Right after the Korean independent counsel team announced that they planned to indict Samsung Vice-Chairman and heir to the Samsung empire, Lee Jae-yong, the Samsung Group announced it would dismantle the “Future Strategy Office” with its two top officials resigning.  The unit, which was comprised of roughly 200 company officials from Samsung affiliates had been the company’s policy making group, coordinating major programs among affiliates, including government affairs.  This ‘control tower’ was considered the root of the scandal that led to Lee’s arrest and now indictment, and was part of the scandal that led to the impeachment of Korea’s president, Park Geun-hye.

The company is expected to hold one more hiring event in March under the old system, and then turn the hiring and decision making back to the affiliates themselves, with no central governmental affairs group.  While the expectations that the group would be disbanded has been percolating since the end of the year, when it was mentioned by Lee as part of the scandal investigation, the timing coincides with the end of the investigation on Tuesday, and the aforementioned indictment.

A small Canadian company, whose founder has two siblings that are legally blind, has developed an OLED-based appliance that allows those with compromised vision to see more clearly.  Toronto-based eSight (pvt) has developed a high speed, high definition camera based system that can instantly refocus visual range without the ill effects found in other similar devices, which allows the user the freedom of mobility that is unavailable using older devices such as magnifiers or bulky CCTV devices.  The unit comes with a processor which is pocket size, and the visor can be adjusted to fully or partially cover the eyes.

While there have been many attempts to produce devices that can be used to enhance the visual acuity of those with compromised sight, most have been bulky and slow to respond.  Response time can be a very significant factor, as those who have toyed with 3D visors can attest to, but for the visually impaired, it can be an impossible experience.  By using OLED displays, the devices can be light, and the response time can be so short as to be considered real-time., and the ability of OLED technology to reduce battery drain, gives the user a new level of flexibility.  We don’t mention this to promote a company or product, but to help investors understand the far reaching effects of using OLED technology, which has the ability to extend the use of display devices into realms that we were unable to penetrate with older display modalities.  While the cost is still high, ~$10,000, as with any new technology, the price will decline as production increases and the technology matures, and while it will likely always be significantly more expensive than static sight-enhancing devices, the 200m people worldwide who have low or almost no sight would likely not consider any premium a burden.

Sharp (6753.JP) and the Japan National Institute of Material Science has devised a way to improve the color efficiency of LED driven LCD TVs.  In this case, the company and NIMS were working toward improving the color of 8K displays in order to meet 8K broadcast color gamut requirements, and have jointly developed a green fluorescent material that they believe will bring the overall screen color to 90% of the BT 2020 standard (the newest commercial standard).  In many cases, the enhancement of color gamut is accomplished by using cadmium-based quantum dots (although not all QDs are cadmium based), but concerns over the use of cadmium in consumer products has pushed display developers to look for alternatives.  Cadmium-free QDs are available from a number of sources, but some do not believe they can meet the same specs as cadmium-based QDs.  The use of Sharp’s new ‘green’ would entail changing the LED backlight, which Sharp believes is less of a burden than using dangerous heavy metals to achieve the same goals.

While we commend Sharp for its discovery, the application that it was developed for is 8K TV, which is a focus for the Japanese broadcast industry, and consequently Japanese TV set suppliers.  The concept of 8K TV is a logical one, however the TV and broadcast industries are still trying to wrap themselves around 4K, which is the step up from full HD, which is what is commonly used in most TVs.  4K broadcast and storage bandwidths are already taxing infrastructure, and the cost of upgrading even small scale broadcast systems is high, which leaves most 4K content to single unit storage or compresses broadcast modes.  4K Blu-ray players are a new animal, and little native 4K content is available from traditional broadcast venues, but we admit that 4K TV sales continue to increase as consumers are being convinced that not buying a 4K set will leave you alone and befriended once 4K really gets going.  8K bandwidth and storage requirements are ‘a bit’ larger, and while we have seen a few 8K sets at shows, they will remain out of the mainstream for a few years.

For comparison:

4K uses a resolution based on 8,294,400 pixels, which is 4 times current ‘full HD’ resolution

8K uses a resolution based on 33,177,600 pixels, which is 4 times 4K resolution and 16 times full HD.

