Imagine you used to sell lightbulbs and now your products enable self-driving cars to recognize pedestrians and manage the distance from other cars.  You’re not buying it?  The capital markets are currently struggling with the story too.  While others argue about it, the whole thing can be picked up for 5x EBITDA or 9x EBIT…

A short introduction

The story of Osram Licht AG begins before WWI.  Osram was one of the early commercial lightbulb producers and rode that wave to become an enterprise of respectable size.  Osram became a full subsidiary of Siemens in 1978.  Fast forward to 2013 – Siemens was in the middle of conducting a full-scope portfolio review and spun-off Osram.

Cleanup efforts

Enjoying its newly gained independence, Osram began to transform with great farsightedness.  In 2015, Osram announced the carve-out of its consumer business with traditional lightbulbs and LED lights for general lighting applications. At the time, traditional lightbulbs had been suffering from declines for years while LED lights were not able to make up for the loss due to longer replacement cycles.  The carved-out business was renamed Ledvance and sold to a Chinese consortium on March 1st, 2017. 

A new Osram

With €4 billion of sales, Osram specializes in LEDs, which are smaller, more efficient, and cheaper over the product lifetime than substitutes.  LEDs can generate any wavelength, adjust dynamically, and fit into small devices where traditional lamps would never fit, enabling new fields of application such as photonics:  surface treatment, sensing, plants & horticulture, and human therapy.  The main difference between an LED and a standard semi-conductor is the high-tech functionality of its packaging – an LED emits photons.  Osram’s strategic goal is to become a global photonics and lighting systems player.

The company has three business units:

  1. Specialty Lighting (“SL”/€2.2 bn sales, €281m LTM EBITDA).  SL sells lighting systems for automotive and specialty applications.  LEDs continue to rapidly penetrate the global automotive market.  CEO Berlien estimates that the transition to LED headlamps is only approximately halfway through in new models.  The profitability of the division is above typical automotive suppliers at 13% EBITDA.
  2. Lighting Solutions & Systems (“LSS” /€954m sales, -€95m LTM EBITDA). The LSS division offers light management systems, control systems and luminaires.  The products including relevant serviced are used for advertising, bridges and similar large projects. The business has been stagnating for years and is unprofitable.  Projects tend to be highly bespoke which prevents economies of scale.  Zumtobel, a European competitor, has a revenue development and profitability that confirms the difficult market environment.  In August 2018, Osram announced its intention to sell the luminaires business.  Luminaires are low margin lighting components that are used for large projects and decorative lighting.  We assume that it’s burning cash.  Its intention to exit luminaires underlines Osram’s willingness to move away from low margin end products, towards the more knowhow intensive part of the lighting industry.
  3. Opto Semiconductors (“OS” /€1.7 bn sales, €428m LTM EBITDA).  OS is Osram’s future.  Opto-semiconductors are light emitting semiconductors which are the basis of many modern lighting and sensing applications. The OS division has grown at a sales CAGR >10% and recorded an EBITDA margin >20% since 2007.  Osram is the #1 emitter player including LED, VCSEL, Laser, MiniLED and uLED.  Osram scientists file on average 3 patents per day.  Within the general industrial space, the application fields of visualisation, sensing, and treatment are growing at 15% per year.  This includes 3D sensing (gaining information on objects around the sensor e.g. for security or positioning), vital sign monitoring, high resolution video walls, mobile projection, robotic sensing, drones, and surveillance.

Allocating capital

Semiconductor manufacturing is at the heart of Osram’s transformation. In November 2015, Osram announced its plan to build the world’s most modern semiconductor factory in Kulim, Malaysia.  Up to €1bn was to be invested in the project and capital markets reacted skeptically.  The big bet, however, is now paying off.  The factory was successfully commissioned in November 2017 without delays and is already generating revenue.  Out of this factory, Osram produces greater volume at higher quality and lower cost than its competitors.  As cash-return oriented investors, we applaud companies that can profitably invest capital internally and gain a large edge on competitors.  Osram is one of those companies.

Future applications

In a variety of future technologies, Osram has an excellent position.  Amongst those are LIDAR (Light Detection and Ranging), which is radar with lightwaves (photonics) instead of radiowaves.  One of its applications is environment recognition for cars.  LIDAR is thus a core technology for autonomous driving. Osram has also developed smart LED headlights for cars that consist of thousands of pixels; when another car is approaching, the headlights recognize that and shut off exactly those pixels that could potentially blind the other driver.  With this technology, one could always drive with high beam on.  Furthermore, in May 2018, Osram acquired the Austin, Texas based company Fluence Bioengineering. The company develops LED systems for horticulture. Their technology enables energy and resource-saving Vertical Farming.  The business is growing attractively in part thanks to the flourishing marijuana industry in North America. 

Why now?

Osram’s market cap stood at €7.5bn in January 2018.  Two profit warnings later, a mere €3.3bn is left. The first warning in April was triggered by a higher dollar and higher restructuring costs.  The second profit warning in June was due to the German auto OEMs revising downward their expectations for 2H’18 volumes.  Faced with slower sales and earnings growth than originally planned for 2018, investors sent the share price from €79 to €34.  The chart below demonstrates that this was more of a de-rating than an earnings-induced correction.

The irony of the de-rating is that the timing broadly coincides with the company’s successful shift toward new technologies, just as the Kulim OS plant ramps up.  In many ways, the new Osram more closely resembles semi-conductor peers such as Infineon (15x NTM EBIT) than automotive tier-ones (c. 7x NTM EBIT), yet has traded down to this level over the course of the year.

Investors remain concerned about a potential slowdown in automotive volumes as well as implications of a trade war on the global supply chain. Purchasing managers around the world are hesitant because it is often not clear which products and components are impacted by the tariffs. The trade war has begun to impair the systems of globally producing technology enterprises.

Nonetheless, the current situation is interesting for investors with a long-term view.  They should consider:

In 5 years, will there be more cars with intelligent LED lighting?

In 5 years, will there be more cars with environment recognition technology such as LIDAR?

In 5 years, will it be necessary to save space and resources within the agricultural sector?

Has Osram put itself in a position to capitalize from this development with its recent capex?

We believe the answer to all these questions is “yes.”  To get a grip on the current valuation of Osram, compare it to a company that has also been hit by the trade war and also has a very attractive positioning for the medium and long-term: KION.  The company manufactures forklifts and automated warehouse equipment which is indispensable for a world increasingly driven by ecommerce.  KION is priced at 12x of NTM EBIT (next 12-month).  Osram trades at 25% discount.  In fact, we think both companies are undervalued and reflect a significant fear discount.  Previously mentioned competitor Zumtobel trades at 20x NTM EBIT but is not nearly as attractively positioned for the future.

Health warning:  softness in auto volumes could lead to further near-term drawdowns for Osram.  However, if you can afford to take the long view, we think a company packed with long-term growth drivers valued at a single digit EBIT multiple is an interesting opportunity. You don’t need Uber, Google or Tesla for high-tech megatrend exposure. Go with the boring gals and guys from Germany that used to sell lightbulbs.

 

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