Goldman Sachs recently highlighted LED lighting as a top “disruptive” theme over the next decade. While I'm often inclined to believe that these sell-side "theme pieces" are designed more towards generating attention during stretches of slow company news, I have little doubt that the penetration rate of LEDs in the lighting market is going to increase significantly over the next decade. That is going to fuel significant demand for LED-making equipment, LED packaging, and finished lighting fixtures for companies like Aixtron (Nasdaq:AIXG), Cree (Nasdaq:CREE), Philips (NYSE:PHG), and Osram What is less clear to me is the extent to which investors can expect to see huge gains at this point – the “LED revolution” has been long in coming and while there are certainly going to be trading opportunities come and go, the idea of “buy and hold” in this sector seems optimistic at best.
It's About The Benefits … And The Costs
There's really no significant debate that LED lighting offers major improvements over traditional incandescent lights. LED lighting can use as little as one-tenth the power and lasts around 50 times longer. LEDs are also much more easily controlled than traditional lights, have fewer fragile components, and don't require a “warm up” period.
The big “but” at this point is the cost of LED lighting. Although there are programs in place in a number of countries to encourage LED adoption and the full-life costs of LED lighting are already competitive, the upfront costs can be considerable. The upfront cost of LED lights are more than 30 times those of incandescent bulbs and nearly 10 times the cost of compact florescents (CFL), but that does not include the cost of fixtures and retrofitting. 
As time goes on, adoption will pick up in residential and commercial lighting. While LED lighting has roughly 15% to 20% share of the global market today, it seems likely that the market share will increase significantly over the next decade, as General Electric (NYSE:GE) (a major lighting company) has projected 5% annual growth through 2020. 
Opportunities On The Cost Side
Equipment vendors like Aixtron (Nasdaq:AIXG) and Veeco (Nasdaq:VECO) are working hard to development tools that will allow LED chip makers to use larger wafers and generate better yields. As wafer costs are still more than 40% of the cost of an LED light, this is no trivial matter. While LED equipment demand is likely to be volatile over the next decade, the history of the LED market suggests that lighting will fuel a significant increase in equipment demand starting in 2014 and likely lasting for a few years.
Chips And Components Will Get Competitive
It is my expectation that the LED market will ultimately resemble the broader chip market, with some companies able to differentiate themselves with higher performance and specialty products, but much of the market evolving to nearly commodity-like competition with production costs emerging as the distinguishing feature.
There are already numerous manufacturers in the market, including major companies like NichiaSeoul SemiconductorSemiLEDs (Nasdaq:SEMI), and Cree, and companies like Cree, Philips, Osram, Samsung, and Neo-Neon have already vertically integrated multiple stages of the process, including the LED die, packaging and components, and lighting fixtures. It's worth noting that Cree is far and away the most integrated company in this respect, as it has differentiated technology across the full breadth of the supply chain.
Will The Lighting Companies Control The Economics?
It will be very interesting to see who ultimately captures the best economics in the lighting chain. Cree, Philips, Osram, and Samsung all sell LED lighting products (lamps, fixtures, controls, etc.) and also produce their own components. Other major lighting companies like GE, Acuity Brands (NYSE:AYI), and Eaton's (NYSE:ETN) Cooper are not likewise integrated, and will depend upon competition between LED chip makers and component manufacturers to reduce their input costs.
How this all plays out will be interesting indeed. If Cree can effectively control their production costs and/or develop differentiated products and technologies, they could well have an advantage over companies like GE and Eaton and the same may be true (albeit to a lesser extent) for Philips or Osram. If cost differentiation proves difficult, though, GE and the like may well benefit from playing suppliers off of each other and using lower supply costs to compete on price in the end market.
The Bottom Line
Cree shares were punished harshly after its recent earnings release, but the stock is still up more than 100% over the past year and has nearly tripled off of the late 2011 lows. What's more, the stock still trades at more than four times next year's revenue (though that multiple was at 5x-plus before the earnings report).  By comparison, stocks like Aixtron and Acuity are in the green over the past year, but not nearly to the same extent.
As is often the case with trends, investors are likely to be better off if they ignore the trends and focus on the companies. Taking it as a given that LED lighting demand is going to be positive, investors will do better for themselves identifying those companies with truly leveragable technologies or business models trading at reasonable models.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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