Does Synaptics Merit a Higher Bid?

Synaptics (SYNA, Financial) – the human interface company known for its fingerprint and touch screen sensors solutions for smartphones – is reportedly in talks for a potential merger with Dialog Semiconductor (DLGNF, Financial) – the infamous supplier of power management chips for the iPhone.

Bloomberg reported that the deal is yet to close. The talks may not result in an agreement, according to person familiar with the matter. Synaptics jumped 10% on the new last Friday.

There are, however, several hurdles to cross before the deal can go through. Synaptics has already rejected a $59 all-cash bid from Dialog Semiconductor back in March. Moreover, regulators might not be thrilled about the overseas acquisition in the aftermath of Broadcom’s effort to buy Qualcomm, noted CNBC. However, it is worth mentioning that Broadcom is a Singapore-based company while Dialog Semiconductor is based in Europe; regulators might be less hostile to a bid coming from a European player.

What’s the background of this merger?

Synaptics is facing headwinds in its mobile segment, especially with the demand of its fingerprint sensors. Smartphone OEMs are moving towards face recognition and Iris recognition technologies. Capacitive fingerprint is becoming a commodity, pressurizing Synaptics’ top line. The company reported a 30% year-over-year decline in its revenue during the third quarter of 2018. In short, the slowdown in mobile segment is one of the possible reasons for Synaptics to seek a business combination.

On the other side, Dialog Semiconductor is desperate to reposition itself as it has lost 30% of its orders from Apple (AAPL, Financial); Dialog was the lone provider of power management integrated circuits (PMICs) for Apple’s iPhone before. Apple is now planning to keep some of the PMIC in-house, leading to a 30% reduction in orders from Dialog Semiconductor. Given Apple’s history of ditching suppliers in favor of in-house products, Dialog is rightfully looking to acquire growth elsewhere.

To review, both Synaptics and Dialog need diversification in order to be shielded from short-term headwinds. In Synaptics’ case, that headwind is the slowdown in uptake of capacitive fingerprint sensors.

$59 – A Fair Bid?

Dialog might have underestimated the value of Synaptics when it made a $59 bid to acquire the human interface company.

On the surface, a $59 bid from Dialog seems reasonable. Synaptics was trading around $45 at the end of March 2018, giving it an upside of 31% over the bid price. On the flip side, a $59 price tag gives Synaptics a forward price-earnings ratio of 12 based on 2019 earnings consensus. As analysts are modeling for 12% per-year growth for Synaptics, the case of a higher price is strong for the maker of smartphones’ interface. Based on the bid price of $59, a 12% growth boils down to PEG ratio of exactly 1, indicating that the growth is cheaply priced. It seems that Dialog has to up the ante if it wants to acquire Synaptics.

Moreover, except for the capacitive fingerprints, Synaptics has several growth assets, including in-screen fingerprint sensor, TDDI, display drivers and far-field voice sensors for IoT and automotive use cases, bringing the possibility of a higher bid into the realm of reality.

Regarding the concerns surrounding the in-screen fingerprint sensors of Synaptics, it should be noted that face recognition is not coming to mainstream Android phones during the next couple of years. The shortage of vertical-cavity surface-emitting lasers (VCELs) that enables 3D mapping is delaying the mainstream adoption. Only one or two android flagships will feature 3D sensing technology in 2019, according to Bill Ong, senior director of investor relations at Viav Solutions (VIAV). Moreover, the possibility of 3D sensing and in-screen fingerprint sensors existing together can’t be rejected given a spectrum of consumers’ choices.

This means that the fears relating to a slow uptake of Synaptics’ in-screen fingerprint sensor are blown out of proportion and Synaptics has a window of opportunity to push its in-screen fingerprint technology to device OEMs and capitalize on this opportunity of growth, consolidating the case for a higher bid.

Valuation reveals $59 isn’t enough

The economic-value-added (EVA) valuation shows that the stock is priced above the acquisition price proposed by Dialog back in March.

Focus Equity Estimates, Notes to the valuation table: Earnings are expected to grow 10% during 2020 to 2023, which is based on weighted average industry growth in the fingerprint sensor market and Synaptics’ serviceable addressable market. Cost of equity is based on the risk-free rate and the balance of money circulation. No dilution is assumed in outstanding shares as Synaptics is consistently buying back stock.

The valuation reveals that if Synaptics manages to match the analysts’ consensus for 2018 and 2019 earnings, the stock is worth $71. It is worth $59 only if Synaptics matches the lowest earnings forecast on the street for 2018 and 2019. You can compare this valuation to the previous valuation here.

Takeaways

• Both Synaptics and Dialog Semiconductor are striving to diversify away from short-term headwinds; the deal talks are self-evident. Synaptics is trying to offset its fingerprint sensor woes while Dialog is trying to limit its reliance on Apple.
• Given Synaptics’ exposure to growth in display drivers, TDDI and far-field voice communication alongside favorable valuation, Dialog will have to increase its bid in order to acquire the Silicon Valley based human interface company.
• The rejection of a $59 bid from Synaptics also signals the management’s confidence in the growth prospects of its future products.
• From an investment perspective, Synaptics is quite cheap if it achieves analysts’ earnings consensus for 2018 and 2019.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.