To make matters worse, 4K transmission runs at 60 frames/second, which means the information for 8.2m pixels must be transmitted 60 times each second, which is a massive amount of data, however the 8K frame rate is twice that (120 fps) which means the information for 33.2m pixels must be transmitted 120 times each second.  “Ok, ok, You’re gonna need a bigger boat…” might be an appropriate quote.

In Part 1 of our review of Universal Display’s (OLED) 4th quarter, full year 2016 and 2017 guidance, we focused on 5 specific points that we believe are key to understanding UDC’s prospects for the next few years.  In part 1, we reviewed bullets 1 & 2, and in this note, we review bullets 4 & 5.  We will review bullet 3 (LG OLED TV royalty in a separate note.

1.       Color relating to the expiration/renewal of the Samsung Display (pvt) IP license and material supply agreements

2.       A continuing increase in emitter sales, particularly red emitter

3.       Some incremental improvement in LG OLED TV royalty

4.       An increase in non-Korean product sales

5.       A realistically optimistic view on 2017 sales that has some correlation to OLED capacity growth

4.            An increase in non-Korean product sales – In this case, we are looking for growth from customers outside of South Korea, where UDC’s two primary customers Samsung Display and LG Display (LPL) are located.  While UDC has agreements of varying types with almost every OLED producer, developer, or R&D project, the OLED industry is currently based on these two suppliers, who we believe currently represent 90.7% of raw OLED capacity and 92.8% of currently available OLED capacity (see Fig.1 below).  That said, the longer-term objective for both the industry and UDC is to broaden that supplier base and to that end we watch ‘non-South Korean’ sales as an indicator of progress in customer diversification.  We look at customer breakdown and regional metrics for help in understanding that growth, as can be seen in Fig.2 and Fig.3

While regional China sales grew each quarter during the 1st three quarters, 4th quarter Chinese sales were below earlier quarters. We believe this is a result of over-ordering of materials in 3Q, an issue that has affected Samsung Display sales over the last few years and was also likely the cause of the 4th quarter decline in ‘non-Samsung’ sales.  We note also that sales to China in 2016 were up 167% on a y/y basis, a more important metric than sequential quarterly results (Fig.4).  We would expect that much of the sales to China were to BOE, the largest overall panel producer in the region, the 4th largest worldwide panel producer, and the most aggressive in terms of adding OLED capacity. 

BOE (200725.CH) is right at the cusp of becoming a commercial OLED producer, and as such is using more OLED materials to produce test runs, samples, and small quantities of OLED devices for potential customers, which we believe represents much of the incremental growth seen in the China region.  That said, there are a number of other Chinese OLED producers that are either in low level production or are ramping capacity in 2017, 2018, and 2019, which would lead us to believe that China, as a percentage of UDC’s sales, should continue to grow over the next three years.  That said, material usage growth comes from increasing capacity, but more realistically from utilized capacity and from customer demand.  When a new OLED fab opens, it does not start producing with equipment at 100% of efficiency or capacity and more so, produces what is needed for customers, and in the early stages of OLED mass production, product yields are particularly low, especially for new producers. 

This leads us to continue to expect substantial growth from China over the next few years, but we also caution investors not to over-expect from the region as it is both new to the OLED space, and faces considerable competition from very well established South Korean producers.  A conservative view on the growth from China would be the most logical path, and one that will likely lead to more accurate estimation of UDC’s ‘non-South Korean’ growth.

5.            A realistically optimistic view on 2017 sales that has some correlation to OLED capacity growth – By ‘realistically optimistic’ we mean a growth rate akin to the growth of the industry, particularly industry production capacity, as UDC’s material sales should be at least coupled to such a metric.   As a basic metric, we take the 2017 company guidance of $240m (single point) and assume ~50% of total revenue from material sales (49.9%, 59.2%. and 66.4% for 2016, 2015, & 2014 respectively) and the industry growth rate (using utilized OLED capacity) and map those metrics in Fig.5, with the dotted blue line being the incremental change in UDC material sales needed to meet the 2017 guidance.

