Trade Resources Industry Views Universal Display Is a Bet on The OLED Market

Universal Display Is a Bet on The OLED Market

Summary

- Shares of OLED have sold off on Samsung concerns regarding Universal's host materials business. This is a sideshow and doesn't belie the potential in OLED TVs next year.

- The LG contract signed earlier this year should assuage investor concerns as to the long-term value of the company's patents.

- The sell off in the shares following the second quarter results was due to transitory issues as customers switch to next-gen products and ramp TVs later this year.

We believe the recent sell-off in the shares of Universal Display (NASDAQ:OLED) represents a solid buying opportunity as investors cut their positions due to the second quarter earnings miss. However, management reiterated their full year guidance on the call and noted that OEMS are buying their newer products, which have higher margins, which accounted for the weakness in the quarter.

Universal is a display technology company that owns the patents to OLED (organic light emitting diode) technologies and materials that are growing in use among wearables, smartphones, televisions and tablets. The company has a royalty business model whereby they simply license out the technology to the device OEMs.

The long-term thesis rests on the value of the patents and whether the OEMs will have to pay Universal Display for the use of their technology. We believe that they will need to as the recent agreement with LG confirms. We think the technology is migrating from adoption by OEMs to widespread growth. The recent sell off appears to be a buying opportunity as the LG contract shifted their pricing from fixed fees to royalties on sales, indicating confidence in the technology's growth.

LG Contract Confirms OLED Technology And Patent Value

Shares jumped in late January when the company announced that it had reached a long-term agreement with LG Display. The seven-year deal that expires in 2022 was much thinner on the financial details in terms of the royalty rates and structure compared to when they signed a similar deal with Samsung several years ago. The agreement is in addition to a materials supply agreement. The contract with Samsung inked in 2011 carried fixed license fees with a price escalator.

The agreement goes beyond the Samsung deal by five years and should address some of the market's concerns regarding the Samsung deal expiration in 2017 and patent expiration on some key technologies. LG is betting heavily on the growth of OLED televisions and other devices and we believe that the current story for Universal is no longer about adoption following this deal. Instead, it will be about its ability to meet demand on a cost-effective basis. The proliferation of devices over the last year utilizing OLED technology likely means the technology is here for the duration.

As such, the deal with LG is more heavily tied to commercial sales of their devices compared to the fixed fee structure of the Samsung contract. Clearly Universal believes that the industry is no longer in "development" and has moved to scaled production of devices.

We believe this is evident as LG recently unveiled a 55-inch wallpaper OLED TV panel that is just 0.97 millimeters thin, and weighs just 1.9 kg. Samsung a month later introduced a 55-inch mirror and transparent OLED display for digital signage. There are also reports that the 2017 Audi A8 will have OLED lighting, a key expansion into the automotive space. While the OLED industry is keenly centered on Korea, we think expansion is likely over the next several years due to the better energy efficiency (compared to LED), novel and innovative form factors, lower glare levels and cooler operating temperatures.

Television Should Power Demand

As 4K television becomes more prominent over the next 12-24 months, the proportion of new TVs that are 4K OLED are likely to rise. OLED technology is already used heavily in the mobile phone market and embedded within much of the Samsung Galaxy franchise.

The global OLED TV market is expected to grow at an amazing 76.2% CAGR, albeit from a small base, between 2014 and 2019. We think the TV market will adopt this technology at an increasing rate given the advantages over LED technology. For instance, OLED TVs do not require backlighting and are thus, thinner and lighter. Also, one of their largest advantages is that the viewing angle is 180 degrees, key for larger rooms or commercial establishments.

Second Quarter Opportunity

The shares sold off following their second quarter earnings in early August. The company wrote down $33 million of assets on existing host material inventory. Management noted that it was due to a customer's quick reduction in demand for the product. Clearly, this is due to Samsung's shift away from using Universal for their materials supply after they purchased Cheil Industries in 2014. The CFO on the conference call noted that the fast moving shift within the industry was a result of new product launches that utilized their new red and green emitters. This occurred in conjunction with existing customers shifting away from existing host materials (Samsung) which led to the write-down of existing finished product.

The market clearly didn't care for this and the quarterly figures that missed by a wide margin only added to the negativity surrounding the name. However, we would note that management reiterated their full year guidance which means there's an expectation for a second half ramp. We believe this is in relation to the LG contract which pays on sales of their products. LG is targeting to sell 600K OLED TVs this year, mostly in the third and fourth quarters, but ramp to over 1.5M units next year.

The play on Universal is a long-term one and quarter-to-quarter results are likely to be very lumpy. We think the business is likely to experience significant operating margin growth over the next two years. Management has suggested that last year's 31% rate could eventually hit 50% as new display manufacturers enter the market- something we expect to occur over the next year as costs come down and the technology becomes standard.

Valuation

The shares on an absolute basis of 25.6x forward earnings are not cheap but when you factor in the potential of this business, given the market opportunity and scale, we think the recent sell-off could be a very compelling buying opportunity. The share price decline on the reset in the Street numbers and the investments by Samsung and LG Display to increase capacity and boost overall OLED usage into a wider array of products, suggests to us that there is significant upside to estimates over the next two years.

We think the market is too focused on the near-term issues while ignoring the potential. For instance, a few months ago Samsung filed trademarks for OLED TVs in South Korea to obtain exclusive rights to the names for its OLED models. We think the OLED TV market is likely to be understated and that the increase in capacity build will lead to pricing declines and better technology that addresses some of the negative concerns.

Universal saw its share price decline after it was reported that Samsung was dropping plans for an OLED TV stating that the production process was too complicated for the large form factor RGB-OLED displays it was interested in manufacturing. But a month later, Universal appeared to highlight a new advancement that essentially solved Samsung problems. And now, we see the company applying for patents on OLED names.

We think the market is not factoring in this adaptability in the company's technology and innovation capabilities. As such, we think the estimates by the Street are likely too low and embed a significant amount of pessimism and "bet hedging" in order to mitigate career risks.

We think EBITDA generation could rise substantially to $125 million by 2017 and that the prospects for growing by 20% from there are very high. Generating $125 million in EBITDA, up from $71 million in fiscal 2014, and trading at a 16x multiple, the shares are worth over $50 a piece.

EBITDA 125 Multiple 16 EV 2000 Net Debt 356 Equity 2356 Shares 46.45 Value $50.74 Upside

26%

The above is likely a very conservative estimate and we believe the risk is to the upside. The shares currently trade at 44x ttm EV/EBITDA, a handsome sum, but this is due to the expectations for significant growth, which is highly visible, in the near-term. We used a very cheap, given the growth prospects and potential, 16x multiple in our analysis. However, we think that, as we move into 2016, as the TV prospects for the OLED begin to be realized, the multiple will likely be significantly higher than that.

Conclusion

The shares are down as the company shifts from a fixed-fee license contract with Samsung to a royalty stream structure with LG Display. As such, there is likely to be near-term disruption as LG ramps up their television business later this year and next.

Universal Display is a bet on the OLED TV market with upside catalysts as they attempt to expand the product market into other product lines including, possible wearables like the Apple Watch. Should such prospects become reality, these shares will be trading in the triple digits. Still, even at current levels and not factoring in those call options, the shares are a compelling buying opportunity as OLED technology and pricing continues to improve and TV production ramps. We think the shares are minimally worth $50 with call options that could double that figure easily.

Source: http://www.led-search.com/news-view-4432.html
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