How Substantial Is the Opportunity for Universal Display Investors?

The next generation of display technology will be centered upon organic light-emitting diodes, or OLEDs. The technology's viability in mainstream applications continues to ramp up in conjunction with advancements, but its advantages over traditional LEDs and other display technologies are too promising for investors to ignore.

As the dominant supplier of OLED materials and intellectual property, Universal Display (NASDAQ: OLED  )  has a bright future ahead of it. To break down exactly how investors should understand this company, the Fool recently crafted a premium research on Universal Display, a brief excerpt from which we've included in the text below. Enjoy!

The opportunity
Since OLEDs consist of organic materials that emit light when electricity is applied, there is no need for a separate backlight like in traditional displays. This facilitates thinner form factors and improved power efficiency. OLED displays can also be made flexible and transparent because of this attribute, paving the way to new possible use cases. Other advantages include faster refresh rates, better contrast, higher brightness levels, lighter weight, and increased durability.

However, there are still some disadvantages relative to traditional LCD displays, such as decreased lifetimes, particularly for blue materials. Red and green have much more adequate lifetimes, but a display panel is held back by its lowest common denominator, since two primary colors are no good without the third. Manufacturing costs remain high, and OLEDs don't perform as well in direct sunlight.

Universal Display specializes in phosphorescent OLED technologies, or PHOLED, which are more efficient than traditional fluorescent OLEDs, as well as LCDs. Universal Display has two primary businesses: material sales, and royalty and license fees. Total revenue quadrupled from 2009 to 2011.

Source: SEC filings.

With materials sales, PPG Industries is the exclusive manufacturer of Universal Display's proprietary phosphorescent OLED materials. The two companies have partnered in OLED material production for over a decade (since 2000), and a year ago renewed their supply agreement through the end of 2014.

Material sales consist of phosphorescent emitter materials and host materials. Emitter materials are disbursed into a host material to create displays, and sales of these materials are highly complementary to each other. Universal Display's customers are free to purchase host materials from other sources, and the host materials market is more competitive than the phosphorescent emitter material market, so its long-term prospects in host materials sales are more uncertain.

The breakdown of material sales does tend to fluctuate as a result, but emitter sales generally stay in the neighborhood of 85% of materials sales.

Source: SEC filings.

Gross margins in the materials sales business are also high, typically 90% or higher.

Samsung is Universal Display's largest customer, and inked a long-term contract where Samsung pays licensing fees as well as purchasing materials through 2017. Universal Display's agreement with Samsung involves annual licensing fees of $30 million, payable in two semi-annual installments of $15 million in each of the second and fourth quarters. This licensing revenue is subject to a 3% royalty fee from Universal Display's university partners as well as 16.5% in South Korean taxes, for a total of 19.5% right off the top.

LG Display is Universal Display's second-largest customer, and has yet to ink a long-term contract, instead opting to continue short-term renewals of its original 2007 contract. The Samsung deal has added some visibility to royalty revenue, and a similar LG deal would also further validate the business.

Eventually, OLEDs may very likely power the next generation of TVs as well. Top TV manufacturers like Samsung, LG, and Sony have all announced OLED TVs, but they remain prohibitively expensive for mainstream adoption. The advantages of OLED enable these TVs to be remarkably thin and light, but those may not be values that consumers prioritize, since TVs typically remain stationary and an OLED TV can easily cost over $8,000.

Fortunately, OLED TV prices are predicted to fall rapidly over the next couple years, making them competitively priced by 2014 or 2015. The OLED TV market is expected to reach $1 billion in 2014 and reach $16 billion by 2020.

OLED white lighting is also another opportunity for Universal Display. This market remains very small and the company only generates a very small amount of revenue related to white lighting products. Flexible OLED panels are also an exciting prospect in the future with innovative use cases. The overall OLED display market is projected to top $34 billion by 2019, representing immense long-term opportunities for Universal Display.

Universal Display has a powerful patent portfolio behind OLEDs, a technology poised to dominate the displays of the future. Its placement at the center of OLEDs makes the company an underappreciated way to play the enormous sales growth in tablets and smartphones. However, like any new technology, there are plenty of risks. I've put together a new premium report that dives into reasons to buy the company as well as the challenges facing it. For access to this comprehensive report, simply click here now.

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