We believe that UDC guidance is based on a number of factors which include the timing of fab construction and expansion, the adoption of individual colors by customers, the adoption of new materials by customers, the efficiency of material usage by customers, and material pricing.  These are each significant variables that can affect the sales flow throughout a quarter and for the full year, as it has in the past.  We are concerned that only small variable changes could put the full year guidance in jeopardy, and hence the rather wide guidance range ($230m to $250m), and we caution investors that such variable deviations are more the norm than the exception in the OLED space, particularly those that are under the control of customers rather than suppliers like UDC.

We are currently adding additional variables to our OLED industry model to allow us to further define, and in this case down to individual OLED emitter materials, the effect they might have on UDC sales in 2017 and beyond.  This is a complicated task and we expect will take a few additional weeks, but we expect that it will give a level of detail and flexibility in our model that will be able to track and predict UDC sales to a degree of accuracy that we believe would be unique.  Stay tuned.

We have already commented on January and February panel pricing, but we have filled in our data for the display space as to broad unit volumes and individual company results.  The company results are sorted by total sales – m/m gain/loss.

Sony (SNE) announced that its Playstation VR headset, which was released in October 2016, has sold a cumulative 915,000 units[1] since its release, despite the manufacturing shortages the company has been facing.   Working off a base of 53.4m Playstation 4 units worldwide, the number of developers for the VR platform has increased to 360, with more than 220 software titles and content in development, and a total of 100 new titles to be released this year.  Currently there are ~100 titles available worldwide.

Estimates for unit volumes for VR units are for ~9m units this year, rising to 50m in 2020[2], although it would seem most VR brands have underestimated demand and are facing similar shortages as the display industry finds it footing in what was a nascent market a year or two ago.  Once the hardware side comes into balance, much of the dollar value in the VR industry will come from software, which is estimated to account for ~60% of $70b in total VR sales  in 2020.  Total VR revenue is estimated at $1.8B in 2016.  Samsung, with its Gear VR dominated unit volumes, both as a popular device, and as a give-away promotion with a number of high-end Samsung devices, particularly the Galaxy smartphone line.

[1] As estimated by Sony Interactive Entertainment

[2] Trendforce 2016

Early this month we noted that Samsung (005930.KS) had verified that it would release a new Galaxy Tab S3 at Mobile World Congress, the first new high-end tablet the company has released since September 2015.  In our note we pointed out that the significance of such a device, should it have an OLED display, would be the continuation of Samsung’s use of OLED in its high-end tablet line, which it had not used in its low-end Tab A & E models.  The just announced model has a slightly larger (9.7”) display than we had expected (previous was 9.6”) and represents the equivalent of 3.8 5” smartphones in area.

The tablet market has been deteriorating since its peak in 2014, and while expectations for a 2017 low point and modest increases from 2018 to 2020 have been predicted, we see both the larger average size of smartphones, and the impact of detachables weighing on the space.  Early tablet market share holders such as Asus (2357.TT) and Barnes & Noble (BKS) have dropped below the top 10 with the market dominated by Apple (AAPL), Samsung, Lenovo (992.HK), Huawei (pvt), and Amazon (AMZN) and an increasing percentage of white box brands, particularly in China.  While the overall impact of a new OLED tablet will not make or break Samsung’s numbers in 2017, it is important for the company to maintain the use of OLED displays in their high end small panel products and the new tab continues this trend.  Ideally we would hope they will eventually extend the use of OLED displays into the lower priced A & E tablet lines, as they have done in the smartphone market, but Samsung’s OLED capacity remains tight and better margins are likely on the smaller OLED displays.

Samsung also revealed the Galaxy Book line, which consists of a 10” and 12” ‘2-in-1’ type tablets, essentially tablets with detachable keyboards, an increasingly common configuration for high-end tablets, which puts them in competition with notebooks, but at the same time blurs the statistics as to what should be regarded as a tablet.  What makes these (actually one of them) important is that the 12” model uses an OLED screen, a step up in size for Samsung’s OLED display category, which would be the equivalent of 5.8 5” smartphones, and while the unit volumes of these devices will be small relative to the Samsung smartphones lines, it is incremental to Samsung’s OLED display business going forward, and represents Samsung Display’s further commitment to OLED for small panel devices and their constant push to increase the screen size of its small panel OLED production.  We would surmise that the 10” model, which uses an LCD screen, could not support the cost of the OLED display, which given its early stage of production and low starting volumes, would be more expensive that the 10” LCD screen. 

