Earlier this week, the world’s largest lighting producer Philips announced its plan to spin-off its Lumileds LED lighting unit and automotive lighting segment into a separate company by early 2015. Philips believes that after significantly improving the performance of Lumileds over the last few years, and establishing strong intellectual property, the business can further grow, attract more customers and increase scale as a standalone company by increasing sales to customers who currently view Philips as a rival. Philips plans to spin-off the manufacturing side of the LED business, and will keep the higher margin integrated systems and services as part of its business. Though the move intensifies competition for Cree (NASDAQ:CREE), the news led to a marginal upsurge in its stock price (~5% increase) backed by rumors that Philips could try and merge the spun-off unit with Cree.
Philips mentioned that it will explore strategic options to attract capital from third-party investors for the business. It stated as well that it intends to maintain a minority interest in the company. Cree, which is a direct competitor for Lumileds and has over 1.2 billion in cash and cash equivalents, declared in its last earnings call that it is open for opportunities to grow through strategic acquisitions. Philips’ LED parts business, which is a major supplier to carmakers, had sales of 1.4 billion euros ($1.91 billion) in 2013.  Cree earned $1.4 billion in revenue from LED sales during the same period.
With increasing global awareness about the economic and environmental benefits of LEDs, their adoption is rising at a fast pace. LEDs offer energy savings of 50%-60% over incandescent alternatives, leading to lower greenhouse gas emissions and a much higher lifespan compared to conventional technologies. LED lighting accounts for 15%-20% of the global lighting market at present and the LED market share is expected to rise at a rapid pace over the next decade. 
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LEDs are quite expensive compared to incandescent bulbs and reducing the price gap between the two is an important goal for manufactures. The intense price competition has lowered margins for manufacturers, a trend which led to the spin-off of Osram from German industrial conglomerate Siemens last year. Apart from Philips and Osram, Cree competes with GE (NYSE:GE) in the LED market.
The spun-off company further intensifies competition in the LED industry. Acquiring or merging with the spun-off company, which integrates automotive applications for LED lights, will increase Cree’s competitiveness in the LED market. In the absence of any additional information, we will just have to wait and watch how this plays out in the future.
Our price estimate of $63 for Cree is now at an approximate 25% premium to the current market price.Notes: