Having excited tech bankers and domestic investors since the end of last year, the large size TFT-LCD or flat screen panel sector as it is otherwise known, will come under the scrutiny of international equity investors for the first time over the next month.
UMC is likely to set the ball rolling within the next two weeks after revealing plans for an exchangeable into AU Optronics, Taiwan's leading producer of TFT (thin film transistor) panels used as the display screens for notebooks and increasingly LCD monitors and televisions. With Lehman Brothers as lead manager, local bankers report that the semiconductor giant has decided to cash out at a fortuitous peak in the cycle and has consequently increased the number of shares it intends to sell from 80 million to 120 million.
If correct, the group will raise $173 million at a current share price of NT$50.5 and divest 4.04% of its overall 18.6% stake in the company which was formed last September through the merger of Acer Display Technologies and Unipac Electronics. Benq is the other major shareholder in AU with a 20% stake.
However, May looks likely to be the peak issuance month for 2002. Both Chunghwa Picture Tubes (CPT) and AU Optronics are planning to compete against each other for investors' attention in the DR market taking advantage of what are tipped to be better than expected first quarter results over the next couple of weeks. AU mandated Salomon Smith Barney over six months ago for a 500 million share issue that will raise $722 million at current prices, while Chunghwa recently mandated Goldman Sachs for a 400 million share deal that will raise about $450 million.
Slightly further afield, Chi Mei Optoelectronics has already mandated Morgan Stanley for a debut ADR that should follow hard on the heels of its forthcoming domestic listing scheduled for June/July, while HannStar Display is planning a $300 million GDR, with ING Barings and JPMorgan both said to be close to the mandate. Rounding off the year, Quanta Display also wants to follow a domestic fourth quarter listing with a GDR offering via UBS Warburg.
For investors the two key considerations will be how easily the market can absorb such a heavy uptick in supply and more importantly, what potential is there for further upside given the heady valuations the sector has now risen to.
According to local analysts, AU has set an internal price target of NT$70 in an effort to raise up to $1 billion from its forthcoming issue. Based on a 2002 book value per share of NT$16.98, this would price the issue on a price to book ratio of 4.1 times. Recently, however, the share price has come down from a year-to-date high of NT$62.5 in mid February and is currently trading on a price to book of 2.97 times.
Analysts say that the share price has been weighed down in recent weeks by the overhang of the impending exchangeable and a realisation that the combination of an NT10 billion convertible issued last November at a conversion price of NT$15.8 and a new share DR offering will be highly dilutive to the stock.
Similarly HannStar is trading on a price to book ratio of 2.2 times 2002 earnings, a roughly 26% discount to its larger and more diversified competitor. Together, the two companies represent the only pure exposure available to global investors since CPT still makes cathode ray tubes and the world's two largest producers, Samsung Electronics and LG Philips have yet to spin-off their TFT-LCD divisions.
As a result, analysts argue that both companies deserve to trade at a premium since the highly cyclical nature of the TFT-LCD business means that they will both outperform on the upside. Nomura's Frank Lee also says that valuations are complicated because of the short history of the sector, the fact that there are only two pure plays and that p/e ratios are fairly meaningless given that every company posted losses last year - AU NT$6.71 billion, HannStar NT$6.41 billion and CPT NT$5.71 billion.
He says that the most relevant indicator is probably the DRAM sector, which is also highly cyclical and posts the same kinds of ROE. "We have re-rated AU on a 4.3 times P/BV which is a 20% discount to the peak P/BV of 5.4 times for the Taiwan DRAM sector during the last industry cycle," he comments. "We think this is fair because there is a higher risk premium attached to the TFT-LCD industry."
Indeed, Taiwan's TFT manufacturers are only now coming to prominence having had zero market share back in 1999. Having built up a 26.1% position by 2001, they have largely replaced Japanese manufacturers such as Sharp, Hitachi, NEC and Toshiba which became uncompetitive in cost terms at the end of the last industry cycle and have now largely moved into LTPS (low temperature poly-silicon) TFT-LCDs, producing small panels for appliances such as PDAs and mobile phones. In Taiwan, the only company currently operating in this sector is Toppoly Electronics, which is linked to Compal.
