When Universal Display Corporation (NASDAQ:OLED) signed a long-term license agreement with Samsung (NASDAQOTH:SSNLF) Display in mid-2011, its stock understandably skyrocketed in response. After all, investors had nervously followed a series of successive three-month extensions signed between the two companies, and the 6.5-year deal put to rest persistent rumors that the world's largest display maker intended to split up with the OLED technologist.
Under the agreement, Samsung Display now pays Universal Display a lower price for higher volumes of material, as well as a twice-per-year IP licensing payment, which currently stands at $25 million (received by UDC in the second and fourth quarters) and increases with each successive year. For perspective, last year, those bi-annual payments were $20 million apiece, up from $15 million the year before.
Ironically, here we are over three years later, and -- even as revenue and earnings have jumped significantly since then -- shares of Universal Display have largely given up what proved to be only temporary gains:
In fact, as it stands, Universal Display currently trades for a mouthwatering 15 times trailing-12-month earnings, thanks most recently to a weaker-than-expected quarter amid sluggish high-end smartphone sales from Samsung. As it stands, Samsung Display is still Universal Display's single largest customer, accounting for 70% of total revenue so far in 2014.
Enter LG Display
But that raises the question: When will Universal Display score another lucrative long-term contract to both smooth out its revenue stream and reduce its reliance on Samsung Display?
For that, look no further than LG Display (NYSE:LPL), which is UDC's second-largest customer, having generated around 22% of this year's revenue so far by purchasing materials for its large-screen OLED TVs, mobile devices, and development of next-gen OLED displays. But similar to Samsung Display in early 2011, LG Display currently does business with Universal Display through shorter-term material supply agreements.
So, where do the two companies stand right now? Here's what Universal Display CFO Sid Rosenblatt had to say on the topic recently at the Goldman Sachs U.S. Emerging/SMID Cap Growth Conference:
When you look at what they're paying today for materials, there is an economic model that shows a crossover point where it is cheaper to sign a license agreement and pay a royalty or license fee than what they're doing today. From our standpoint, clearly we want that to occur. ... They've committed billions of dollars toward building OLED facilities, [and] we fully expect them to sign a license agreement. They know what our terms are, they know what they're going to receive and what their price is when they sign a license agreement. ... Do I know specifically when? Negotiations have a life of their own.
In short, Rosenblatt reiterated it's only a matter of time before LG Display signs a long-term contract. But again, LG Display first needs to reach the appropriate manufacturing capacity for such a deal to make economic sense.
Judging by LG's current plans, that could happen in the very near future.
Most notably, according to LG Display during its most recent earnings conference call, it's still on track to fully ramp its Gen-8 OLED TV production line by the end of this year. When that happens, LG Display will have increased its manufacturing capacity by 75% to 14,000 plates per month. That said, considering LGD is starting from a relatively small base, we can't be entirely positive that'll be enough to push it over the cusp to immediately merit a long-term contract.
But even then, LGD is planning to add another 20,000 plates per month by the end of 2015, bringing its total capacity to 34,000 plates. According to Rosenblatt, "that's almost 50% of the equivalent of square meters of glass that Samsung Display has today in its gen-5.5 [OLED] facility."
Why it might not matter
If 50% of Samsung's current capacity doesn't sound impressive, remember Samsung Display has also made significant, continuing investments to bolster its own OLED manufacturing capacity since signing the long-term deal with Universal Display three years ago. Just this past May, for example, the Korea Herald reported Samsung Display was investing another 3 trillion to 5 trillion won (roughly $2.7 billion to $4.9 billion) during the second half of this year to build a new OLED production line for small and mid-sized displays.
What's more, Rosenblatt also touched on the long-term growth potential as OLED television takes hold: "There are currently 125 LCD fabs in the world today. There are essentially only two OLED fabs in the world today," he stated. "No one is going to shut down 125 fabs and just start from scratch. It's a progression having two players in this industry, and you'll start to see the followers coming into this industry."
Whether a long-term contract between LG Display and Universal Display is imminent remains unclear. However, the clues do point toward a deal happening at some point down the road. And when it does, as OLED technology continues to become more pervasive, Universal Display investors will be happy they held onto their shares.