Samsung has produced larger OLED screens (13” for Dell’s (pvt) Alienware gaming laptop, 13” for the HP (HPE) Spectre X360, or the 14” Lenovo ThinkPad X1 Yoga), but has not entered the market for OLED laptops itself. We have no timeframe at which we believe Samsung will enter the OLED laptop space, as we believe it will depend more on the relative cost of the display coming from Samsung Display (pvt) and the overall potential profitability of such a laptop, but each time Samsung Display and Samsung Electronics moves up the screen size curve, it signals that the structure of SDC’s OLED display business is moving toward a profitable structure for larger panels.

Earlier this month we noted that BOE (200725.CH) had opened its Gen 8.5 LCD line in Fuzhou a number of months earlier than scheduled, and ~7 months ahead of our schedule.  The new fab, which when fully built out, will have a capacity of 120,000 sheets/month (phase 2) will focus on both TV and monitor panel production, and will have some capabilities for oxide backplane production, although we believe the bulk of backplanes produced at the fab will be a-Si.  We now believe the fab is in actual commercial production and is shipping product to a variety of customers including Samsung and a number of domestic Chinese TV brands.

We note that our previously updated expectations for production from this new BOE LCD line were for a gradual ramp starting in March and full phase 1 capacity (330,000 m2/month) by early 2018.  We now accelerate that production schedule by ~ 4 months.  While on an industry basis, this will only add ~0.2% to the total industry capacity for the year, it is an indication of how aggressive BOE, and other Chinese panel producers are on adding capacity.  Further, BOE will be producing 43” TV panels at this plant, a substitute for 42” TV panels which are in short supply and have seen continual price increases after the closing of Samsung’s L7-1 LCD line, which is being converted to OLED production.  While we expect BOE to take full advantage of the higher TV panel prices, we also expect to see some volume discounts established in order to fill the fab as quickly as possible, and BOE is able to produce 43” panels more efficiently than typical for 42” panels, which gives them some leverage in their price negotiations.

In order to regain share in the Chinese smartphone market, Samsung Electronics (005930.KS) is said to be stepping up its component procurement from local suppliers.  In particular, BYD Electronic (285.HK), a spin- off of BYD Co. (1211.HK), a Shenzhen based automotive and component supplier whose lead company investor is Berkshire Hathaway (BRK).  BYD Electronic has received an order for high-end smartphones from Samsung, according to Taiwan press, and Samsung has been courting a number of other Chinese component suppliers, with O-film Technology (002456.CH), Holitech Technology (002217.CH), Truly Opto (732.HK), and BYD’s ODM division. 

We note that back in July 2016, Samsung invested $450m in BYD Co., supposedly under the concept of a way for Samsung to improve its automotive semiconductor results, but BYD will use the capital to expand its battery production and for R&D toward ‘new-energy’ vehicles.  The relationship between the two obviously is broader than just the automotive market as Samsung broadens its touch with BYD in order to lower the cost of assembly on the Chinese mainland.  The new relationship is said to be replacing some existing component suppliers in Taiwan, but we cannot point to specifics at this time.  

Universal Display (OLED) reported 4th quarter and full year 2016 results last night.  Yesterday we posted our expectations for the quarter, 2016 year, and for 2017, so what did we get?  Starting with the simple stuff, consensus estimates for 4th quarter revenue was $68.6m, which the company beat by 8.7%, reporting $74.577m.  The full year 2016 company guidance was $190m to $200m ($195m sp[i]) and consensus was $192.9m, putting the consensus beat at +3.1%, and +2.2% over our full year estimate.  Reported EPS was $0.55, 31% above consensus and 22% above our estimate, which put full year reported EPS at $1.02, 14.6% above consensus and 10.9% above our $0.92 estimate.  As we have noted many times in the past, at this point in the development of OLED technology, the accuracy of quarterly estimates is of far less importance than the full year results, given the potential for pushes and pulls during the industry’s capacity expansion phase.  While its always nice to be accurate on a quarterly basis, and we know investors are sensitive to quarterly performance, our true focus is on yearly metrics.

