​The China Securities Regulatory Commission has received an IPO and listing guidance report from China International Capital Corp. (601995.CH) concerning the potential IPO and listing of Huike Company (248.HK) (aka HKC), a producer of large panel LCD displays in China.  According to the report HKC has a ‘relatively complete accounting management system’ and is ‘relatively independent in terms of business, assets, personnel, finance, and organization.”  As we noted on 02/10/2022 HKC was added to the ‘unverified’ list managed by the US Department of Commerce’s Bureau of Industry & Security, which does not preclude US exporters from ‘engaging’ with listed parties or that there are specific foreign policy or national security concerns with those on this particular list, only that the BIS is unable to establish the legitimacy and reliability relating to the end use or end user of the items that fall under the US Export Administration Regulations (EAR) by such parties. 
The reasons for this inability could be an failure to contact or locate the parties involved, failure by those parties to demonstrate the disposition of items subject to EAR, or lack of cooperation by a host government with the BIS when making end-use checks.  The corporate structure of HKC overall is a bit complex but the company that owns HKC’s Chongqing Gen 8.6 LCD fab (Chuzhou HKC Optoelectronics), which is owned by HKC and two Chongqing government entities, had submitted proposals for the purchase of equipment used in the display process and the US government was unable to verify that the end user for HKC products that were being produced (using US equipment) was not in violation of the BIS rules (no sales to Chinese military).
HKC itself, owns four Gen 8.5 LCD fabs and currently has a ~5.5% share of the total LCD market (by capacity) and an 11.6% share of the Gen 8+ LCD market and this year has been generating between $380m and $430m in sales on a monthly basis.  Peak sales were in June of last year when the company generated $540m in LCD panel sales.  We expect the actual IPO filing will reveal a bit more detail about HKC, in particular its recent performance as it has not yet released results in 2022.

​As we have noted, Chinese LCD producers have been reticent to cut production levels this year and with large LCD panel pricing at or near cash costs, one would expect utilization reductions that would tighten the market.  At least that is what one would expect, especially given that inventory levels at panel; producers are higher than normal, but thus far utilization rate cuts from Chinese panel producers have been almost negligible, and the rhetoric remains basically the same as it has been for the last 6 months, with “…panel prices are at cash costs so they cannot go much lower…”, and “…the 2nd half will be better…” (by how much would be the real question), and some panel producers continue to build inventory to gain share as Samsung Display (pvt) makes its final exit from the large panel LCD business.
Demand does not seem to be a driver behind these statements, as target cuts in the TV, smartphone, and notebook markets have already been registered and components, such as display drivers, that were in desperate short supply last year, are now seeing price pressure and production reductions, so where does this end?  Will it continue throughout the rest of the year with Chinese panel producers hiding their heads in the sand until they are forced to unload excess inventory at even lower prices to avoid showing y/y levels 50% or higher than last year?  Hopefully not, as the impact on the display industry under that scenario would be profound, and the best suggestion were have heard was that Chinese panel producers should drastically cut utilization in June and July to bring inventory levels down, and then return to higher utilization levels for the remainder of the 3rd quarter.  While this seemed a good idea, the mindset of Chinese panel producers would likely not allow such a move, as the risk of a competitor lowering utilization by less and gaining share, is foremost currently.
Whether the need to gain share and show positive growth is strong enough to offset the lack of profitability and the extent of the downturn in panel pricing is still an unknown, but the fact that Samsung Display is finally ending its large panel LCD display business, and parent Samsung Electronics (005930.KS) is playing the long game by becoming a beneficiary of LCD panel price reductions as a net buyer, should be some indication of how those with the most experience view the situation.  More than likely it will not be the force that will change opinion as the immediate response to SDC’s large panel termination scenario has been to look to gain share by increasing production and capacity.  You can lead a horse to water but you can’t make him drink…

​disenfranchised but to its residents to ‘incentivize’ them to purchase certain items that the city government deems important to the economic health of its population.  This is in addition to the many subsidy and tax-advantaged programs that the city sponsors to attract businesses, as it competes with other cities and regions in China, including a very public one announced last June that promised up to 40% of total investment cost paid (max. $47m/project) for any company willing to build out a satellite development project in the city, which came as a result of competitive offerings from Hong Kong, Macau, and other cities in Guangdong province that had positive results.
Such subsidies are well-known across China for businesses,  but Shenzhen has also offered incentives and rebates to consumers for direct purchases, particularly  a June 2020 program that paid each purchaser of an all-electric vehicle the sum of $2,974 (50% of that for hybrids), and that included 1 hour of free on-street parking for all electric vehicles purchased under the program.  The program allowed non-residents to participate if they had a valid current resident permit including Chinese citizens living overseas and foreigners with valid visas.
Now Shenzhen is at it again, this time offering subsidies of up to 15% (maximum $300) on purchases of electronic products including smartphones, laptops, drones, wearables, fitness equipment, robots, and smart home appliances.  That said, the list of eligible items does not include any foreign brands, with over 40% of the 8,249 items (multiple models) being from Shenzhen-based Huawei (pvt), and while that might only make a small dent in the CE product weakness seen across China, it is going to make some Shenzhen residents happy.

