LED makers have defied the post-crisis market turmoil with off-the-charts share price gains reminiscent of the dot-com boom.
Now, the sudden rise of dozens of government-backed Chinese competitors threatens to steal the thunder of market leaders just as a global transition to super-efficient lighting gets under way.
Light-emitting diodes are used mainly to light consumer electronics products such as mobile phones and television screens. They are poised to unseat incandescent and compact fluorescent light bulbs as governments, businesses and consumers seek to cut electricity costs and curb emissions.
Cree Inc, Philips Lumileds, Siemens' Osram unit and Japan's privately held Nichia Corp and Toyoda Gosei have long been seen as the heirs to the LED lighting fortune.
Cree became a darling of Wall Street, with shares soaring 450 percent between January 2009 and April 2010, when it carried a lofty forward price-to-earnings ratio of 39, according to Thomson Reuters Datastream.
Cree made an early bet on China, where it now generates 40 percent of its sales. But the Durham, North Carolina-based company and its entrenched rivals weren't the only ones looking to ride the nascent LED lighting wave. Chinese local governments quickly moved to subsidize at least 70 percent of the price of tools used to make LEDs, prompting dozens of companies to start fabricating the semiconductor light sources.
That flood of competition has sent LED supplies skyrocketing, pressuring prices and contributing to several quarters of disappointing results from Cree. Its shares are down 40 percent from their 52-week high reached in April.
It's a tsunami, Raymond James analyst Hans Mosesmann said, likening the flood of LEDs in the market to what happened in the solar panel industry when Chinese players closed the gap on their Western counterparts even though those companies had an early lead and technological edge.
China will invest $10.5 billion in LED projects in the next three years, and the nation's annual market for LEDs is expected to reach $7.08 billion in 2014, up from $4.37 billion in 2010, according to research firm iSuppli.
The Chinese are very keen on learning how to produce LEDs ... and, all things being equal, the Chinese are going to prefer the local suppliers, said Mosesmann, who has an underperform rating on Cree's stock.
Chinese LED makers now number in the hundreds, and Cree's dominance in the Chinese market could be eroded in the coming years by rivals like Sanan Optoelectronics Co Ltd and Hangzhou Silan Microelectronics Co.
Sanan and 10 other Chinese LED chip makers are spending at least $5 billion on chip reactors to boost production over the next few years, a UBS report said.
The world's two LED manufacturing equipment makers, Veeco Instruments Inc and Aixtron AG, stand to benefit from those orders. But analysts and investors warned that the expected expiration of China's LED tool subsidies this year is likely to put a damper on their growth.
The orders are probably too aggressive on the equipment side, and you might see some order cancellations and pushouts, said John Segrich, manager of the Gabelli SRI Green mutual fund and the Gabelli Green Long/Short hedge fund.
Segrich's hedge fund is short shares of both the LED equipment makers and Cree, which he said is still overvalued despite a pullback of nearly 40 percent since April.
You can buy Apple for what, 13 times earnings? Why pay 25 for Cree? Segrich said. The valuation has been very high for a company that has missed numbers three quarters in a row. We're not convinced.
Cree is not the only LED stock that has struggled in recent months. After Taiwanese LED maker SemiLEDs Corp went public in December at $17, the shares soared to more than $32 but now trade just above $18.
Shares of Rubicon Technology Inc, which makes sapphire substrates, a key raw material for LEDs, have slid 50 percent since late July, and Canaccord Genuity downgraded the stock to hold on Monday.
Today, 80 percent of the demand for LEDs comes from the consumer electronics industry. The lighting market, according to Mosesmann, makes up only about 20 percent of LED demand. That is expected to change dramatically in the coming years as governments -- particularly China's -- encourage a transition to more efficient bulbs and as prices on those products drop.
Compact fluorescent bulbs, another energy-efficient alternative, are problematic because they contain mercury, which complicates their disposal. That leaves LEDs, which are expected to make up just 5 to 10 percent of all bulbs replaced in 2012, according to J.P. Morgan.
Everyone is excited about lighting, but it's not a consumer electronic impulse purchase, said John Segrich, manager of the Gabelli SRI Green mutual fund and the Gabelli Green Long/Short hedge fund. It's going to be big, but it's just going to take a long time, and people have underestimated that.
To stay exposed to the market potential of LEDs, Segrich prefers lighting fixture manufacturers like U.S.-listed Cooper Industries Plc and Austria's Zumtobel AG.
Some investors, however, see the current turmoil as a short-lived blip in the long-term growth prospects for LEDs.
According to Canaccord Genuity analyst Jed Dorsheimer, China will announce $20 billion of capital for energy-efficient lighting products in the first week of March that should inject new demand into the market.
General lighting is going to take off quite strongly in China, said Philippe de Weck, who manages the $550 million Pictet Clean Energy Fund and owns shares of Cree and Veeco.
Once that gets traction, Cree is really the premier chip supplier until the Chinese can ramp up ... it will take several years before they can get to the position Cree is in today.
(Additional reporting by Leonora Walet in Hong Kong; editing by Gunna Dickson)