Primasia News, Taiwan
08.10.2011
Lextar Electronics Corp. (3698 TT, EME/NR/NT$25.2)

Event: TW¡¦s only vertically-integrated LED maker will launch IPO in August (Neutral.)

Primasia Comment
• The only vertically integrated LED maker in Taiwan. Founded in 2008, Lextar, a subsidiary of AUO (2409 TT/NR/NT$12.45) with a 48.6% stake, is Taiwan¡¦s only vertically¡Vintegrated LED maker. In March 2010 it merged with Lighthouse, another LED packaging subsidiary of AUO. It manufactures raw LEDs, packaged LEDs, light bars and lighting end-products, at respective sales weights of 6.5%, 27.1%, 59.8% and 5.0% in 1Q11 (Exhibit 1). The company plans to launch its IPO at the end of August, although the date has not been announced. Lextar plans to issue 22.5mn shares of common stock in the offering at a tentative price of NT$30/share, implying potential share dilution of 5.7%. The expected proceeds of NT$675mn will be used to improve its financial structure.

• Turned profitable in 2Q11. For 1Q11 the company reported a net loss of NT$74.2mn (4Q10 NI: NT$106.8mn) on sales of NT$1.7bn (+0.9% QoQ), mainly due to low utilization rate, ASP cuts and high sapphire substrate costs. On the back of its improving utilization rate, a 5%-10% cut in sapphire substrate prices and 116% QoQ growth in LEDs for lighting applications, the company turned profitable in 2Q11 and posted net income of NT$112.3mn (1Q11: -NT$74mn, -75.6% YoY) on sales of NT$2.4bn (+32.2% QoQ). GM/OM also improved to 18.2%/8.4% in 2Q11 vs 1Q11¡¦s 8.3%/ -3.7%.

• Conservative 2H11 outlook on weak backlight LED demand. Management did not provide detailed guidance for 2H11, but has a conservative outlook for backlight LEDs because of weaker-than-expected consumer demand for PCs and TVs. Lighting LEDs, on the other hand, are expected to continue to show stable growth because of rapidly rising sales of LED lamps in Japan. According to GFK, 49.8% of light bulbs sold in Japan were LED lamps in the first week of July. As utilization in Lextar¡¦s epitaxy and packaging businesses is only around 60% at present, we believe the strong sequential growth seen in 2Q11 is unlikely to be repeated in 2H11.

• Lowering dependence on AUO by increasing lighting sales. AUO has been Lextar¡¦s largest client and accounted for 78.8% of its 2010 sales. Due to weak demand for backlight LEDs and the difficulty it has faced in entering supply chains of other panel makers, Lextar has been shifting production to LEDs for lighting applications. Its associated sales weight was over 30% in July, up from 11% in 4Q10. Lextar also provides OEM services to local lighting vendors in Japan and China, a strategy that has helped it reduce its sales weight at AUO to 42%-50% in 2Q11. The company guides it will increase lighting sales to over 40% of total sales by year-end.

• Uncertain advantages in vertical integration. Lextar noted that its vertical integration model has several benefits, including fast time-to-market ability and higher efficiency in production and operations. We have not yet observed these advantages being reflected in the company¡¦s performance, however, and its gross margin is below some second-tier LED peers (Exhibit 2). While a higher scale of production may be needed to benefit from these advantages, it remains a question as to how beneficial the business model really is.

• High debt level a potential downside risk. The company had a high net debt to equity ratio, which increased to 69.3% in 2Q11 from 57.4% in 1Q11, much higher than most of its Taiwan LED peers (Exhibit 4). The company guides the proceeds from its IPO will be used to pay down debt to reduce debt ratio. As of 2Q11 it had short-term and long-term borrowing totaling NT$6.1bn on hand. Although Lextar is unlikely to face liquidity problems in the near term, its high debt level is a potential downside risk to its share price performance.

• LED-epitaxy capacity on the rise. The company plans to increase the number of MOCVDs at its Taiwan plant to 64 units in 2H11. With an additional 16 MOCVDs planned for Suzhou, which it will begin to move in next month, Lextar will have a total of 80 MOCVDs by year-end. For its packaging business, it currently has no expansion plans due to the currently low utilization rate of 60%.

• Conservative 2H11 and high debt level may limit share price performance. The counter now trades at 16.4x 2011E street consensus PE. Valuation is similar to where most second-tier LED players trade (6.9x-18.9x 2011E PE). Although we believe its increasing lighting sales will support the company¡¦s performance in 2H11, weak backlight LED demand in the second half and high debt levels may cap share price performance. We therefore hold a neutral stance on the stock.