A Potential Big Profit – Lighting Science Group (symbol LSCG.OB)

As a rule, I do not recommend long shot investments on this blog; I like companies that have already established themselves as profitable and growing. Occasionally, however, a product comes along that seems so clearly to be in the right place at the right time, that I will make an exception. Such a product is now here; it is the line of LED light bulbs from Lighting Science Group (LSCG.OB).

First let’s look at some background. Under current law, it will become illegal to purchase new incandescent light bulbs in just a few more years. The plan from congress was to force Americans to use fluorescent bulbs in order to reduce energy usage and to combat global warming. Of course, “global warming” has now become “climate change” since the world has inconveniently cooled for the last few years. Nevertheless, there remains a potent climate change lobby that includes the president among its supporters. Obama may have failed to get his cap and trade plan passed, but he would never agree to removal of the impending ban on most incandescent lighting.

Of course, problems with the lighting plan have appeared in ever increasing frequency. The latest one is the move within the European Community to overturn their ban on incandescent lighting as a result of the potential for mercury poisoning from fluorescent light bulbs. Apparently, breaking a fluorescent light bulb releases into the air mercury at levels many times the level allowed under the safety standards set by the European equivalent of OSHA. Further, even if the fluorescent bulbs are not broken in homes, they will likely end up in landfills where the mercury they contain will eventually leach into the water supply. In essence, these fluorescent bulbs boil down to a method to fight “climate change” by poisoning the environment. Something has to give!

So there is pressure to do away with incandescent bulbs and fluorescent bulbs seem not to be the answer. The better choice then come in the form of LED bulbs, and this leads to Lighting Science. Light Emitting Diode or LED bulbs use much less power to produce their light. They last for much longer than other types of bulbs. They do not contain mercury or any other pollutant (at least none has yet been identified). In short, they seem to solve the dilemma of what to do to get rid of the incandescent bulbs.

Let’s look at a comparison: According to the data published by LSCG, its A19 bulb uses 8 watts of electricity to produce light comparable to a 40 watt incandescent bulb. Right away, there is an 80% power savings. The LED bulb, however, has an estimated rated life of 50,000 hours versus the 1000 to 2000 hour life for the incandescent bulb. That means that once installed, the LED bulb is in place for the foreseeable future. There are no maintenance or replacement costs. LSCG even guarantees its products for 5 years. It also means that one LED bulb is the equivalent of at least 25 of the incandescent bulbs even ignoring the power usage differential.

The big difference with LED bulbs has always been the price compared to incandescent bulbs. Most LED bulbs have carried prices of about $50 per bulb or higher. The LED bulb from Lighting Science mentioned above, however, carries a retail price of just under $20 each according to LEDs Magazine. That means that over its lifetime, these bulbs now cost no more than the equivalent supply of incandescent bulbs that would be needed, and the LED bulbs cost only 20% as much for power usage and have no associated costs to change the bulbs.

Second, let’s look at the LED industry. Lighting Science seems to be the cream of the crop here. Their products are much less expensive than the competition. I spoke to the head of a large supplier of lighting in the Northeast who tells me that the color for the Lighting Science product is also better than the competition and that the output in lumens for the LSCG product is also higher. When that is coupled with the price differential, the Lighting Science product seems clearly superior. So, on a product basis, LSCG seems to be the investment of choice in this industry.

Another point in favor of LSCG is that it does much of its manufacturing in the USA. This may be a strong selling point for some folks. In fact, Lighting Science is about to celebrate its manufacturing of its one millionth LED bulb in the USA.

So, now we need to look at the company itself. As of the close yesterday, LSCG stock sold for $3.25 per share. That gives the company a market cap of roughly $265 million. The average daily volume for the stock is in the area of 50,000 shares, but this has risen lately.

LSCG, however, has never shown a profit on its LED products. Although the company has been around for quite a while, its LED business is best characterized as a start up. Revenues have been rising coming in at $32 million in the last year, $21 million the year before that and only $4 million two years ago. The company is also getting much wider distribution; since the summer it sells in Home Depot stores across the country.

The company seems to have sufficient capitalization to allow it to continue ramping up its LED line. As of November 22, 2010, it got a $15 million line of credit from Wells Fargo Bank. This loan can give one some security since the bank was not a lender to LSCG prior to this, so Wells Fargo must have done a detailed review of the company’s books and found them satisfactory before proceeding with the loan.

The big issue for Lighting Science is whether it will be able to increase sales to the point where it will become profitable. That is obviously an unknown at this point, but the signs are good in my opinion. First, the potential market is large. Light bulb sales in the USA were $3.2 billion in 2009. If incandescent bulbs are banned as currently scheduled, this market will have to move somewhere and LED seems clearly preferable to fluorescent bulbs. There is also an enormous market around the world. Second, Lighting Science seems to have protected itself with regard to the advances it has made in the quality of its product. According to the company, it has 15 patents on the product and another 10 applications are pending. While I cannot tell how well the patents protect the LSCG LED bulbs (or even if the patents are valid), it does seem that the company has been active in its attempts to get whatever protection is available. Third, for installations in industrial or commercial settings where maintenance and energy costs are clearer, the economics of the LED bulbs seem to allow the bulbs to sell themselves. As a result, ultimate success for Lighting Science is a bet that I am willing to make. Further, if the quality differential for the Lighting Science bulbs is as great as it seems, this company presents a major acquisition target for larger rivals in the lighting field.

In short, I recommend opening a position in the stock. Be advised, however, that this is a highly speculative investment; it is not a place to put the kids college fund.

Disclosure: In the accounts I manage I am long LSCG and will likely continue to accumulate further positions in the near term.