>KEY SURPRISES FOR 2010 (MORGAN STANLEY)

Where we are versus consensus: The market views backlight module makers as assemblers with a backward integration threat from panel makers. Our view: 1) BLM is more than assembly to panel makers: Panel makers, including CMO, are now increasing outsourcing after taking production back in-house, as it is more economical to purchase externally than to produce internally after benchmarking, factoring in customer model changes. 2) External backlight makers have larger scale than internal panel makers do, increasing cost efficiency. BLM makers are clearly strong in optical usage, which has greater valueadded than pure assembly. 3) BLM is better than panels: While Taiwan panel makers have been losing market share to their Korean counterparts, Taiwan backlight makers have been gaining share on better competitiveness. LED transition has added value for existing backlight makers on higher average selling prices (ASP).

Backlight module makers are direct beneficiaries of LED proliferation. Coretronic is our top pick in TFT LCD supply chain.

Key share price catalysts: 1) Faster-than-expected LED proliferation for LCD TV and monitors in 2010, as happened with notebooks in 2009. 2) Better-than-expected pico projector shipments in 2010.

Near-term risks: 1) Taiwan panel customer shipments could decline sequentially in 4Q09 and 1Q10, partially as a result of the Taiwan power outage that affected Corning’s glass factory. Lower panel outputs could hurt backlight module shipments. 2) Christmas sell-through in the US and Europe may be hurt by high unemployment.

LED proliferation trend: LED backlight makers add more value in making light guide plates to improve light transmission. Light guide plates are being reused for LED edge lighting in LCD TV and monitors, rather than diffusers/plates (direct lighting), just as happened with notebooks. Backlight makers achieve higher margins on light guide plates than on backlight module assembly.

As LED backlight becomes mainstream for notebooks, LED TV should become more popular in 2010 thanks to thinner design and less power usage. The same goes for LEDbased monitors for the all-in-one PC with multi-touch functions as Windows 7 proliferates.

LED accounted for ~60% of notebook backlight in 2009, up from ~10% in 2008. We expect a similar trend for LCD TV and monitors starting in 2010, when we expect LED to be ~15-20% of LCD TV and ~10-15% of the LCD monitor backlight module mix, up from a minimal amount in 2009.

Coretronic purchases LED wafers and outsources to local LED back-end foundries for packaging. It believes its special design for light bars is key to its success. The company is also working with panel makers and branded customers on customized BLM designs. Coretronic thinks 52”+ LED TVs will still use direct-lit-type BLM for its Japanese customers, given that direct-lit provides a better image on local dimming.

LED BLM ASP is ~2x CCFL-based BLM prices; while LED backlight for LCD TV and notebooks is multiples of the price of LED backlight for notebooks. Adoption of LED in LCD TV/monitors should improve backlight module profitability.

We consider a cheaper way to gain exposure to LED is backlight modules, which, on our estimates, trade at discounts to the P/E or P/B of LED chip supply chain companies.

To read the full report: KEY SURPRISES