Guidance for 2017 was set at $230m to $250m ($240m sp), which was slightly (-1.6%) below the 2017 revenue consensus of $243.9m.  No EPS guidance was given, while consensus for 2017 is $1.29.  The table below gives some further 4Q detail as to reported metrics and our expectations.

Yesterday we noted that we were watching for the following points (in a different order):

1.       Color relating to the expiration/renewal of the Samsung Display (pvt) IP license and material supply agreements

2.       A continuing increase in emitter sales, particularly red emitter

3.       Some incremental improvement in LG OLED TV royalty

4.       An increase in non-Korean product sales

5.       A realistically optimistic view on 2017 sales that has some correlation to OLED capacity growth

1.       While Universal Display cannot speak about potential negotiations with customers, nor do we believe that such negotiations are near any conclusion, we do believe that Samsung will be looking to sign a new long-term agreement with UDC as the old one expires at the end of this year.  Should negotiations bog down as the 2017 year ends, we would expect a limited term renewal, but we do not expect Samsung to push for single year agreements with annual renewals.  We do note that the current IP license contract has called for increases each year, and we were surprised that the 2017 increase was $15m, boosting the full year to $90m.  As this rate was negotiated in 2013, and was based on the expected growth of the industry, we had expected the yearly increases to diminish as the industry grew larger and the rate of relative expansion slowed.  That has not been the case as can be seen from Fig.1, and bodes well for the IP license revenue in a new long-term contract.

1.       Commercial Emitter sales in 4Q increased, looking at the aggregate of both red, green, and other colors as seen in Fig.2., but declined on a total 2016 y/y basis.  Our focus was on red emitter material, which is used in every RGB OLED display, and now potentially in OLED TV displays, while green is an option in many cases.  Therefore red emitter sales should grow in step with industry capacity expansion.  Of course, that excludes the increases in material efficiency that is the goal of every OLED panel producer, which can lessen that correlation, but given that UDC reports dollar value of emitter materials, not units shipped, the effect of ASP and volume discounts must also be considered.  That said, we have been concerned that there has been no red emitter growth this year, making it more difficult to project long-term material sales that grow at industry expansion rates. 

UDC kindly supplied a bit of color in that they indicated that total emitter shipments were up on a y/y basis, which indicated that the primary cause for the lack of growth was pricing.  While this sounds even more onerous, cumulative material price discounts are part of the supply contracts that UDC has with all of its customers and are already built into our industry model.  That said, as customers reach those volume targets, the value of material sales is impacted, although there is a ‘terminal volume’ at which no further discounts are given.  UDC counters this issue by developing new materials, which restarts the ‘cumulative volume clock’ at full price as the new material is adopted.  This year’s lack of emitter growth has been affected by a delay in the adoption of some of these new emitter materials by key customers, which would have boosted emitter dollar values as ASP’s were reset to higher levels.

This remains a concern, as the adoption of new materials is at the option of the customer, but upon detailed examination we note that looking at commercial emitter sales does not paint an complete picture, as UDC sells these new materials to customers for testing, but does not book them as commercial sales unless they are being used in a high volume commercial product.  We believe a portion of UDC’s ‘developmental’ material sales includes these new materials, and as such, the commercial emitter material sales should be ‘adjusted’ to give a better picture of emitter growth, particularly red emitter.   Fig.3 illustrates the absolute and adjusted red emitter quarterly growth in 2016 and indicates red emitter growth.  Further, looking at ‘developmental’ material sales itself, there was significant growth in the 2nd half of 2016, which would imply both a higher volume of new materials being sampled to customers and a larger base of new customers that are not yet in commercial production but are using UDC emitter materials.

Given the constraints of our AM note, we will continue the review of the UDC results in our next note in order to give the depth we feel is necessary when discussing the OLED display space.  Don’t touch that dial!