RBC Capital’s Andrew Dunn this afternoon kicked off coverage of Imagination Technologies (IMG.UK), traded on the London Stock Exchange, which designs microprocessor cores, and which counts Apple (AAPL) as one of its customers.
Specifically, Imagination focuses on the “graphics processing unit,” or GPU, a section of the chip responsible for rendering graphics on the computer display. The company’s designs are used in Apple’s “A5″ chip and prior custom parts, and so have benefited from the rapid expansion of sales of Apple’s iPhone, iPod Touch, and iPad.
But with a 30 times P/E based on 2013 projected earnings, the stock is too rich unless Imagination can diversify, writes Dunn.
“In our view, IMGN will need to diversify its royalty base significantly (from 50% Apple) in addition to defending its exclusive presence in Apple’s mobile products in order to drive upgrades to forecasts.”
Imagination probably has 60% to 70% of the mobile GPU market, and may see as much as 38% growth in units that bring royalties, writes Dunn. It makes on average 17 pence per unit, he estimates. Royalties are the key driver to profit, he writes, as they have 100% gross margin.
Dunn’s projection for revenue for the fiscal year ending in April is slightly below consensus, at 126.7 Great British pounds, while his EPS estimate of 11 pence per share is in line with consensus. Dunn maps out a couple of scenarios where things could turn out better or worse for the company. In the bull case, if Apple just keeps using the technology and Samsung Electronics (SSNLF) puts Imagination’s technology into a future handset, such as the forthcoming Nexus phone, that could boost profit by 13%. But should Apple switch GPU providers, say for the next iPad, it could bring down profit 29%.
Dunn has a price target of 400 pence based on a multiple of 22 times enterprise value to projected 2013 Ebitda.
Imagination shares today closed up 12.97 pence, or 3%, at 445 pence.
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