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Cree: Fading Out?

As Cree builds business for the long-term, shares fall as investors lose faith. What next for the LED lighting heavyweight, asks Compound Semiconductor.

Shares may be falling but Cree's cash-rich balance sheet makes industry acquistions a very real option for the LED maker.

Despite posting an increase in sales and rising revenues in its latest financial quarter, Cree's overall lower-than-expected earnings saw shares suddenly plummet by 11%,  slipping another 9% in the days that have followed.

Coming in at $405 million, quarterly revenue just missed analyst's estimates of $407 million. And with chief executive Chuck Swoboda pointing out how his company's already squeezed gross margins will continue to fall throughout the fiscal year, some investors have jumped ship.

"Cree is focused on building a long-term viable business which often comes with short term difficult decisions," says Jed Dorsheimer, managing director of equity research firm, Canaccord Genuity. "But investor expectations have been too high and now we are seeing the pull-back."

Indeed, Cree's long-term views have seen near-term operating expenditure rise, and as Dorsheimer puts it: "Investors aren't getting the gross margin expansion or the operating margin expansion, which is calling into question its earning power, so stock has been sold off."

But the drop in shares represents new opportunities for new investors and Dorsheimer believes the coming year holds great promise for Cree. "Our thesis is that 2014 will represent a transition year [for LED lighting] as we move from an early adopter phase into the growth phase and mass adoption in 2015," he says. "All evidence I have seen supports this."

Critically for Cree, wider LED lighting adoption should ease pricing pressures on its components, boost LED replacement bulb and lighting systems sales, leading to margin expansion. And tumbling shares aside, Cree's focus on technology, cost and branding has delivered positive results.

Innovation-wise, the company's success is doubtless. In just over a year the company has released five versions of its LED light bulb. Then last month, it demonstrated a 303 lumen per Watt, high power LED; the first LED component to exceed 300 lumen per Watt ever.

Amid dogged development, the company has also pushed the price of the light bulb lower and lower. Its 60W equivalent soft white LED bulb now costs only $6.97 at the Home Depot, down $3 in price in the last month. Meanwhile Philips' SlimStyle version currently costs $8.97.

As Swoboda said in his post-earnings call: "We continue to work with the Home Depot to test the price to consumers... The lower retail price points... have already increased sales and confirm there are significantly more opportunities to drive LED adoption."

Dorsheimer expects replacement bulb prices will continue to decrease until mass adoption take place. but not so rapidly. "We will probably see an updated version of its bulb... with a lower cost structure, but we are not going to see the same level of price cuts," he says. "The combination of subsidies in North America and the prices manufacturers are offering today means we are ready for widespread adoption."

Dorsheimer also reckons the company's partnership with the Home Depot has helped it build the Cree brand. At the beginning of this year, the analyst, for one, didn't believe the name 'Cree' was selling bulbs. Not anymore.

"Cree is definitely becoming well known as a lighting company, which is their goal," he says. "They have having success here and the Home Depot has helped."

But if the market really is on the cusp of mass LED adoption, where next for Cree? Despite its hefty spending on development and brand building, Cree remains a cash-rich company. On its latest balance sheet, cash and investments come in at $1.2 billion, and so now the company is eyeing future acquisitions.

Chuck Swoboda: As industry consolidation sets in, Cree is ready to make acquistions. [Cree]

As part of his post-earnings call, Swoboda said: "We believe some opportunities may emerge over the next 24 months... as industry begins to go through a consolidation phase. The strength of our operating model gives us the flexibility to make these investments and continue to maintain a strong balance sheet."

For a vertically-integrated cash-rich company such as Cree, surely the opportunities for acquisitions are vast? Dorsheimer believes Cree will remain focused. He reckons thanks to its well-established components and bulb business segments, acquisitions from these markets are unlikely.

But highlighting how Philips Electronics bought commercial and industrial lighting systems manufacturer, Genlyte, back in 2008 he says: "Cree is a newcomer in the commercial and industrial lighting systems market. We would positively view any acquisitions that would expand its presence here."

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