Prices for the TFT industry's benchmark 15-inch panels bottomed in September last year at $200 and industry experts say that the whole sector returned to profitability a lot earlier than expected in January this year. By March, average selling prices were back up to the $260 level again and most companies were saying that they could only fill 70% of orders. Shipments are also expected to more than double from last year's 11 million units to 25 million by the end of 2002.
The upturn has encouraged all the Taiwanese producers, with the notable exception of CPT, to bring forward ambitious plans to construct 5G fabs at a cost of about $1.2 billion apiece. These will enable significant cost savings since the size of the glass plates from which the screens are cut will increase from 15-inch to 17-inches.
Analysts say that they are now at the stage where they are starting to question how much demand is really still unfilled, when the cycle will peak and specifically whether the dynamics of the current cycle mean that it will prove to be long-lasting than the last one.
"The key difference is that the last cycle was supply led and this one is demand led," says one industry expert. "It means that it will last a lot longer and since the whole sector only turned round six months ago, we have at least a year to a year-and-a-half run yet."
"In previous cycles," he adds, "excess capacity led to oversupply and sharp price drops. This time, if prices fall, more demand will be stimulated, because penetration is starting from a very low base but starting to grow fast."
Tech bankers tend to agree that one of the key drivers has been the fall in end-pricing for consumers. During the first half of 2001 TFT-LCD monitors retailed for three times the price of CRT monitors. By the first half of this year, the differential had dropped to 1.5 times, with US consumers able to buy a full PC package for about $1,000.
This means that whereas the industry's growth driver has previously been notebook computers, which nearly all use TFT-LCD screens, the future now lies with LCD monitors, of which only 13% currently use TFT screens. Display Search, the industry's international research group, has reported, for example, that the 14.1 inch and larger panel share of the overall TFT market rose from 45.7% at the beginning of 2000 to 81% by the fourth quarter of 2001. It concluded that ever larger displays in notebook computers show that many consumers are starting to use notebooks to replace their desktop computers rather than as a second computer for travel.
Bankers believe that replacement of LCD monitors will therefore be the industry's main earnings driver over the next three years, with TFT TV's (currently only 1% market share of TV shipments) taking hold over the next five to 10 years.
The growth statistics are impressive, but analysts conclude that the swing factor will be the impact of the 5G fabs coming on line in Korea, where advanced production facilities are running ahead of Taiwan. "There are two possible scenarios," says Nomura's Lee. "The more positive scenario is that there will be no effect until the beginning of next year since it will take six to nine months to fully ramp up. At this point, the Koreans push towards 17-inch panels will absorb excess capacity, but the sector will remain stable.
"The less positive scenario," he continues, "is that 17-inch demand never takes off and the Koreans start to cut prices in the 15-inch sector instead. This will hurt the Taiwanese quite badly since the 5G fabs will allow the Koreans to gain a roughly 30% cost advantage."
In the meantime, market players conclude that AU, whose stock price remains 35.03% up on the year and 80.80% up on a one-year return basis, will see its DR well received by investors. "AU is taking its existing facilities and adding a 5G production line," one analyst explains. "This should save about 25% of the time needed to build a new fab and puts it ahead of the pack."
Local analysts say that both AU and Chi Mei Optoelectronics (whose parent comes comes from the petrochemicals sector) have the size, scale and diversity of panel production to appeal to investors. CPT is said to be less favoured because its production of cathode ray tubes is increasingly regarded as a sunset industry. The company is also the only one that is still planning to build a 4G rather than 5G fab.
HannStar, by contrast, is regarded as the dark horse. A sister company of Winbond, the company is said to be the most leveraged of the five producers and has traditionally been regarded as a more marginal player. But analysts believe that it will report strong first quarter results because its production is heavily geared to 15-inch panels where prices are currently strongest and as a result of this will also benefit from strong replacement demand from CRT to TFT in the PC sector.
Some bankers also point out that while there is a heavy pipeline, most of the deals are well spread throughout the year. But high share prices are likely to make investors more selective and as one US analyst concludes, "This is a very capital intensive business and it will the companies with size and scale that end up being the winners. If the market continues to rally, the more discerning accounts are only going to go for the big boys."