Samsung Display (pvt), an affiliate of Samsung Electronics, was once the large producer of LCD display panels[1], then competing with South Korean rival LG Display (LPL) for supremacy in that market.  While much of SDC’s revenue came from its parent, Samsung Display was a major global large panel LCD supplier to the industry. But as can be seen in Figure 1, SDC’s focus moved away from large panel LCD display production and more toward higher value small panel OLED displays, where the company still dominates.
  In 2020 the company made a formal decision to end its large panel LCD production business by the end of that year, and sold its Gen 8.5 fab in Suzhou, China to Chinastar (pvt), while taking a 12% stake in the company, but postponed the closing of large panel LCD production facilities in South Korea at the behest of parent Samsung Electronics.  While sustaining a single large panel LCD fab during 2021as panel prices increased, SDC maintained it goal of exits the large panel LCD display business but used existing fab infrastructure to add small panel  OLED capacity or to develop a production line for its proprietary QD/OLED panel process, which has begun production.
As large panel LCD prices began to decline last July, it became inevitable that SDC would finalize its plans and close that fab, although the moratorium was extended into this year.  As large panel LCD prices continue to decline it becomes more critical for SDC to close their last large panel fab as panel prices approach cash costs, which is the case currently, and sales for SDC’s large panel LCD segment declined to only $7m in April, down from $65m in January and a peak of 2.13b in March of 2012.   Given the declining panel price and the reduced production assumed, we would expect the fab to be closed by the end of 2Q.
According to local Korean press, Samsung Display employees (at least those 37 years old or less) can apply to be transferred to the chip packaging business of parent Samsung Electronics, which operates under a different division.  300 such positions are being offered to the ~1,000 SDC employees still working at the L8 LCD fab, which will take some time to wind down.  Staff will be needed to secure the equipment, which could be sold to smaller producers, with some potentially held until SDC decides what it will do with the idle space. 
SDC has been developing plans to produce Gen 8 OLED panels using a vertical deposition process that would allow for RGB patterning rather than the WOLED process used by LG Display, or the fab can be converted to additional capacity for the QD/OLED process, which currently stands at 30,000 Gen 8.5 sheets/year, a relatively small production volume level, but we expect plans to be finalized for the fab in July if it goes toward QD/OLED, as that conversion would likely take 9 to 12 months, giving SDC enough time to increase QD/OLED production for the 2023 holiday season, although that is a bit speculative on our part.  All in, SDC should be out of the large panel LCD business within the next 30 to 45 days.


[1] By Sales

​Over the last few days various sites have speculated that Taiwanese panel producers AU Optronics (2409.TT) and Innolux (3481.TT) would merge to create an LCD powerhouse that could compete with Chinese panel producers, such as BOE (200725.CH) and Chinastar (pvt).   Given the poor performance seen by LCD panel producers in April and a continuation of same for the 2nd quarter, we expect drawing such conclusions would be a way for some to refocus the declining profitability of the display space toward such combinations that would give promise to a new order, but it seems that neither company was interested in the idea and Innolux went as far as to appeal to the media not to publish false reports that would mislead the public.  AUO indicated that the transformation it has made over the last few years, moving from commodity panel  production to more specialized displays, and branching out into Mini-LED and Micro-LED technology, have performed well and are creating value, so a merger would only be viable if it were synergistic to that goal.
The problem with such a merger is the capacity that both parties already have and how that plays into today’s market.  Both AUO and Innolux have significant Gen 5 and Gen 6 capacity, which is ideal for IT panel production, but combined lave less Gen 8 capacity than China’s leading TV panel producer BOE, which is essential for efficient TV panel production.  Both also have a number of Gen 4 and Gen 5 fabs, which are relatively old and therefore inefficient by current standards.  We note that AUO has recently indicated that it is planning to build a new Gen 8.5 LCD fab and has expanded capacity at its fab in Kunshan, the first capacity expansion project that the company has made in many years, and Innolux has stated it will not build any new LCD capacity but will upgrade existing LCD lines.  With the continuing downturn in LCD panel pricing, we expect such plans are less prone to be rushed and the result of combining existing assets would likely also be less crucial.

