June 15, 2010: The Coming LED Lighting Revolution

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A brief audio review of this research can be found here: http://live.ssrllc.com/wp-content/uploads/2010/06/June-15-2010-Paul-Sagawa-The-Coming-Revolution-in-LED.wma

Advances in LED technology are likely to drive significant improvements in the cost and functionality of LED lighting that would begin a dramatic replacement cycle for the massive global installed base of incandescent and fluorescent lighting.  In an upside scenario, LED lighting could grow 20 fold to more than $25B by 2020, with decades of significant growth thereafter

Theoretically, LED lighting is superior in almost every respect to traditional alternatives.  LEDs are unusually efficient in translating electricity into light, rather than heat, and, unlike fluorescent bulbs, do not contain toxic materials that would require special handling for disposal.  LED’s are also unusually long lasting and durable – 15 to 20 year lifetimes are typical.  LED’s are instantly on and dimmable, unlike fluorescents, and certain types can change color on command – a unique attribute for known lighting technologies.  They are also much more compact than alternatives, a major advantage in applications where size is an issue

The primary downside of LEDs is cost.  Despite a 20 times cost reduction over the past decade, LEDs are still too expensive for most general lighting applications.  Unlike many semiconductors, LED costs do not decline geometrically according to Moore’s Law, rather improvements have come irregularly in the form of manufacturing and materials innovation.  We believe that laboratory breakthroughs that eliminate the need for a costly sapphire substrate and ongoing manufacturing improvements will make lifecycle costs for LED lighting preferable to incandescent or fluorescent lighting for all applications within a decade.  We also note that pending innovations are also expected to resolve brightness limitations that have also hampered demand

The penetration of LED lighting will be hastened by the strength of international environmentalism.  Many governments have already mandated a shift from incandescent to more efficient compact fluorescent (CFL) light bulbs, despite the “unnatural” quality to the light spectrum produced, the toxic mercury content in the bulbs, and the higher initial costs.  Given that LED lighting may be as much as 300% more efficient than CFL and the ongoing pressure to reduce dependency on carbon-based energy, we would expect vigorous support in the form of government subsidies and mandates in many parts of the world.  Moreover, the heightened consumer attention to “green” solutions should also spur demand ahead of pure economic drivers

The growth of LED lighting has begun.  The first applications have been backlighting for LCD based displays, where form factor and power efficiency are paramount, and for outdoor lighting applications, where the long-life and ruggedness of LEDs have added value vs. alternative applications.  As costs come down and brightness increases, we would expect demand from commercial lighting to quickly become the largest market, until eventually surpassed by residential applications.  Gartner projects an addressable market of more than $12B by mid-decade, a target that we expect to double by 2020, given the $90B annual global spending on lighting products.  It is also likely that investment in retrofitting the world’s installed base of lighting will result in significant further growth beyond the end of the decade

Given the surge in demand, LED makers have begun to order capacity based on existing high cost and limited luminosity manufacturing processes.  While there is danger of short-term overcapacity in these early phase products, we would not expect any significant overhang on the market, as strong demand growth works to fill capacity, and technology shifts in the design and manufacturing of ultra high-brightness LEDs work to obsolete it.  Moreover, we believe that the immature state of the technology will yield opportunities for leading players to differentiate, particularly in packaging for general lighting applications

That said, it is difficult to forecast timing for significant technical advances to reach viability and for demand stimulation as LED solutions fall to ever lower price points and governments legislate mandates.  Furthermore, the capex needed to keep pace with such a fast growing and fast changing technology will strain cash flows and punish competitors that miscalculate at any stage of market development.  As such, the performance of individual LED manufacturers may be extremely volatile going forward, leading us to prefer capital equipment suppliers as a vehicle for investment

We believe investment in LED manufacturing capacity will show less cyclicality than is typical of semiconductor fabrication, as high growth rates and rapid innovation cycles will lead to investment programs by producers to overlap rather than coincide.  Companies with participation in LED capital equipment include Aixtron (AIXG), Cymer (CYMI), KLA-Tencor (KLAC), Nanometrics Inc. (NANO), Veeco Instruments (VECO) and Ultratech (UTEK).  We also highlight Universal Display Corp. (PANL) which participates in the LED market through license agreements for its technology

The Performance of white LED producers, which include Cree (CREE), LG Display (LPL), LSI (LYTS), Bright LED (TPE: 3031), Epistar (TPE:2448), Everlight (TPE: 2393), Formosa Epitaxy (TPE:3061), Genesis (TPE:3383), Lite-On Technology (TPE:2301), Novatek (TPE: 3034), OPTO Tech (TPE:2340), TOPCO Scientific (TPE: 5434) and Tyntek (TPE 2426), will depend highly on company-specific factors such as product differentiation, production costs and capital efficiency

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