IQE: Leading the way with crystal technology

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In the outskirts of Cardiff you will find IQE (IQE), the world's leading manufacturer of compound semiconductor technology.

Grown from crystal and programmed at the atomic level, IQE's chips are found in a host of cutting-edge technological devices, starting with the chip that governs communication inside a mobile phone, on to a host of opto-electronics such as lasers and lights, and all the way to the next-generation solar technology.

While other areas are now becoming significant, IQE's success so far comes down to the booming wireless technology industry.

"Wireless continues to be the big driver behind the business," chief executive Dr Drew Nelson told Interactive Investor, as the group reported half-year results in September. "The smartphone cycle, first with 3G and now with 4G, is still just beginning so we still see very exciting growth in this sector."

In the six months to 30 June, IQE saw a 16% rise in revenues, to £38.3 million. Pre-tax profit rose by 28%, to £2.8 million, and the group went from having £7 million in debt to a £1 million cash balance.

Don't forget to visit our Guide to investing in technology for more on what opportunities exist in the sector.

Size matters

Only 28% of the world's mobile phones are multi-function smartphones, and this segment continues to grow rapidly. Crack open your mobile phone and you will see a handful of different chips in there, as the constant addition of new functions to mobiles means the phone needs more chips on which to store data.

Traditionally, semiconductor chips are made from cheap silicon, but now that devices are becoming increasingly complex, silicon is starting to hit its limits; the amount of data being piled on chips means the physical size is becoming a problem. Compound semiconductors, such as the ones from IQE, are programmed atomically so size is less of an issue.

Crystal chips were traditionally too expensive for widespread use, but as we become more demanding about the qualities of our gadgets, the economics of crystal are changing. With a global share of over 30% of the pie, IQE is sitting pretty as the compound semiconductor market grows.

"What is happening now is that we are moving towards adding compound semiconductors onto silicon chips. Intel (INTC) is sponsoring work with IQE to explore this, and we have a number of joint patents filed in this field," said Dr Nelson, who co-founded IQE in 1988. He adds that Intel believes these new integrated circuits may well become the future of chips, with the first products incorporating the new technology set to see the light of day by 2015.

"By using compound semiconductors you can use much less power, and store much more data. Then you can communicate off the chip by optical means," said Dr Nelson, explaining that today's system of running band wires from computers will soon become redundant as we start to transfer data optically; today we may think downloading a film in 15 minutes is pretty good, but soon enough this will take 15 seconds.

Speed revolution

The first consumers will see of this speed revolution is Intel's Light Peak cables, developed in partnership with IQE, which Dr Nelson believes will be launched in six to nine months. He expects the change will be felt more widely in the industry also, as any data volume over 25 gigabytes that has to be moved more than a foot will need an optical solution.

"Light Peak cables are the replacement of USB-2 cables," said Dr Nelson, adding that last year along, three billion USB cables were supplied to the market. Each Light Peak cable will have six to 10 vertical-cavity lasers (VCSEL), which is where IQE's products come in.

The reason we are now seeing VCSELs hitting the consumer market is due to price: "They have been very expensive to make in the past, but now they can be mass produced at low cost. We are seeing them in optical computer mice, in corporate intranet systems and in finger-navigation pads like on the BlackBerry; because it is a solid-state light it has no moving parts, meaning it is much more reliable than the traditional trackball."

Brighter lights

IQE's two most recent acquisitions are also translating into new markets for the company; 2010's takeover of Galaxy has led to growth in the infrared materials market, while 2009's play for NanoGaN has been significant for IQE's foray into developing blue and green lasers.

The significance of this is the development of next-generation solid-state lighting (SSL) for the commercial market, but in the meantime SSL is used for pico-projectors:

"A device the size of your smallest fingernail has the power to project large high-coloured images. The first cameras with pico technology are coming out now, but in the not-too-distant future mobile phones will have these too," said Dr Nelson.

IEQ's technology has applications across a number of other arenas as well: medically, different-coloured lasers are used to treat conditions such as psoriasis, hair-loss and wrinkles.

Crystal chips are also vastly superior to the traditional technology used in the solar power industry; Concentrator Photo Voltaic (CPV) solar represents a very small portion of IQE's revenues at the moment, but the world market for CPV is expected to see a compound annual growth rate of around 175% over the next five years, compared to 19% for the overall solar market.

Analysts' view

"The half-year results could be described as a robust and reassuring performance, particularly in contrast to weaker trends at some of IQE's wireless customers during the period. The bright spots are within wireless, where IQE's products are in the majority of top-tier smartphones; tablets are the icing on the cake," said analysts at Cenkos following September's results announcement, pointing to solar and solid-state lighting as areas showing especially positive development.

With the shares down 28% this year to date, this positions IQE as an underperformer compared to industry peers ARM Holdings (ARM) and Imagination Technologies (IMG) by 46% and 13% respectively, said Cenkos: "That is unjustified in our view."

Arun George, analyst at Altum, agreed that the recent drop in the share price is unwarranted, but cited some of this could be due to greater forecast risk on earnings. Still, George maintains a 52p target price for IQE, which closed at 44.5p following September's results announcement.

Bob Liao, analyst at Canaccord Genuity, pointed out that IQE should continue to benefit from margin expansion as high revenue growth drives scale benefits: "IQE derives an increasing portion of revenue from very high growth markets such as VCSELs and CPV solar. [...] In particular the CPV solar market appears to be reaching an inflection point," said Liao, adding that the CPV dollar cost to kilowatt hour ratio has now fallen below other energy sources, according to Strategy Analysis.

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