Cree Could Light Up With This LED Spinoff

Philips is shedding a unit that could reverse decking rates of growth for LED maker

Jul 1, 2014 at 1:50PM

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There will be another power player lighting up the LED market after Philips (NYSE:PHG) spins off two lighting divisions into a new, stand-alone company. The Lumileds LED lighting unit and Philips automotive lighting segment will be calved off into a separate business that will have an estimated $1.9 billion in revenues and follows a similar effort made last year by Siemens (NASDAQOTH:SIEGY), which spun off Osram Licht (Nasdaqoth: OSAGF) to create an independent lighting specialist.

The move to separate LED divisions comes as pressures on manufacturing margins mount, even as it shines a spotlight on the growth of the LED market. According to the market researchers at McKinsey & Company, the global lighting industry will be valued at $160 billion by 2020, more than three quarters of which will be LED lighting. 

The benefit of LED lighting is its efficiency and savings on power consumption, but its long life and reduced energy requirements come at a cost: a single LED bulb can run $10 or more, which consumers still balk at even though they'll save significant sums of money over the life of an LED bulb.

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To incentivize consumers into buying LEDs, the Energy Dept. offers instant utility rebates when you buy bulbs that meet its Energy Star Certification requirements that cut its initial cost in half. Cree (NASDAQ:CREE), one of the leading manufacturers of LEDs and components, scored that certification last year, which should help to bolster sales that have been growing at double-digit rates for the past six quarters.

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Even so, Cree's stock has fallen hard since last October, dropping more than 34%, as its rate of growth has decelerated. The industry is facing a supply glut at the moment, as Chinese producers enjoy heavy subsidization by their government and the industry moves toward one of commoditization. Although it's profitable at the moment, margins will eventually move lower.

By separating the divisions now, Philips will reduce its exposure to the manufacturing side of the LED equation while keeping the higher margin integrated systems and services businesses that the LEDs themselves run on. But the new company will also highlight the integration of automotive applications for LED lights and might just be a unit Cree would want to buy.

Earlier this month its shares got a lift on vague M&A rumors, but it was more along the lines of Philips or General Electric (NYSE:GE) -- which itself is a large player in the lighting industry -- acquiring it. Such rumors have swirled for years, but never materialized. It may be that the talk was actually surrounding this spinoff and how that would be an attractive acquisition for Cree because it will be competing head to head with Philips in the lighting systems business.

Philips itself has faced some rough patches recently and is behind the diversification moves its been making to bolster its own bottom line. The lighting division, which accounts for one-third of its revenues, has been one of the few bright spots in its performance, so shedding a unit that it anticipates will sap margin strength in the future, benefits its outlook now.

LED lighting has vastly improved from its early days, in terms of the brightness of the light it casts to the cost savings derived from its use. There's still a lot of jockeying for position in the space, and Cree, which has long been an industry leader, could brighten up its future prospects further if it flips the switch on this spinoff.

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Rich Duprey owns shares of General Electric Company. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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