San'an Opto Production Expansion Plans More than Bluff

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LEDinside analyst Figo Wang, who has over a decade of experience in the Chinese LED industry, gives a thorough analysis of San’an Opto’s production capacity strategy in this article, and asks whether using this production capacity expansion plan as a threat is successfully deterring competitors.

San’an Opto officially announced moving its LED production plant from Wuhu, Anhui, China to its Xiamen headquarters on April 3, 2014. The company scaled up the project investments from RMB 4.08 billion (US$ 660 million) to RMB 10 billion. At the same time, the company established subsidiary Xiamen San’an Opto within Xiang'an Torch Development Zone, which has a registered capital of RMB 10 million.

The company has signed an investment agreement with Xiamen Torch Development Zone, that has decided the area should invest in building up LED epiwafer, chip R&D, and manufacturing projects.

The project’s investments reached a sum of RMB 10 billion, and totaled to 200 MOCVDs (calculations are based on 54 PCS of 2” sapphire substrates). The company has initiated 100 MOCVDs that are to be constructed within one year. Factory and related infrastructure constructions will be completed within two years, and the remaining 100 MOCVDs will enter manufacturing phase after the first batch are initiated. However, the MOCVDs must all enter production by 2018, or the Xiamen Torch Development Zone has the right to cancel subsidies for the remaining MOCVD subsidies.

San’an Opto announced on April 10, 2014, a business partnership with Seoul Semiconductors and Seoul Viosys (a Seoul Semiconductor subsidy). The new company established through the joint venture will supply the Korean investor with LED products. The company has a registered capital of US$ 2 million, in which San’an Opto has injected 49% or US$980,000. The joint venture will provide San’an Opto an opportunity to enter the patent supply chain.

The following day San’an Opto announced investing RMB 325 million in cash into a joint venture project with Chengdu matt Electronics Co. The two companies will be establishing a new company “Xiamen San’an Integrated Circuit Company” (literal translation) at Xiamen Zhonghang in Fujian Province. San’an Opto has a 65% stake in the new company that has a registered capital of RMB 500 million. Xiamen San’an IC Company main business operations will be IC design, manufacturing and sales, which will enable San’an Opto to enter the wide-bandgap semiconductor industry.

Is San’an Opto trying to raise stock prices with frequent announcements? Perhaps. However, the company just recently completed increasing stock issuance, and has shown no signs of reducing stocks. The timing is not right. There is no particular need for the company to speculate in the stock market to raise price/earnings ratio (PE ratio), as the company’s last stock issuance raked in more than RMB 1 billion in cash.

San’an Opto and FOREPI investment plan

Originally, San’an Opto hoped exchanging stocks with Taiwanese LED manufacturer FOREPI could deepen strategic partnerships between the two companies. But various limitations imposed by Taiwanese authorities have turned San’an Opto purely into a financial investor. Both San’an Opto and FOREPI incurred losses as a result, if the initial stock exchange plan had been carried out, it would have brought the two companies closer, and expanded FOREPI’s strategic options. San’an Opto’s equity value would have doubled as a result. As San’an Opto’s business strategy becomes increasingly comprehensive, aside for investments to prevent patent restrictions, there are few stocks similar to FOREPI worth purchasing.

San’an Opto expands production capacity to deter competitors

What is the better explanation then? An overview of indicators throughout 2013 convey the company’s recent actions are part of a strategy of using production capacity as a deterrent.

The oversupply situation in 2012 is still fresh in LED chip manufacturers memory. Stimulated by soaring San’an Opto and Hangzhou Silan Microelectronics Co. stock prices and government subsidies, a large number of Chinese manufacturers aspiring to becoming the “second San’an Opto” implemented a flurry of LED chip projects. The market has surely punished these blind followers.

However, people tend to selectively forget painful memories. The LED industry has gradually rebounded since 2013, with obvious improvements for midstream and downstream manufacturers, which has also spread to upstream. Since there has been LED chip shortages, additional MOCVD equipment volumes are under discussion, unveiling an upcoming new round of production expansion competitions.  

