Shares of Universal Display Corporation (NASDAQ: OLED) may have risen 118% year to date, but the stock is still a buy. Why? The company's decade-long strategy to go all-in on organic light emitting diodes, or OLEDs, is finally paying off -- but there are plenty of opportunities left to expand the market. Thanks to a patent portfolio spanning some 4,200 exclusive claims to OLED technology, any display panel maker that wants to take advantage of it pretty much has to go through the company.
Then again, placing all of your chips on a single technology works both ways. It will drive growth for the foreseeable future, but it also exposes the company to significant risks if and when the technology landscape changes. While it remains a relatively distant threat, there's a clear pathway for replacing OLEDs with a superior technology -- and it starts with what is likely its largest customer. It's one huge risk Universal Display Corporation bulls need to know.
Risks in plain sight
The market opportunities are lopsided in the company's favor, but the risks are just as concentrated. All raw materials critical to manufacturing OLEDs, which still generate half of all revenue adjacent to licensing and royalty revenue streams, are sourced from one company (PPG Industries).
More importantly, in 2016 fully 91% of all revenue came from just two customers, which are Samsung Display and LG Display (NYSE: LPL). They aren't explicitly unmasked as "Customer A" or "Customer B" in SEC filings, but it isn't difficult to derive their identities. The two largest licensing agreements in place are with these two companies, and over 91% of all revenue last year came from South Korea.
While the concentration of revenue is a risk, it should also be expected.
Samsung Display currently produces over 90% of all OLED screens for smartphones, while LG Display has a commanding lead in the TV market, producing OLED screens for Philips, Panasonic, and Sony. There are only a handful of display manufacturers to choose from, so it makes sense that Universal Display Corporation would encounter revenue concentration for its technology.
Besides, OLED displays are becoming increasingly important. LG Display recently announced plans to invest $13.5 billion in its OLED display manufacturing capabilities in the next three years alone. It's just the latest piece of evidence hinting that Apple -- an LG Display customer -- is gearing up to incorporate OLED displays in an upcoming iPhone.
That said, recent moves by Samsung Display hint at what may one day replace OLED technology.
The biggest risk to OLED
The biggest risk is the same force enabling the company's growth: the fast pace of innovation. OLEDs are quickly gaining traction because they're superior to older technologies. However, there is one technology being developed that has the potential to beat even OLEDs in most specifications: quantum dot displays.
They have a funny name, but quantum dots are metallic nanoparticles with semiconductor properties. In other words, they could be used as transistors, solar cells, and LEDs, among other applications. On paper, they could power incredibly high-quality displays while consuming less energy, enabling thinner screens, costing less to produce, and being easier to manufacture than OLEDs.
Why does that matter for Universal Display Corporation bulls? While there's no true quantum dot display technology on the market today, Samsung Display has already seen the writing on the wall. It announced that it will no longer incorporate OLED displays in 2017 model TVs. Instead, the company will offer TVs with quantum dot light emitting diode, or QLED, displays -- a technology it's developing in-house.
The name is a bit misleading, as the quantum dot technology Samsung Display uses today is really just a beefed-up version of LCD technology. It's not an LED technology. But it still matters immensely: Even the company's first misleadingly named QLED displays are cheaper to manufacture and offer comparable specs to OLEDs. Will the company attempt to convert smartphone displays to its own in-house technology soon?
That would be a terrifying scenario for Universal Display Corporation. But even if Samsung Display remains a committed customer in the near term, its "QLED" technology is the first step on the path to utilizing quantum dots in their full capacity as true LEDs.
When true quantum dot displays arrive on the market, it could be game over for OLEDs. Screen manufacturers will probably have no hesitation deciding to switch for reasons spanning economic and performance.
What does it mean for investors?
To date, Samsung Display's decision to ditch OLEDs for TV screens hasn't stung Universal Display Corporation shareholders (remember that most of the customer's consumption goes to smartphone applications). However, having your absolute largest customer working on a competing technology -- and one that promises to be superior -- to what your entire business is based on is something shareholders shouldn't overlook.
The silver lining for Universal Display Corporation is that true quantum dot displays remain a relatively distant threat -- only existing in R&D laboratories today. Quantum dots are difficult to produce in the quantities needed to power such a revolution in the near term, and the best-performing types still require heavy metals such as cadmium to function. Many countries ban such products today.
That said, there are a lot of companies attacking these problems, and a major commitment from Samsung Display may be all that's necessary to mobilize an industrywide effort to discover, develop, and deliver market-ready solutions in the next 10 years. That's why quantum dot displays are the one huge risk Universal Display Corporation bulls need to know.
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