTCO, which expanded its product line for smaller,
packaged LEDs. In March 2008, Cree acquired LED Lighting Fixtures (LLF), which
further expanded its product line into LED-based light fixtures. Today, Cree enjoys a
leadership position in all of its different product families, including LED chips, LED
packages or components, and LED fixtures.
Customers. In fiscal 2009 (ended June), Seoul Semiconductor accounted for 13% of
sales, Arrow Electronics accounted for 11% of sales, and Sumitomo, historically a 10%
customer, accounted for 8% of total sales. Sumitomo serves as a distributor for Cree’s
customers in Japan, some of which include Stanley Electric, Rohm, and Citizen
Electronics. Seoul Semiconductor and Sumitomo’s customers manufacture LED
packages or components with LED chips purchased from Cree. Given that Cree is
focused on keeping its chip business stable and growing the components and LLS
businesses, we expect Cree’s current customer concentration to decrease over time.
Cree sells its LED components to manufacturers of lighting fixtures, lighting engines, and
bulbs. In the future, we would not be surprised to see new 10% customers, which could
include Asian contract manufacturers which manufacture LED bulbs for some of the
biggest names in the lighting industry. Arrow is one of the world’s largest semiconductor
distributors in the world and primarily sells Cree’s XLamps. For its LED Lighting
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CREE INC. (NNM: CREE) July 8, 2010
Competition – LED Chips. Cree’s primary competition is Nichia, which primarily uses
its chips for its own LED packages. However, we believe Nichia sells some of its chips
to other packaging customers in Japan, who in turn compete with Nichia’s LED
packages. Cree’s LED chip competitors are primarily Epistar (based in Taiwan), and
Toyoda Gosei (based in Japan). Cree’s LED chips lead the industry with respect to
brightness, reliability, and color consistency.
Competition – LLS (LED Lighting Solutions). There are many LED fixtures in the
market, however, from the perspective of color and efficacy, few are able to compete
with fixtures made with Cree’s TrueWhite technology. Some competitors are the largest,
traditional lighting fixture manufacturers in the world, all of which are in the middle of
transitioning to LED technology. These include Acuity Brands, Cooper Lighting, and
Hubbell in the US, Zumtobel, Philips, and Schneider Electric in Europe, and Toshiba,
Sharp, Panasonic, and Iwasaki Electric in Japan, as well as hundreds of others around the
world. Other competitors include new entrants to the lighting fixture market that have
focused on LED-based products, like BETA LED, Nexxus Lighting, and Lighting
Science Group. Lastly, LLS will also compete with makers of LED-based bulbs, some of
which include Philips, GE, and Sylvania, as well as newcomers like CRS Electronics,
LEDengin, and Nexxus Lighting. There are countless others, though we would highlight
that among the ones tested by the Department of Energy, many demonstrate lumen output
at roughly half the manufacturer’s claims.
PRODUCT OVERVIEW
CREE Revenue Breakdown by Product (FY09) CREE Revenue Breakdown by End Market (FY09) CREE Revenue Breakdown by Geography (FY09)
XLamps Korea
31% 15%
High Video
Brightness Screens
LEDs 25%
23% United States
20%
LED Components (51% of FY09 sales, 56% of FY10E sales). LED components
includes the power LEDs (the XLamp product family used primarily for general lighting)
and high brightness LEDs (products typically used in digital signs and scoreboards).
Power LEDs are characterized by their large die size (at least 1 mm x 1 mm, or roughly
10x the size of a high brightness LED) and generate a significant amount of light
compared to a high brightness LED.
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CREE INC. (NNM: CREE) July 8, 2010
LED Chips (32% of FY09 sales, 27% of FY10E sales). Cree also manufactures LED
chips based on silicon carbide technology, while the rest of the LED industry uses
sapphire to manufacture LED chips. Cree currently uses silicon carbide because it
believes it can manufacture the brightest chips with that substrate. We believe Cree’s
scientists are not necessarily married to any technology. Chips range in size from 0.2
mm x 0.2 mm to 1.4 mm x 1.4 mm. The larger sized chips (> 1 mm x 1 mm) are used in
power LEDs. Blue LED chips are coated with a yellow phosphor in order to create white
light. Cree will participate in the shift to LED backlighting for LCD notebooks, TVs, and
monitors through its LED chips, which are sold to packagers like LG Innotek, Seoul
Semiconductor, Lite-On, and others.