May display panel pricing was worse than expected, but more significant is the forecast for June, which is typically the strongest m/m gain for the year and potentially the beginning of the holiday build season.  Given there are a number of unusual circumstances surrounding the CE space and the display industry, particularly the COVID lockdowns in China that have disrupted the supply chain and slowed Chinese CE demand, however as we noted last week, Chinese LCD panel producers have made relatively minor adjustments to their utilization rates and have therefore been pushed to keep lowering prices in order to attract customers.  Inventories remain relatively high in the channel for most display products but it seems that industry expectations remain fixed on a demand recovery in 3Q.  There will be some new device production increases in July as Apple (AAPL) and others prepare products for the holidays but initial orders generally are modest as brands have already lowered targets and China’s lockdown policy continues to pressure the production and assembly supply chain.
A can be seen in the tables below, TV panel prices fell far more than we expected, putting the aggregate TV panel price at the lowest point seen in the last 5 years and down 58.8% from the high reached in June of last year.  Aggregate IT panel prices are now down 34.9% from the high reached in August 2021 and only 8.6% from the 5 year low seen in November 2017.  April industry panel shipment data saw large panel revenue decline 13.6% m/m and is now down 25.9% y/y, with all categories showing lower shipments on y/y basis other than monitors which saw a severe shipment decline last year in 1Q and 2Q.  While China’s share of overall large panel revenue increased to 51.8% in April, China’s large panel producers saw revenue decline 9.5% m/m and decline 24.1% y/y, while Japan (Sharp (6753.JP)) saw the only increase in large panel sales.  We break out major large panel producers in Table 3, which shows the severity of the revenue decline in April.  We note that Samsung Display (pvt) is in the process of closing its last large panel LCD fab, so the decline in that case is exaggerated and Panda (pvt) sold two of its fabs to BOE (200725.CH) last year, making the y/y comparison less relevant.

India is the 2nd largest market for smartphones and hosts assembly and component manufacturing for Samsung (005930.KS), Apple, Xiaomi (1810.HK), Vivo (pvt), Oppo (pvt), and others, but the country does not have any capability for producing LCD or OLED displays themselves.  The Indian government has sponsored various incentive programs over the last few years to attract producers to produce displays locally but most panel manufacturers are wary of building a new fab without the specialized infrastructure needed to support such an endeavor.  Such display complexes in Taiwan, South Korea, Japan and China are built around component supplier manufacturers, some of which are situated adjacent to the display facility to reduce transportation issues, and while India does have a plentiful supply of workers for assembly and similar processes, the country lacks both the supporting infrastructure (including reliable power and water) and the skilled talent to operate and maintain display fabs.
Display projects are expensive ($3b to $b typically for OLED) and require considerable government support both logistically and financially, to become a reality, and we have seen a number of display projects in China come and go over the last decade because of a lack of management and operating expertise, even with the support of the government, so when we read that a company with no experience in the display industry is ‘looking to sign an MOU with one Indian state within the next few weeks’ concerning such a project.  The company is Rajesh Exports (RJEX.IN), a Bangalore based company that is, according to the company, the largest processor of gold globally and the world’s lowest cost gold jewelers producer.  The company, also investing in the EV market (no experience there either), is looking to take advantage of the Indian government’s semiconductor incentives through a subsidiary Elest (pvt) in order to gain access to the potential financial funding, but will also fund through ‘internal accruals’, along with private equity infusions after the first year, with the project taking between 6 and 7 years.
So far there are 5 companies who have applied to access the government funding, committing a total of $20.5b, with one company having signed an agreement under the semiconductor and display portion of the incentives, ISMC Digital Fab (pvt) based in Mumbai, for a $3b plant, while other participants continue to look for deals with Indian state governments.  There is no doubt that India is a growing market for CE products and one that can support considerable assembly and board level production, but we are less sure that display projects are currently a viable alternative to China, Taiwan, Korea, or Japan, especially as the need for expertise in OLED displays manufacturing continues to grow.  Not saying it can’t happen, but most of the major display manufacturers have passed on the idea, which leaves the territory open to others, regardless of their experience.  Even with considerable government funding we give such display projects a relatively low chance of success and remind investors that Foxconn (2354.TT), the world’s largest assembler of CE products and the largest assembler in India, still has a mostly empty campus in Wisconsin that was going to be the first LCD fab in the US…still waiting on that one.

