Rubicon, it’s all about the product mix
While LED adoption continues to grow at a healthy rate in backlighting, LEDs per panel fell significantly in 2H’10, offsetting much of that growth, In addition, the lighting market is still dwarfed by backlighting. As a result, utilization was not as healthy as expected in Q4’10. Thus, less sapphire was required to meet demand. So, if there was a miss, it will likely be on volume.
Rubicon was downgraded today by Canaccord Genuity on pricing peaking in Q4’10 and price reductions in 2011. However, that is somewhat misleading in that pricing may have peaked in Q4’10, but it is flat to down only slightly in Q1’11 and it looks to be flat to down slightly in Q2’11. We expect to see larger price reductions in 2H’11. In addition, there is still significant room for sapphire suppliers to grow revenues and improve their margins on mix shifts. There are fewer suppliers and less capacity at larger wafer sizes, particularly 6”, and margins are much higher at those sizes. In addition, certain LED manufacturers focused on lighting are looking to move rapidly to 6”. As a result, if Rubicon continues to enjoy elevated penetration at 6” with its $71M 6” contract initiating in Q4’10, it could meet its gross margin target of 56-59%. Rubicon guided to <$5M at 6″ in Q4′10, growth in that number could significantly boost their chances to meet or exceed their gross margin target. In addition, Rubicon will begin to vertically integrate the labor-intensive polishing step in Q4’10 through its new Malaysia facility which may also contribute to higher gross margins.
The bigger concern from our standpoint is total volume. While LED adoption continues to grow at a healthy rate in backlighting, LEDs per panel fell significantly in 2H’10, offsetting much of that growth, In addition, the lighting market is still dwarfed by backlighting. As a result, utilization was not as healthy as expected in Q4’10. Thus, less sapphire was required to meet demand. So, if there was a miss, it will likely be on volume.
Longer term, we believe the sapphire market has the potential to remain quite healthy as 2” sapphire demand will likely remain tight due to all the new entrants in China and sapphire manufacturers reluctance to produce 2″. Larger wafer sizes should enjoy higher gross margins than 2″, although 4″ does seem to be coming under more margin pressure than other sizes. If all the new Chinese LED manufacturers yield poorly, that just means they will consume more sapphire which is good for sapphire suppliers so long as these companies survive. The biggest concern is that capacity investments remain under control and are closely tied to LED demand rather than MOCVD capacity. Sapphire suppliers have done a good job so far, but now many polysilicon suppliers are jumping in and could create a healthy oversupply and kill what has been a lucrative space.
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