LED Lighting Solutions (4% of FY09 sales, 6% of FY10E sales). Through its
acquisition of LLF (LED Lighting Fixtures), Cree’s LED-based fixtures have led the
industry with respect to brightness and efficacy for the past two years. Patented color
mixing technology enables efficacies and a color rendering index (CRI) that are
significantly higher than those of competitors, which rely on standalone, warm-colored
LEDs.
Silicon Carbide Wafers (4% of FY09 sales, 3% of FY10E sales). Cree manufactures
silicon carbide wafers and typically sells the wafers to companies that use them to make
high power switching and microwave devices used in military applications. We believe
silicon carbide is an ideal substrate for applications (such as military) exposed to high
temperatures and radiation. Wafers are produced in 2 inch, 3 inch, and 4 inch sizes.
Other (4% of FY09 sales, 8% of FY10E sales). Cree also manufactures Schottky
diodes, which are used by power supply manufacturers to improve efficiency. Also
included in Other is government R&D work.
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CREE INC. (NNM: CREE) July 8, 2010
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CREE INC. (NNM: CREE) July 8, 2010
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CREE INC. (NNM: CREE) July 8, 2010
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CREE INC. (NNM: CREE) July 8, 2010
APPENDIX SECTION
Company Description: Cree manufactures its own MOCVD tools, substrates, LED chips, LED components, and LED bulbs and
luminaires. Cree is the only LED company that grows its epi on silicon carbide rather than sapphire. Its blue and green LED chips
are based on expertise growing Gallium Nitride (GaN) and other materials on silicon carbide substrates. Cree's products are used in
general lighting (50%), video screens (25%), backlighting (10%), handsets (10%), and other (5%) applications. As a result of its
technology leadership, Cree has #1 market share in LEDs for general lighting.
IMPORTANT DISCLOSURES:
Price Target Risks & Related Risk Factors:
With several major electronics companies already committed to entering the LED market (Samsung LED, LG Innotek, AUO, and Chi-
Mei) and several others currently evaluating the LED market (Panasonic, Toshiba, and Sharp), many investors think that Cree will not
be able to sustain its leadership position in general lighting. In particular, we believe Samsung LED and Toshiba present the greatest
risk to Cree, given their substantial balance sheets and years of semiconductor manufacturing experience.
Our view is that this is a valid concern but not for another 3-5 years. We believe that: 1) over the next three years, these competitors
will be focused primarily on LEDs for backlighting; 2) from the perspective of technology, it is significantly more difficult to make an
LED for general lighting than for backlighting (we estimate that Cree currently has a 2 year technology advantage over its peers for
general lighting); and 3) the lighting market is much more fragmented than the computer or TV markets.
Valuation Methodology:
Over the past five years, Cree's historical average P/E on NTM EPS is 36X, ranging from 20X at the low end to over 66X at the high
end. Given our view that the lighting market is at only 0.45% penetration in 2010, heading to 13% in 2015, we believe it is too early
to consider sustainable multiple compression. Instead, we would argue that the stock's current multiple on forward 12 month EPS is
actually depressed and presents an excellent entry point.
At $66, the stock is currently trading at 29X consensus EPS of $2.26 for FY11 (ending June). Our target P/E multiple of 35X is
consistent with our view that Cree should be able to grow its earnings in the range of 30%-40% over the next five years. By the end of
2011, we believe the stock will be trading at 35X our CY12 EPS estimate of $3.19, which suggests an 18 month target price of $112.
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Appendix Section, Page I
CREE INC. (NNM: CREE) July 8, 2010
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