​LCD panel pricing is a nearly a perfect casebook example of supply and demand.  There are a finite number of LCD panel suppliers and in most cases fab output is a definable metric based on project development plans and updates, but the metrics get a bit more nuanced when factoring in utilization, essentially the rate at which the fab’s full capacity is being used.  The current balance, excluding utilization, is oversupply and has been since mid-2021 as demand for large panel LCD displays began to wane.  There have been some hints that LCD panel producers have lowered utilization rates, but there is a difference in what that means to various panel producers, particularly Chinese LCD panel producers.
Obviously LCD panel producers want to run display fabs at utilization rates in the low to mid 90’s at all times, but as prices for panels fall to cash cost levels it becomes a decision between the effect on margins of lowering utilization or producing a portion of total product at a loss.  Keeping longer-term customers happy is a big part of that decision and absorbing the loss from money losing production is a part of ‘customer service’, albeit a painful one.  The alternative of lowering utilization is also not a pleasant one, as idle capacity means equipment must still be maintained with no income offset and recalibration and restart yield issues will follow when the tools are returned to full production.
But there is another factor involved in those choices and that is ‘face’, and by face we mean not seeming like your company is no longer in the ‘growth mode’, which is how much of the Chinese display industry sees itself.  With LCD capacity expansion projects still in place with a number of Chinese display producers (although some are quietly being pushed back), funding and operating subsidies from provincial or local governments is essential, and those funding sources must be maintained at any cost, with the company’s ‘status’ a big factor in maintaining those relationships.  While producing for customers at a loss is certainly not an enviable position to be in, the Chinese manufacturing mindset is a bit different than in the US where most producers would walk away from money-losing business regardless of the circumstance.  Chinese producers do not want to reduce staff (a distinct negative for government funding sources who answer to the Central government) and would likely find it easier to explain away losses that don’t involve raising the unemployment level than those a result of lowering utilization rates while building a new multi-billion dollar fab.
What this means is that Chinese panel producers are relatively slow to lower utilization rates and when they do it is done in relatively small increments.  This is in contrast to South Korean suppliers who have made far more substantial cuts currently and in past cycles, in order to get closer to a supply/demand balance.  This has kept overall LCD panel utilization rates high during the recent decline in LCD panel prices that began last June and is still a problem currently, and part of the reason that panel prices have declined from peak to cash costs in just over a half year.  Overall utilization rates for Gen 8 LCD fabs fell by only 1.3%, including more substantial cuts made by LG Display, between March and April, with both Chinese brands and panel producers assuming that seasonal production increases in 3Q will be enough to balance supply and demand at current utilization rates.  While it might be more effective to have cut utilization more drastically early this year, panel producers were using that same expectation for 2Q, which obviously was not the case.  Yes, the global situation changed in 2Q, and that was hard to predict, but hoping that each progressive quarter will bail out the industry is just putting off accepting some of the more negative scenarios that should guide those decisions.

​In April and earlier this month (05/09/22) we noted some of the issues that were causing Chinese flexible OLED panel producer Royole (pvt) to fight to stay in business, despite being the first company to produce a foldable OLED display, beating OLED leaders Samsung Display and LG Display.  We noted that a possible scenario would be for the Chinese government to bail out the company, particularly the $1.64b flexible OLED fab project started in late 2016 that was only partially completed.  It seems that things have gone from bad to worse for the company as Royole served notice of termination to a large number of employees earlier this week, giving them three options that must be chosen by today.

• Receive a basic salary (40% or normal rate) times the number of years of employment paid out within 6 months
• Receive the same basic salary as above but paid out at the end of this month at a 50% discount
• May stay as an employee but at a salary of $352.

Notifications have been given to marketing, sales, product development and the smartphone divisions, excluding only some employees that have been with the company for at least 4 years, with some departments seeing >50% termination rates.  That said, the company is increasing the salary of those in the “Advanced Technology R&R & Production Platform” division, essentially the area where the displays are produced in order to retain those employees as the company tries to transition away from producing and selling commercial products (smartphones, tablets, etc) and focus on supplying flexible OLED displays to customers.
In mid-2021 Royole has ~1,800 employees but now has <500 and has closed all but one office as available cash declined to $14.9m in April, and the company had previously offered options to employees to raise capital and provide an additional incentive to stay with the company but with the current large layoffs, most will not be participating in the program.  Hopefully a recently announced potential display order will help to keep the company afloat, however based on past financials between 2018 and mid-2020, the company had produced only 18,000 display units so a massive ramp for such an order would be called for, and the utilization rates for those periods never reached above 32%.  Its going to take a very big Band-Aid to fix this wound…

​Yesterday we noted the weakness at Taiwanese display producers in April, which caused all three to see declines in shipments and sales.  Innolux (3481.TT) has now given some guidance as to what it expects for 2Q, which is an increase of 7% to 9% for large panel shipments and an increase of 17% to 19% for small panel shipments.  While this sounds like a positive for the company, Innolux is also expecting a a 10% to 13% decrease in ASP, which will likely generate an operating loss.  The company also announced a 50m share buyback, which is equivalent to 0.47% of the outstanding shares and declared a dividend of 18.99% of 2021 EPS, or NT$1.05 ($0.04 US).  1Q operating p[profit was NT$2.243b ($75.186m US).