Description

Ledlink (GTSM:5230, 5230 TT)

The LED lighting industry is reminiscent of solar: huge projected demand growth, huge projected supply growth, hordes of low-cost Chinese competitors. 

But not every input into a LED light is oversupplied or commoditized.  The optical lenses that give shape to light comprise only ~1-3% of the total cost of the light.  (Think of a glasses-type plastic lens that fits over the light-emitting chip to adjust the way the light comes out).  Despite the low price, these lenses serve a crucial function.  They are very difficult to make.  And they have large setup costs, so scale is important.  For the #1 player, it’s a great business.  Ledlink is #1 with 35% global market share in LED lenses.  It has the highest gross margins in the LED industry at 48% LTM (vs. Cree at 38% and Epistar at 11%) and operating margin of 18% (vs. Cree at 14% and Epistar at 2%, both pro forma).  It is mostly exposed to the inflecting LED general lighting space instead of the saturated LED backlighting space and is growing sales at 30-50%, a rate it should be able to sustain through 2019 as LED lighting penetration rapidly increases.  Ledlink earned NT$4 LTM and I think it can easily do NT$6 EPS in 2014 which would imply a 14x forward P/E multiple.  That’s really cheap, considering that at 30% EPS growth (a simplified assumption), 14x 2014E turns into 11x 2015E, 8x 2016E, 6x 2017E, etc.  I think Ledlink is worth at least double the current price.

Ledlink is really off the radar.  It’s a US$121 mm microcap company trading over-the-counter in Taiwan (on the GTSM) with average 100-day daily liquidity of US$1 mm.  On my CapIQ, only one analyst (Vincent Yu at Jih Sun Securities) publishes a current EPS estimate for 2014.  There are no public pure-play comps anywhere in the world.  It doesn’t help that the entire LED space is somewhat bombed-out after the 2010-2011 oversupply bubble.  The only reason I found out about it was that I was in Taipei on an Asia LED trip and had a hole in my schedule; GS took the initiative to schedule Ledlink in for me so I went. 

The Business:         

Founded in April 2008, Ledlink has quickly reached the #1 position in optical lenses with 35% share.  Its biggest competitors are Ledil (Finland, 20% share), Fraen (US, 10% share), Carclo (UK, 10% share), and Baikang (China, 5-10% share). 

By end exposure, Ledlink’s sales are split 45% outdoor lighting, 35% interior lighting (commercial/residential), and 20% other.  By product, 85% of sales are of lenses (the remaining 15% consists of lamp covers, reflector cups, heat dissipation modules, etc.).  China accounts for 54% of sales and Ledlink manufactures in China.

Ledlink’s customers include Philips, GE, Osram, Daiko, and Acuity Brands.  Ledlink’s customers are in the downstream LED-lighting-fixture sector, not the chipmakers (Cree, Nichia, Osram, Lumiled, Edison, etc.).  Ledlink considers the chipmakers “partners”, not customers—Ledlink creates lenses to match new chips on the market to sell to the downstream players.  Ledlink’s top 10 customers comprise only 26% of revenue and the largest customer (Daiko) accounts for 4% of revenue.  Despite a few big brand names, the downstream market is actually quite fragmented, with the top 10 players taking 35% share and >1000 players splitting the remaining 65%.

Ledlink IPO’d in May 2011.  Since the IPO, sales and earnings have grown dramatically but the multiple has shrunk.

For an idea of what optical lenses look like, here’s their most recent products catalog: http://www.ledlink-optics.com/Images/Home/4223-80P-0425_s.pdf

Why is it so hard to compete with Ledlink in lenses?

 1.       Huge variety of lenses, fragmented customer base

Ledlink has more than 3000 types of lenses for more than 2000 customers.  That’s a huge number of lenses, each of which requires a different mold, many of them custom-made. 

Here’s an example to illustrate why so many different lenses are needed.  Let’s say you want to match a lens to a LED streetlight.  Well, (1) whose LED component (Cree/Nichia/etc.) are you using?  (2) How high is the streetlight?  (3) How long is the horizontal arm of the light?  (4) How distant is the lamp from the street?  (5) What is the angle of the light?  (6) What kind of light effect do you want to achieve?  (7) Is there a wall next to the light?  Etc.  Each of those factors could lead to a different lens to optimize the effect.

So this is not a commodity business where you are churning out a few standard lens SKUs.

2.       Low cost, high importance

Furthermore, the ASP of a streetlight lens is ~NT$5 (~1 RMB, $0.16 USD), or ~1% of the light’s overall cost.  And yet the lens is critical to performance in terms of light quality, energy savings (by reducing the number of LED chips needed), etc.  The low-cost (both relative and absolute), high-importance nature of the lens means that LED light manufacturers are not incentivized to switch lens suppliers based on small price differences.  That gives Ledlink pricing power and keeps out would-be new entrants. 

