Chipmaker InvenSense's (INVN) shares have gained almost 90% in the last one year, but the stock got off to a slow start in 2014. InvenSense has gained on rumors that it might be a supplier for Apple's (AAPL) next iPhone, a rumor that analyst firm Needham says isn't likely to materialize and removed its $20 price target. Moreover, InvenSense didn't come out with great third-quarter results last time.
Its net revenue of $66.7 million in the fourth quarter increased from $58.9 million last year, translating into a year over year jump of 13%, with smartphone and tablets representing 83% of total revenue. However, with a P/E ratio of 76, InvenSense needs to post superior growth numbers if it is to justify its valuation, and for that it will need a catalyst from Apple. But before that, let's take a look at its existing business.
Solid Product Innovation Is A Growth Driver
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Despite a downturn in its gaming business, InvenSense gained market share at top mobile customers and witnessed growth in emerging markets such as China. InvenSense management strongly believes that market and customer dynamics will drive growth in the coming quarters.
InvenSense's multiple customer design wins with its MotionTracking system on chips, or SoCs, which utilize Digital Motion Processing, or DMP, coupled with its motion algorithms are positives. These design wins validate its strategy of providing customers with a true plug-and-play motion tracking solution, including value-added MotionApps software.
Despite the gaming segment experiencing unseasonably weak unit shipments, InvenSense saw strength in unit volumes in the last quarter with its 6-axis MotionTracking solutions and its 2-axis optical image stabilization (OIS) products. This strength was due to an increase in demand from several areas: growth areas such as Chinese smartphones, including Xiaomi and Oppo, and market share gains at top-tier customers and adoption in flagship products, such as Samsung's (OTC:SSNLF) Galaxy Note 3, Google's (GOOG) Nexus 5 by LG (LG), and Amazon's (AMZN) Kindle Fire.
These devices drove demand for its 6-axis MotionTracking devices, while OIS-enabled smartphones, such as LG's new G2 and the Nexus 5, contributed to robust demand for its 2-axis gyro. Majority of InvenSense's customers have transitioned to the 6-axis platform. Strong market share gain was observed in the 6-axis MotionTracking product, the MPU-6500, with volume shipments in several flagship customer products, including smartphones and wearable devices.
The production ramp of MPU-6515, the world's first MotionTracking SoC optimized for Google's Android KitKat operating system, is promising. The MPU-6515 SoC features InvenSense's second-generation Digital Motion Processor hardware accelerator and algorithms for low-power system operation, thus enabling the first AlwaysOn motion tracking experience in the market.
The wide use of this technology by original equipment manufacturers validates InvenSense's strategy to bring to customers a complete solution for motion tracking and enabling significant system power savings. Moreover, it is working with a number of top-tier customers to tailor its motion algorithms to their specific applications, which increases customer intimacy and platform stickiness for InvenSense.
Also, gyro attach rate continues to increase among Chinese OEMs as smartphones based on the Android operating system grow and drive features for further differentiation within an increasingly competitive landscape.
InvenSense has continued to capture additional design wins in OIS. The unique camera experience in OIS is a differentiating factor in the smartphone OEM segment that is expected to increase the total addressable market for gyros. Owing to a substantial increase in anticipated demand, InvenSense has the opportunity to build inventory in its core products, such as the MPU-6500 and MPU-6515.
Health and fitness applications are also driving demand for higher-accuracy activity monitoring and tracking, enabling increased designing activity for 6-axis and 9-axis solutions for wearable devices. The wearable device category, including health and fitness tracking, smartwatches, wearable computing, and immersive gaming are in the early stages of a multi-year expansion, creating new and exciting growth opportunities for InvenSense.
Apple Can Be A Big Catalyst
One thing that should be noted here is that InvenSense's moves in this segment are in line with Apple's potential iWatch. Going forward, the wearable device category can be a big growth driver for InvenSense. According to Juniper, the wearable device industry will grow to a whopping $19 billion. InvenSense's wearable platform for health and witness indicates that the company has landed a spot in Apple's iWatch which, as per reports, may launch in 2014.
This is definitely great news for InvenSense as most of the speculations suggest that Apple's iWatch will have many health and fitness related features. Apple has been laying the foundation of a fitness-focused iWatch byhiring many health experts in the recent past. So, it's quite probable that the iWatch will come with an InvenSense embedded chip.
Morgan Stanley analysts Kate Stanley expects Apple's iWatch to hit $17.5 billion in annual sales. Stanley is basing her projection of the fact that each new Apple product sells faster than the previous one. If this turns out to be the case and InvenSense lands a spot in the iWatch, it can deliver huge gains in the future.
Some More Tailwinds
The acquisition of Analog Devices' MEMS microphones business will increase InvenSense's total addressable content in mobile and wearable devices. This will also provide it exposure to other markets, such as industrial and automotive.
The transition of existing and new customers from motion sensing components to MotionTracking solutions, such as MPU-6515, will help InvenSense capture additional value by performing sensor fusion and calibration, as well as other algorithms custom-tailored to their applications. This will shorten the development time of customers by offering a complete solution that removes the complexities of managing multiple sensors. This will also help in slowing down price erosion, presenting InvenSense with margin expansion opportunities in the future.
Moreover, several new launches such as AlwaysOn Automatic Activity Recognition solutions for the wearable device market and ICS-40720, the world's first 70 dB low-noise microphone that is highest-performing MEMS microphone for mobile and fixed devices, will serve as growth catalysts in the coming quarters.
InvenSense is quite expensive right now, but the company is targeting the fast-growing wearable devices market aggressively. It could be a possible gainer with the iWatch in the future. At present, the company is seeing a number of solid design wins at various customers, strengthening its prospects in the process. Moreover, on a forward P/E basis, the stock is cheap at 27 times earnings relative to its growth, signifying solid earnings growth in the future.
So, InvenSense can turn out to be a good pick in the future due to the various tailwinds that it enjoys and investors might benefit despite paying a premium for the stock.