Light emitting diodes (LEDs) have massive potential as a low-cost, environmentally friendly light source and could replace the common "incandescent" light bulb in homes and offices. But, today, the companies that produce them present investors with a big dilemma. That's because LEDs will not be affordable enough to replace traditional light bulbs until 2010 at the earliest. While this could prove a great time to get exposure to this trend cheaply, the current crop of UK-listed LED companies have proved to be an unruly investment this year. Indeed, investors cannot be blamed for wondering if there is enough momentum in the market to sustain share prices until LEDs become mainstream.
"People want to gain exposure to LEDs because they are going to replace incandescent light at some point," says Sue Cox, electronics analyst at ABN Amro. "The market does seem to be gathering momentum, so more people are trying to position themselves for when it really takes off."
One such investor is Ian Simm, chief executive of Aim-listed investment management company Impax Group. His fund, Impax Environmental Markets, has just bought 3.25 per cent of LED producer Dialight. "We are seeing some interesting value in the less obvious corners of these [green] markets," says Mr Simm. He is particularly interested in the potential impact of government regulation on LEDs. There are plans in the EU, Australia and some US states to phase out incandescent bulbs by around 2012, and while fluorescent lights will be the prime beneficiary, LEDs offer greater growth potential. Government subsidies are also possible when LED bulbs fall from the current price of $50-$60 to around $8-$10, according to electronics industry watchers iSuppli.
All this is a long way off, though, but investing in LEDs does not have to be a waiting game. Smaller companies such as Aim-listed Enfis and Dialight are tapping into demand from niche markets. For instance, LEDs' lower heat output and lower maintenance has led Wal-Mart to start putting them into its fridges. Besides the well-established traffic-light market, LEDs' colourful properties can be applied to the glamorous - such as shop lighting that can react to the weather outside - and the mundane, such as car indicator lights.
Indeed, Dialight has seen strong growth in its signals and illumination division and solid-state lighting sales grew by nearly 30 per cent last year. Unfortunately, this was marred by a pair of grim trading statements early this year which flagged an inventory-wide slowdown in its components business.
Dialight is now keen to pursue opportunities in niche markets for lights that can withstand rugged conditions, such as lighting on oil refineries and wind turbines, where it is not just the LEDs but the fixtures which are important. "LEDs' lower voltage, lower temperature and lower risk of spark means the engineering challenge for the fixture is much less," says Dialight's chief executive, Roy Burton. While the upfront price offered by Dialight is comparable to current solutions, the ongoing maintenance costs are lower.
"That's the sort of application the likes of Philips would not touch because it's too small an opportunity," says Jagdish Rebello, director and principal analyst at iSuppli.
No conversation about LEDs runs very far without a mention of Philips. The Dutch electronics giant has spent nearly €2bn on four LED-related acquisitions in the past two years. The latest deal was the purchase of lighting systems maker Color Kinetics for a whopping €516m. This represents 10.6 times sales and 63 times earnings before interest, tax and amortisation (EBITA). Based on a sum-of-the-parts analysis of the Color Kinetics deal and attributing such multiples, Dialight's signals and illuminations business implies a vastly higher share price, say analysts.
Of course, such multiples are only relevant if other buyers exist. iSuppli's Mr Rebello says that Philips' rivals, GE and Osram (part of Siemens), would definitely be looking to go out and make some acquisitions as they look to protect their territory in illumination, especially in the broad-based general illumination market.
In a tacit reference to acquisition potential, Enfis chief executive Shaun Oxenham is keen to emphasise Enfis' 20 technology patents, which he hopes to licence to larger manufacturers. "We are talking to everyone [in the market] apart from Philips," he says.
Enfis's strength is in high-output LEDs which Mr Oxenham says can generate up to 200W with a standard interface to allow easy control of colour or power. That makes them particularly suitable for illuminating buildings and public spaces and Mr Oxenham claims Enfis is "24 months ahead of the competition".
With iSuppli estimating a $9bn market opportunity by 2010, competition is fierce. Mr Oxenham claims that traffic lights - where Dialight has made most of its money so far - and car headlamps - targeted by components provider TT Electronics (see separate story ) - are commoditised markets, so production could be shifted to a Chinese manufacturer for "half the price". But others take the opposite view, arguing general lighting is more likely to be mass produced in Asia, while applications in regulated markets with stricter quality standards are where niche providers can differentiate.