3.       Economies of scale –

a. the cost of lenses can be amortized over more customers

Customers can either ask Ledlink to produce an exclusive, custom lens (50% of sales) or allow Ledlink to shop the lens to other customers.  Either way, Ledlink wins, to the detriment of its competitors.

For example, let’s say Cree comes out with a new component and a customer wants a lens for it.  The customer can ask Ledlink to create an exclusive, custom lens (Acuity, for example, prefers to customize its lenses).  Ledlink asks the customer to pay for the cost of development and earns a higher gross margin than average.  The customer is not allowed to take the mold for the lens out of Ledlink, so Ledlink has captured that customer design.  Custom lenses account for more than 50% of sales.

If the customer doesn’t want to pay for a custom lens, it can pay Ledlink for a standardized lens for the specific component.  Here, Ledlink’s scale advantages really kick in.  Ledlink can invest a lot in the fixed cost to develop a new lens because it knows it will have plenty of customers to sell it to.  Thus a lot of customers buy from Ledlink, providing Ledlink with more dollars and confidence to invest in developing the next generation of lenses.  Smaller competitors are more hesitant about investing upfront for an uncertain payoff, but then they can’t produce the variety of lenses needed, so they become locked out.  Lenses change fast and are in naturally small volumes (even for standardized lenses), forming a natural barrier to entry.

b. materials account for only 1/3 of the lens’s cost

Economies of scale are more powerful when fixed cost is a higher proportion of total costs.  Though labor is not a fixed cost, for Ledlink, manufacturing overhead and labor account for 2/3 of the cost structure while materials are only 1/3 (mostly plastics).  This is a difficult situation for a new entrant to compete in.

Ledlink has a further per-unit advantage because it has the scale to buy very large machines that produce molds with 8 points (vs. previously 4 points and 2 points), leading to savings over others using smaller machines.

4.       Small market

The LED optical lens market is tiny—Ledlink is #1 with US$41 mm revenues in 2013E vs. the multi-billion LED lighting market.  With the small revenue potential, low volume/high variety, and high importance, it’s not worth it for the big guys to get into this market.  They might as well use Ledlink.

Competitors

The biggest players besides Ledlink (35% share) are: Ledil (Finland, 20% share), Fraen (US, 10% share), Carclo (UK, 10% share), and Baikang (China, 5-10% share). 

Ledlink is the global #1 and the undisputed #1 in Asia.  Its R&D and manufacturing are vertically integrated and located in China.  Ledil is focused on Europe and doesn’t have an integrated Asian manufacturing presence.  Fraen lost so much share to Ledlink in Asia that in 2011 Fraen asked Ledlink to ODM for it rather than continue to compete.  Only Ledlink and Ledil are 100% lenses; Fraen, Carclo, and Baikang have non-lens business.

Ledlink has lower costs due to scale.  Even in the unlikely event that a competitor can price lower, the lenses are differentiated and important enough and cheap enough that the customer isn’t incentivized to switch.  The competing product would have to be a lot cheaper or better.

Can Ledlink’s lenses be copied?

Yes, in theory, an individual lens can be copied in China, despite Ledlink’s patents.  But widespread copying is not practical.  Ledlink has more than 3000 lenses and produces new ones all the time.  Customized lenses account for more than 50% of sales.  Minor errors in copying can lead to performance problems.   The ASP is low enough that it’s not worth it.  Finally, the customer also relies on Ledlink for not just one lens but all future lenses—a one-time difference in price isn’t worth harming the relationship. 

LED general lighting market growth

The LED general lighting market is poised to take off.  Initial price aside, the energy cost savings and lifespan arguments over CFLs are compelling.  We are already seeing some commercial adoption.  For residential lighting, people are waiting for LED light price points to come down below the psychological barrier of $10 (we’re close).  CLSA estimates LED penetration in lighting to be 4% in 2013 and reach 9% in 2014, a huge growth rate.  WinterGreen Research projects the LED lighting market to grow at 45% per year through 2019. 

It’s worth pointing out that this idea doesn’t need huge LED lighting growth to work—it’s reasonably priced off current earnings. 

Long-term economics

Ledlink costs down older lens ASPs by ~5-10% per year, at a slower rate than average semiconductor ASPs.  Ledlink has some amount of pricing power and charges more for new models.  The company expects 2013 revenue to grow 30-50% with 45-50% gross margins and target 20% operating margins.  At maturity in ~2020, the company expects to have 35% gross margins and 15% operating margins.

Catalyst

No “hard” catalyst per se.  As earnings grow, the multiple will contract rapidly.  Additionally, Ledlink pays out ~25% of net income as a dividend for a current 2% yield.  If it keeps its payout ratio then the dividend will grow and become noticed.