A Look Into Cree’s Past

by Trefis Team
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LED lighting and component manufacturer, Cree(NYSE:CREE) saw its stock price surge from $25 in October 2011 to close to $70 in October 2013. However, the company’s stock price has been downhill since then and it stands close to $25 at present. Currently, the company’s stock price is trading close to its book value. In this analysis, we discuss the key reasons that drove Cree’s stock price higher and then the reasons that contributed to a decline in the stock price post 2013. The chart below shows the trajectory of Cree’s stock price in the last 5 years:

Screen Shot 2016-09-26 at 12.18.44 PM

Source: Google Finance

Factors That Favoured Cree In The Past:

A) High Growth Potential In The LED Market: Cree’ revenues increased from $1,035 million in 2011 to $1,530 million in 2013, which translates to a CAGR of more than 20% during this period. Cree’s rapid growth in revenues during this period was a result of the strong surge in the demand for LED lighting, which offered significant benefits over the traditional incandescent and CFL bulbs. A McKinsey report in 2011 cited that LED lights were expected to account for around 70% of the overall lighting market by 2020.

With energy savings of 50%-60% leading to lower greenhouse gas emissions and a much higher lifespan compared to conventional technologies, LEDs offered significant benefits over traditional bulbs. Furthermore, LEDs seemed to be a cost effective option to lower global electricity consumption. Combined with bans on incandescent lighting in various countries, and the resulting higher penetration of LED lighting in the general lighting market, LED companies such as Cree were directly benefiting from this trend change.

B) Cree’s Pure Play Nature: Unlike other LED manufacturers that use sapphire substrate, Cree is the only LED manufacturer that uses silicon carbide (SiC) as its substrate. The company manufactures LED chips and components that are based on the SiC wafer and are designed to meet a broad range of market needs for lighting applications. Cree entered the lighting product market in 2008. The company’s pure-play nature helped it deliver lower priced LED lighting products, providing an edge over its competitors in the past. Despite the fact that LED prices were falling rapidly, investors believed that Cree will be able to maintain its margins because of its pure play nature. The strong investor confidence was reflected in the company’s stock price as well, which more than doubled in between 2011 and 2013.

What Backfired For Cree Post 2013?

A) Subsidy Provided By The Chinese Government: Despite the fact that there is still a high growth potential in the LED market, Cree is facing heightened competition from Chinese manufacturers that are the direct beneficiaries of the subsidies provided by the Chinese government. Though the subsidy program initiated by the Chinese government around 2010 was aimed at the initial development the LED industry in the region, it subsequently resulted in an oversupply situation, causing massive price declines.

Consider the subsidy provided by the Chinese government on the installation of MOCVD (Metal Organic Chemical Vapor Phase Deposition) reactors. MOCVD is a technique for depositing thin layers of atoms onto a semiconductor wafer that requires high upfront cost. However, subsidies provided by the Chinese government allowed the installation of MOCVD units cheaper in the region. This resulted in lower barriers to entry in the LED manufacturing industry in China, resulting in significant expansion of LED production capacities in China in the recent years.

report by LEDInside cites that the Herfindahl–Hirschman Index(HHI), which measures the size of firms in relation to the industry and is an indicator of the amount of competition among them, is less than 10% in the LED chip, packaging and lighting markets. The fact that the figure is less than 10% is indicative of the high competition in the industry. The resulting supply glut caused by an excess manufacturing capacity in the LED industry is responsible for putting a strong downward pressure on LED prices. Unable to stay afloat due to massive price declines, around 4,000 LED companies exited in China in 2015. Even Cree’s vertically integrated manufacturing  capability couldn’t help prevent its margins from declining in 2014 and 2015 that resulted from an excess supply in the industry.

B) Cree’s Choice of SiC Substrate: The two primary substrates that are currently used in LED fabrication are Sapphire substrate and Silicon Carbide (SiC) substrate. Cree is the only LED manufacturer that uses SiC as its substrate. LEDs based on SiC substrate are expected to have longer lifetime as compared to LEDs based on the Sapphire substrate. This comes from the fact that there is a larger mismatch in the crystalline lattice structure of a Sapphire substrate as compared to that of a SiC substrate.

However, none of the disadvantages of a Sapphire substrate are that critical. In fact, the high availability of low cost sapphire makes the production of LEDs cheaper. Furthermore, there is high industry expertise to produce LEDs based on Sapphire substrates. According to a report, around 96.3% of LEDs produced in 2015 were based on Sapphire substrate. The increased use of Sapphire substrate in the LED production is making it difficult for Cree to compete with other players on price points.

Further, at a time when the LED industry is being driven more by price points than advancements in technology, Cree’s clients are likely in favour of having a supplier that provides more standardized products. This is because sourcing raw materials from Cree neither provides significant cost advantages nor extremely high technology benefits that can help them improve their market share. This might be another key reason for decline in Cree’s LED chips and components revenue in 2014 and 2015.

Editor’s Note: In our next article, we intend to answer important questions related to the future trajectory of the LED market. We will also analyse potential strategies that Cree can use to regain its share in the industry. We care deeply about your inputs, and want to ensure our content is increasingly more useful to you. Please let us know what/why you liked or disliked in this article, and importantly alternative analyses you want to see. We encourage you to comment and ask questions on the comment section of our website, alternatively you can email at content@trefis.com /aditya.sharma@trefis.com

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