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Soid Ahmad
Soid Ahmad
Articles (195)  | Author's Website |

Value Idea of the Month Part 1

Why Dialog is a top value play from a business perspective

June 13, 2018 | About:

Dialog Semiconductor (DLGNF) – the company known for its power management integrated circuits (ICs) for the iPhone – has been in the spotlight for the past month or so. First, the company lost around 30% of its business from Apple (AAPL), which reflected badly on the stock price. Now, there are reports that the company is trying to acquire Synaptics (SYNA), which is leading to further speculation over the health of the company. In the aftermath of the rumor last year that Apple will leave Dialog's “power management integrated circuits” (PMICs) in favor of an in-house PMIC Dialog has lost more than 40% of its market-cap. This has created a decent buying opportunity that can reward investors with returns up to 100% during the next couple of quarters or so.

Key talking points in Part 1

  • The loss of Apple as a customer is not expected to materialize anytime soon.
  • Apple doesn’t have the IP in pipeline to make all its power management ICs in house.

What’s the thesis here?

For starters, the market is mistaking Apple’s in-house development of power management integrated circuits (PMICs) as the company’s ability to completely cut Dialog off, which is not the case as explained later.

Second, Dialog doesn’t just have power management ICs; it also has other double-digit growth segments including AC/DC converter ICs and connectivity ICs. Further, the market is also ignoring the fact that Dialog can reposition its power management IC business toward Android players like Samsung (XKRX:005930) and Huawei, if Apple leaves.

The most interesting of all is the fact that shareholders are protected from the loss of principal with the virtue of Dialog’s book value per share, which is currently above the stock price. As the stock is trading on the low side, its acquisition potential has increased. Any sort of bid from big smart-phone players will boost the stock price. Moreover, upcoming earnings will catalyze the stock price. Before going into the details of the thesis, let’s take a look at the revenue of Dialog.

Revenue Insights

Source: Annual Report 2017, Revenue Mobile Segment (Left), Connectivity Segment (Right)

During the year ended 2017, Dialog Semiconductor registered 13% year-over-year revenue growth in Mobile Systems – the segment that’s involved in the provision of power management integrated chips for Apple’s iPhone. Moreover, revenue from connectivity segment jumped 15% year over year during the same period. It’s also worth mentioning that 77% of the company’s total revenue during 2017 came from the sales of its power management ICs to Apple.

Source: Annual Report 2017, Revenue Advance and Mixed Signal Segment (Left), Automotive (Right)

Apple, Samsung and Panasonic are among the top customers of the Dialog semiconductor. The top five customers of the company chipped in 92% towards the total revenue during 2017. Highly concentrated revenue makes Dialog Semiconductor a risky bet, according to the bears.

What are the prevailing fears?

The two key talking points on Dialog are its concentrated revenue base and the fear of Apple’s departure. It’s worth mentioning here that the stock plummeted after the reports that Apple might be ditching Dialog semiconductor’s power management chip for one of its three iPhone models. Apple will procure only 70% of its power management chips from Dialog this year, reported Reuters in May. Apple was responsible for more than $1 billion of the power-management chip maker’s revenue for 2017. This means that revenue can take a $300 million hit during 2018, which can translate into a 20% decline in forward earnings. This development further consolidates the view of the bears that Apple might be leaving Dialog in favor of its in-house power management chip. Let’s examine the prevailing fears in detail.

Revenue concentration isn’t a serious risk

One can argue that the revenue is concentrated among several players, which increases the business risk for the company. But this is because there is only a limited number of leaders in the smartphone market including Apple, Samsung and Huawei. This is completely different from, say, a hypothetical market with many mobile players, where concentration can prove to be a problem. Even if a new leader emerges in the smartphone market, it will have to procure power management ICs from somewhere. Why not from a leading provider of PMIC like Dialog? The point is that the threat from concentrated revenue is not as great as perceived in the market

Apple isn’t ditching Dialog, at least in the medium term

Another argument from the bears is that Apple can, and is, developing in-house PMIC capabilities, which will lead to catastrophic decline in Dialog’s revenue, and that’s the reason a high premium isn’t justified. Let’s explore.

According to the chief executive of Dialog Semiconductor, Jalal bagheri, it’s likely that Apple might be using an in-house source for the orders’ lost by Dialogue Semiconductor. Bears are using this to point out that Apple is phasing out Dialog’s PMIC.

This development doesn’t mean that Apple can, or will, develop “all PMICs” internally. Apple has not filed for any patent applications relating to PMICs since 2014. The company was granted the 2014 patent in June 2017.

(pdf) Lens.org, design diagram of the PMIC patent granted to Apple in June 2017

The thing to note is that this is a patent for only one PMIC of Apple; iPhone X reportedly utilized three power management ICs from Dialog Semiconductor. See the tear down here.

Source: Techinsights, iPhone 8 tear down

The iPhone X featured two ICs, 338S00341 PMIC and 338S00306 PMIC, which are from Dialog Semiconductor; the phone also featured a third IC from Dialog, which isn’t visible here. The point is that Apple can’t possibly replace three different PMIC designs from only one in-house design, as it only holds a single patent for one PMIC design.

In this context, the news regarding Apple partially canceling orders from Dialog makes sense now. Apple might be using its own PMIC instead of one of the PMICs from Dialog. This doesn’t, however, mean that Apple can replace the other two PMICs from Dialog with one of its own.

This argument is also in-line with the comments of Dialog’s CEO who is guiding for a mere 5% decline in revenue during 2018 and 2019 due to the design loss at Apple. If Apple is indeed phasing out Dialog’s products, the negative revenue impact would have been significantly higher than what the CEO of Dialog is disclosing.

Moreover, as Apple has not filed for any patents for PMICs lately, it’s safe to say that the company will continue to utilize the PMICs from Dialog Semiconductor going forward. Moreover, the risk that Apple will procure PMICs from a third party supplier isn’t likely, at least according the comments of Dialog’s CEO who thinks that Apple might be using an in-house PMIC.

Bottom line

The bottom line is that the market’s fear that Dialog will lose all of its business from Apple is an overstatement due to the fact that Apple doesn’t have the patents to replace all the power management ICs provided by Dialog. Therefore, the recent sell-off is unjustified, creating a serious value case in favor of Dialog.

Stay tuned for the valuation case for Dialog.

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

About the author:

Soid Ahmad
Soid Ahmad is affiliated with the Association of Chartered Certified Accountants. He graduated from Oxford Brookes University. He also holds a Master's degree in Economics and Finance from HSRW Germany. He has been working as a technology analyst for several years and has an eye for mispriced technology stocks. He is also affiliated with Focus Equity, an independent equity research firm.

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