What can companies do to avoid falling into cutthroat price wars? San’an Opto will be adding 100 MOCVDs in 2014, said the company’s Vice President Lin Kechuang at LEDforum 2013 organized by LEDinside that took place on Oct. 16, 2013, in Taipei, Taiwan. There is no doubt that this is a threatening strategy, but the strategy failed to deter competitors. In the following months, the formerly dormant LED chip industry quietly began a new round of equipment expansions.

After HC Semitek installed 34 MOCVDs in Zhangjiagang factory in Jiangsou, China, the company will be moving second phase of the Wuhan project to Zhangjiagang, taking the total MOCVDs installed to 120. Stock analysts estimate HC Semitek will be adding another 60 MOCVDs, and 50 more in 2015, by then the company will be trailing behind San’an Opto with a total of 180 MOCVDs.

Jiangsu Aucksun Co. invested RMB 400 million out of RMB 500 million raised in Huian Auckson Optoelectronics Technology. The company plans to add another 25 MOCVDs in 2014, and in 2013 increased the number of MOCVDs from 5 to 30.

Daliled plans to double MOCVD volume in 2014, up from 10 to 20 MOCVDs.

Summary of San'an Opto game theory results. (LEDinside)

Theoretical game theory analysis of San’an Opto and competitor actions

As the industry is still far from returning to normal gross profit levels, the production capacity race will no doubt ignite a new price war within one year. Competitors view San’an Opto’s additional 100 MOCVDs as an indicator to a rebounding LED chip industry. These competitors believe San’an Opto might not actually add more MOCVDs because of its high equipment volumes, which would make San’an Opto the biggest loser in an oversupply scenario with serious price wars.

In game theory, the first result would be San’an Opto’s future revenue and net present value. The second is competitors revenue and net present value, in which the current info are all assumed means. The revenue in the matrix represents possible future revenue and net present value (profit-capital expenditure (CapEx)). If companies all expanded production capacity, it would lead to oversupply and lowered profits. If manufacturers do not expand than they can lower CapEx, while reaping higher profits.

If all manufacturers chose their own strategies, than the game strategy Nash equilibrium would be San’an Opto does not expand production capacity and competitors actively expand. San’an Opto will still have higher net profits than current, whether it expands or not. If competitors project San’an Opto will not expand than the best strategy is to actively expand. Revenue might be 600 without further production capacity expansions, but reach 650 with production expansions. Although, Lin announced the 100 MOCVD expansion plan, the company has not finished adding equipment. Moreover, Wuhu government has terminated subsidies, and there are not enough evidence to support San’an Opto’s possibilities and necessities for adding MOCVDs. In addition, the claim is easily deciphered as a production capacity expansion bluff and threat by other manufacturers. The threat has been rather ineffective with other manufacturers production expansion plan announcements.

Real world San’an Opto and competitor game theory results 

In reality, manufacturers strategy cannot be established at the same time. Competing manufacturers will observe rivals actions before taking the next step. If San’an Opto completely disregards future revenue by carrying out expansion plans, and convince competitors to believe this is a trustworthy announcement than the game theory results will be rather different. Competitors that believe San’an Opto will expand will chose not to expand, the most beneficial option out of available strategies. Revenue will only be 450 tops following production expansion, but will reach 500 by forfeiting expansion. The final Nash equilibrium is completely overturned, with equilibrium set at San’an Opto expanding, while competitors remain put.

San’an Opto production expansion plans is credible

The decisive key in these changes lies in San’an Opto’s words. With the recent three announcements, San’an Opto’s credibility has greatly increased. The following is our analysis:

1.      Wuhu second phase epiwafer project move to Xiamen Xian’an. San’an Opto originated in Xiamen, but decided to move its major manufacturing base to the distant, yet subsidy-rich Wuhu City because lack of subsidies from the Xiamen government at the time. The Xiamen government probably seriously regretted this, however, with Wuhu terminating subsidies, San’an Opto is finally returning expansion plans to Xiamen. This time round, the Xiamen government has given many support.

