Could Asia be the Light at the End of the Tunnel
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Cree (NASDAQ: CREE) is an industry leader in the design, manufacture and sale of high-efficiency solid-state (SSL) technologies, including semiconductor materials and LED (Light Emitting Diode) lighting systems. The 2 year downward trend of Cree’s stock, which saw shares decline from above $80 to $23, has seen investors bail on the company not executing in an increasingly crowded field where innovation is happening at breakneck speed.
There has been a lot of excitement in the LED space lately as new designs and production techniques are driving down the price. The price per 1000 lumens for consumer level drop-in replacement LED bulbs has crossed the $20 level, down from $50 just a few years ago; making it an increasingly attractive alternative to conventional lighting. The U.S. and Europe can benefit the most from this change. As increasing energy costs continue to cause concern around the world, technologies that generate long term savings will see capital attention. The initial costs of LED lighting systems are a high barrier to entry for existing structures, but the long-term savings can be substantial and new construction can easily be adapted to take advantage of LED’s differences; deploying them to greater effect.
Cree is also making waves with new transistor technologies for High-Frequency, High-Power Commercial Radar and Satellite Communications, seen as game changing disruptive solutions. Jim Milligan, director of RF and microwave says the new product family "represents disruptive technology that we believe will set new standards of efficiency and performance for high-frequency, high-power applications such as satellite communications and X-Band commercial radar.” According to the company's website, Cree's investment in research and development and has yielded over 2,300 US and foreign patents, as well as over 3,000 additional patents pending.
Upheaval and Marginal Shrinkage
Cree CFO John Kurtzweil recently left to join Extreme Networks (NASDAQ: EXTR), causing a 13% drop in the company’s stock price. Cree's former Director of financial planning and Director of sales, Mike McDevitt, has again been tapped to become the company's interim CFO, a position he previously held in 2006. Cree CEO Charles Swoboda sought to ease concerns about the departure as the company forecast revenue for the next quarter to come in between $295 million to $315 million, which would be a signal that the long slide in their margins is at an end.
The global LED market in 2007 topped $5 billion. By 2011 that figure had doubled, with the market set to continue growing at a robust 25% year over year through 2016. As of 2011, Cree’s market share of the LED lighting space was 10%, up 2% from 2007Cree's competitive edge has been hurt by the company's reliance on exotic materials while the materials used by its competitors have gotten cheaper. Operating margin plunged from 21.6% in 2010 to 3.3% in Q1 2012 due to increased research & development, and amortization overhead. Margins have been falling for 2 years along with the stock price. Their current market cap is $2.7 billion while trading at a P/E of 48.
They are still paying for not spending sufficiently in 2010 on R&D, 9.4% of revenues. For a technology company focused on innovation to create growth to be spending less than 15% of revenue on R&D is a recipe for exactly what we are seeing with Cree. For example, Qualcomm (NASDAQ: QCOM) spends more than 20% of their much larger revenues on R&D. It does not matter the industry, new technology requires money. Corning (NYSE: GLW) on the other hand, with their much more established business and market leading position spends similarly to Cree.
The Sun Rises in the Far East
In its strategy to increase market share and boost revenue, Cree has turned to Asia to take advantage of opportunities in this growing region; opening Cree Asia-Pacific Ltd. in Hong Kong in 2005 as a center of product development and innovation. Inventory issues in China related to demand and delays in government projects caused a hiccup in in 2011, but the company remains positive about the future of LED technology as declining costs and increasing efficiency continue to make LEDs more attractive. Soo Ghee Lee, General Manager of Cree Asia says “Hong Kong is situated in the heart of Asia, the best base from which to manage the Asian region. Its political and cultural links also make it an ideal stepping stone into Mainland China.”
It is estimated that China accounts for 35% of the global lighting market, and is expected to grow to 45% by 2020. To better service increasing demand in China for Cree products, the company recently expanded TEMPO (Thermal, Electrical, Mechanical, Photometric, Optical) Services technology centers providing local support to improve design and marketing of its products and accelerate mass adoption in the region.
Cree’s financials confirm a growing focus on Asia, with realized income from foreign operation growing at 30% per year since 2009. Cree is also deploying more assets on the ground in China and Malaysia; growing fixed assets there by 20% in 2011 to $153 million, most of which is in China. Such in-country investment is key to establishing a strong foothold in a region where local investment is necessary establishing trust and goodwill.
Home Away from Home
U.S. multinationals keep running into this over and over. Those that invest in China from the ground up see far greater success than those that try a top down brand expansion, cf. McDonald’s struggles versus KFC’s dominance or Intel’s success versus H-P’s lack thereof. With nearly 26% of their fixed assets residing in China, this is a sure sign that the company takes the regions seriously and sees it as a key to expanding margins and regaining investor confidence.
At the current price, however, there needs to be evidence that is taking place before the market will begin rewarding them with stock accumulation. Selling out of the money puts below $15 may be a way to get paid while one waits for the stock to find a bottom. The question one has to ask is whether Cree is the right company to play the LED lighting revolution that is nearly upon us.
PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Corning and Qualcomm. Motley Fool newsletter services recommend Corning. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.