Optical Film Brightens 3M's Picture

Saturday June 5, 8:18 AM EDT
By Karen Padley

CHICAGO (Reuters) - Move over Post-It notes. Hold on Scotch tape. There's a
bright new star at 3M Co. (MMM).

Optical films, its fastest-growing product line, have reached nearly $1 billion
in annual sales and are being snapped up as quickly as 3M can make them.

Such films increase the brightness of liquid crystal displays, or LCDs -- the
so-called flat panels increasingly used in computer monitors, televisions and
cellular phones. As the demand for those products has soared, 3M's bottom line
has gotten a substantial boost as well.

In the first quarter alone, sales at the 3M division that includes optical films
gained more than 20 percent while operating profit jumped more than 61
percent. The division, display and graphics, is now the most profitable of the
company's seven units.

The only question seems to be how long this winning streak can continue. There's
constant margin and price pressure in the consumer electronics markets and
General Electric Co. (GE) recently entered the optical film business.

"Optical films have been a key growth driver for 3M but the high returns and
growth in the business was bound to attract new competition," wrote Jeffrey
Sprague, a Citigroup Smith Barney analyst, in a research note last week. He
rates 3M as "low risk."

The diversified St. Paul, Minnesota-based company, which also makes sandpaper,
industrial adhesives, drugs and fiber optics connectors, has had the market
mostly to itself in the 12 years since it introduced Vikuiti brand optical
films.

The films work by using tiny prisms to capture light that would otherwise bounce
off the screen at wide angles and be lost. Once captured, that light is then
directed back toward the user, increasing the display's brightness without using
more power.

3M makes the basic material for its brightness and dual-brightness enhancement
films in Wisconsin and Alabama. These are then shipped overseas where they are
cut, combined and otherwise customized for specific products.

Bank of America Securities estimates 3M has about 80 percent of the market for
brightness enhancement film, with Japan's Nitto Denko Corp. (6988) a distant
second. And 3M has virtually all of the market for dual brightness enhancement
film, according to Bank of America.

"We have seen many challenges over the years -- technology challenges,
manufacturing challenges, competitive challenges, currency swings and pressures
to bring prices down," said Andy Wong, head of 3M's optical film business, in an
interview with Reuters. "I guess we've learned a few things along the way."

He also noted the company has extensive patents.

FLAT-PANEL TELEVISIONS TAKE OFF

What may be the largest market for 3M's optical films is still in its infancy --
LCD television.

DisplaySearch, a research firm based in Austin, Texas, estimates demand for LCD
televisions will increase to 34.8 million by 2006 from about 3.9 million in
2003. Only in 2007 will growth start to slow, with demand reaching 47.0 million,
the firm said.

Wong acknowledged there will be pressure industrywide to lower component costs
for the televisions, especially on the larger flat-panel TVs now dominated by
plasma technology, a rival technology that does not use 3M's films.

"We'll have to work harder not only at coming up with value-adding, useful
products but we also have to address the cost challenge, the affordability
challenge," Wong said.

Analysts generally aren't expecting major price drops on LCD TVs, at least
near-term partly due to tight component supplies. 3M, for example, is spending
$100 million over the next 12 months to double its production capacity.

Demand is also expected to remain strong.

"For the next year, most people are forecasting a very gentle decline in prices,
simply because demand is exceeding supply," said DisplaySearch analyst Andrew
Shulklapper. "Probably two years out, we'll see some pretty substantial cost
reductions, especially in the larger screen sizes."

A NEW COMPETITOR

Can 3M continue to get the wide margins it currently enjoys? Marc Gulley, a Bank
of America analyst, thinks so. He noted the company is getting its current
margins despite a large amount of waste, which reduces yields.

"As 3M uses Six Sigma (quality and productivity plan) to refine film production,
it can cut waste and improve margins," Gulley said in a recent research note.

General Electric's entry into the optical films market in late January with its
Illuminex diffuser product has some worried, though.

The company has forecast cumulative revenue growth of $300 million from its
optical films from 2005 to 2007, according to Smith Barney's Sprague.

"We would not be surprised to see GE broaden its line of optical films to
include a challenge to 3M's current dominance in brightness enhancing films,"
the analyst wrote.

While rapid growth in the LCD market probably means there is room enough for
both 3M and GE, Sprague said GE's entry could mute 3M's growth and profitability
in that area.