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The Starting Line: Applied's health depends on flat-panel fervor

Wall Street takes a shine to the stock offering from Applied Films, a maker of materials for flat-panel displays. But will the flat-panel market retain its luster?

Wall Street took a shine to last week's stock offering from Applied Films, a maker of materials for flat-panel displays.  

Whether that glimmer of enthusiasm will hold up is the question, though, as flat panels aren't necessarily as hot as they used to be.

Applied's stock price rose more than 15 percent Friday as the maker of equipment used in making bottles, packages and liquid-crystal displays (LCDs) unleashed an offering of 3.8 million shares. The deal increased Applied's shares outstanding by almost two-thirds, yet shareholders couldn't resist the lure of the flat-panel market that drives much of the company's business.

According to earnings tracking company First Call, all the research firms that follow Applied recommend the stock as a "buy" or "strong buy." But most, if not all, of the brokerages covering Applied also are part of the underwriting syndicate for Friday's stock offering.

"Flat-panel displays have recently reached price points low enough to warrant widespread replacement of traditional, bulky cathode ray tube (CRT) monitors," wrote Wells Fargo Van Kasper analyst Susan Crossley, who has a "strong buy" rating on Applied. "This should presumably drive a need for large additions to flat-panel manufacturing capacity."

Yet Applied hasn't been anything to brag about lately, at least from a profit point of view.

The company has seen earnings per share fall year over year each of the past two quarters, and analysts expect that trend to continue for the next two quarters.

The company sells coated glass for flat panels and machines used to deposit thin films used as conductors in displays. Its coated-glass business hasn't done as well as executives originally hoped, and the thin-film equipment business, while healthy, also remains a small player in its overall market--holding no more than 10 percent or 11 percent of the active-matrix LCD market, by some estimates.

Still, long-term expectations for the overall flat-panel market remain high, which translates into increased interest in Applied. The prospectus for the company's stock offering cites a forecast from market research firm DisplaySearch predicting the flat-panel market will produce revenue of $49.3 billion by 2005, up from $22.5 billion this year.

That would require a reversal of recent trends. This year's prediction of $22.5 billion would also mean an 8.2 percent decline in LCD revenue this year because of slowing growth in sales of wireless phones and handheld devices that have fueled most flat-panel demand until now. And though DisplaySearch has a long-term forecast of 21 percent compound annual growth, that represents a "significant" decline from previous expectations, the research firm said.

Even worse, pricing has been savaged for flat-panel displays this year precisely because demand has slowed with the worsening economy just as the industry has bulked up on manufacturing capacity, said Barry Young, a vice president with DisplaySearch. The result has been a supply glut coming after a supply shortage the previous year. In addition, prices recently have fallen to as low as $190 for a glass panel used to make 15-inch, XGA-resolution LCD monitors, according to DisplaySearch's data.

Demand is rising because LCD displays have become cheap enough to replace some CRTs for desktop computers, Young said. Prices also should recover--a bit. By end of next year, those 15-inch glass modules could hit the $200 level again, Young said. And other segments of the flat-panel market, such as plasma displays, are growing rapidly.

"We're in price stability right now," Young said. "We expect prices to increase slightly."

As long as prices stay at a reasonable level, demand for monitors should increase, which in turn should drive factories to buy more of Applied's equipment. But the industry has to be careful of raising prices too much. The plummet in LCD prices was what attracted monitor buyers to begin with, said David Mentley, a vice president with Stanford Resources. Those would-be buyers could easily desert the market if flat-panel prices rise to where they were last year.

Although prices have bottomed out for now, all it takes is one company undercutting rivals to send prices tumbling again, said Mentley, who likened the situation to OPEC's (usually unsuccessful) attempts to cap oil production.

"It's a really unusual situation," Mentley said. "All the display vendors are trying to put on a brave face and convince everyone the price increase is sticking...It's just a really delicate balance."