In the San’an Opto announcement, the company will be receiving RMB 5 million subsidy for 54 pieces 2-inch sapphire substrate MOCVDs. If the next generation MOCVD production capacity is doubled, so will MOCVD subsidies, which will reach RMB 10 million for every MOCVD. In other words, the portion of San’an Opto equipment costs will decrease, which manufacturer would not add additional production capacity.

Lastly, the actual number of MOCVDs installed might differ from Lin’s proclaimed 100 MOCVDs, but with government subsidy as support the company’s credibility is immediately above 90%. Following San’an Opto’s announcement Aixtron and Veeco stocks fell. The market was not concerned about San’an Opto orders, but worried the Aixtron and Veeco will only be receiving San’an Opto orders in the future.

2.      San’an Opto and Seoul Semiconductor’s joint venture. Using Epistar and Toyoda Gosei partnership model as reference, there is no need to emphasize the advantages of the cooperation. Then why is San’an Opto-Seoul Semicounductor partnership just emphasizing the company’s production capacity expansion? If San’an Opto is unable to enter the patent locked market, then its main market will always be China’s domestic market. However, with San’an Opto’s already leading market penetration rates in the Chinese market, reducing oversupply will become a major issue. By entering the patent locked market, San’an Opto not only will be able to tap into Europe, U.S., and Japanese lighting markets, but also the vast global backlight market. For the Chinese company giving a small portion of profits to Seoul Semiconductor is just a small entry fee to pay for gain access to a much larger market. With the support of a large potential market, the company can be held accountable for its plans.

3.      The new joint venture is entering the IC semiconductor segment. If the global LED market growth reaches its limits in the future, what will happen to San’an Opto’s 400 MOCVDs? MOCVDs are a highly specialized asset, although, this is an advantage to specialized investments, when the maturing industry enters recession, this asset will completely become a liable cost. The larger the production capacity the heavier the burden. However, wide-bandgap semiconductors could increase MOCVD purposes, and greatly reduce specialization. The production capacity expansions would broaden San’an Opto’s economic options. San’an Opto’s intention of entering the wide-bandgap semiconductor for real has been revealed in its recent joint venture. Even if LED industry meets its demise, San’an Opto MOCVD expansion can still be applied to other territories.

Conclusion

To sum up the above mentioned points, San’an Opto production expansion announcement is a credible and strong statement. It will force the production capacity game theory to enter two development models. The first is San’an Opto will realize production expansions. The second is competitors need to evaluate San’an Opto’s claims and decide the following strategy. From a game theory result perspective, competitors best option is to bypass expansion, which will make San’an Opto’s production expansion threat strategy effective.

Things can be simplified since San’an Opto is considering to add equipment. The Chinese manufacturer could end market speculation by placing orders with Aixtron and Veeco, but has chosen to buy itself one year time with the recent announcements. The series of production capacity expansion announcements will force competitors to choose the no-expansion route, and give San’an Opto time to consider the volume, type and order pricing of MOCVD models it will invest in one year later. This greatly raises the company decision’s present net value.

Definition of Alpha dog and docile dog strategies. (LEDinside)

Under classical competitive price wars, the strong statements to fend off competitors are coined “alpha dog strategies” in China. By initiating the “alpha dog strategy” San’an Opto is forcing other competitors to implement the “docile dog strategy.” The LED chip industry is also entering the final gaming season, with San’an Opto and Epistar competing for the top spot. To defend their reputation, other manufacturers are also competing for the industry’s less popular bronze medal.

(Author: Figo Wang, Analyst, LEDinside Chinahttp:// Translator: Judy Lin, Chief Editor, LEDinside)