Dialog Semiconductor (DLGNF, Financial) – the supplier of power management integrated circuits (ICs) for the iPhone – is not at a serious risk of losing all its power management integrated circuit (PMIC) designs in the upcoming iPhone. Apple (AAPL, Financial), the Cupertino-based technology giant, can’t just develop an IC out of thin air if it doesn’t have a patent or an application pending, as pointed out in the Part 1.
Nonetheless, Apple is supposedly using one in-house PMIC in its upcoming iPhone models. Dialog’s revenue, therefore, will certainly take a hit. However, the market has overreacted to the news. Valuation reveals a different story. Dialog offers upside, even after accounting for the $300 million order loss at Apple.Â
Key talking point in part 2
- The market has overreacted as the stock is now trading below its book value. The stock offers up to 100% upside with apparently no downside.
The value-added approach to Dialog’s valuation, after accounting for loss of actual orders from Apple:
Notes to the valuation table: Revenue for 2018 is derived by subtracting a revenue loss of $300 million from analysts’ consensus as the company lost 30% of its orders from Apple. Revenue for 2019 is derived from the analyst consensus after adjusting for the partial-loss of orders from Apple. For 2020-2023, 10% growth is assumed in light of double-digit growth from mobile, connectivity and advanced and mixed signal segments during 2017. Earnings are assumed to grow in line with revenue. Cost of capital is assumed at 7.5%.
It can be seen that Dialog Semiconductor is severely underpriced, even after considering the loss of orders from Apple. Note that the valuation assumes a $300 million loss of revenue during 2018 while Dialog has disclosed that revenue will fall 5% during 2018. Using Dialogue’s guidance will result in an even higher price target for the company.
The economic value added valuation approach presented above reveals a price target of $37.60, an upside more than 100% over the current stock price. In short, the market’s reaction to Dialog losing some business from Apple is a bit extreme, at least from the valuation perspective.
What if the unlikely becomes likely?
The market is concerned that Apple might completely ditch Dialog in the future, which will affect Dialog’s business significantly. Although Dialog can still reposition itself toward Android device manufacturers who are already customers, like Samsung (SSNLF, Financial) and Huawei, Apple’s departure would be a big blow to Dialog from a business perspective. Despite the fact that this is an unlikely scenario, as evident from lack of PMIC design patents at Apple, the departure of Apple is certainly not a threat to Dialog’s existence.
This concern, however, should be looked at quite differently from an investment perspective. If Apple leaves, Dialog will still have other revenue streams with growth prospects, albeit less important ones. It is important to note that the connectivity segment, and advanced and mixed signal segments of Dialog, are not relying on Apple for revenue. Combined revenue of both these segments amounted to $269 million for the year ended 2017. Furthermore, both of these segments witnessed double-digit growth during the given period; revenue from connectivity was up 15% year-over-year while advanced and mixed signal was up 13% on a year-over-year basis during 2017.
Moreover, the company is already trying to diversify, as is evident from its talks with Synaptics (SYNA, Financial). A merger with Synaptics will expose the company to the growth prospects of the human interface solutions market including touch screen, display drivers and fingerprint sensors. The point is that design loss at Apple is not the end of Dialog Semiconductor; the market is reading too much into it. If the company loses Apple, it’s still not a lost cause amid other revenue streams and options to redeploy assets.
The risk of capital loss in minimal
What’s even more interesting is that there’s little risk of capital loss for investors in case of Apple’s departure. Dialog is already trading at a discount to its book value, which makes the stock a safe bet even if Apple leaves.
As of the quarter ended March 2018, Dialog’s book value stood at $18.50 a share while the stock currently trades at $17.60, translating into an upside of upside of 5% if the company decides to sell its assets altogether. Note that this is the worst-case scenario, though. The company doesn’t only have tangible assets and IP to sell – it also has a cash-generating business. It’s worth mentioning that the company can generate around $1 billion in revenue after accounting for a 30% loss of orders from Apple. The valuation below sheds light on Dialog’s value in case Apple leaves.
Value added, in case Apple withdraws all orders
Inputs and assumptions:
Focus Equity Estimates, Notes to the valuation table: 2018 revenue is based on the analyst consensus after subtracting half of Apple-related revenue in 2017, i.e., $531.50 million. The rationale is that, in an event of Apple terminating its relationship with the chip manufacturer, Dialog will still get the revenue from Apple for the first half of 2018. The revenue estimate for 2019 is based on a 10% growth in other business segments after eliminating all revenue from Apple. For 2020 to 2023, 10% growth is assumed in the light of double-digit growth from connectivity and advanced and mixed signal segments during 2017. Earnings are assumed to grow in line with the revenue. Cost of capital is assumed at 7.5%.
The valuation depicts that the stock is priced for perfection even if Apple leaves all together. Note that the chances of that happening are remote as discussed above. Even if such a catastrophic event happens, Dialog semiconductor’s balance sheet will protect investors’ principal investment.
It is worth mentioning that the valuation above doesn’t include any revenue from mobile segment for 2019 and beyond, despite the possibility of Dialog re-positioning its power management business towards the android market. In short, the only possible explanations for the current market pricing of Dialog are either irrationality, or fear. Once Dialog reports earnings, the market might gain confidence again.
What can be the catalysts for stock price growth?
- As Dialog’s book value per share is below the stock price, this can tempt smartphones giants to swoop in and acquire the company. Internalization would save the acquiring company some component costs and bring in some additional power management ICs intellectual property. Low bids can also catalyze the stock price because they can result in positive sentiment for the stock.
- Upcoming earnings can also catalyze the stock price. The market is still in shock amid loss of some orders from Apple. The stock will recover once the market sees better-than-expected results.
What are the thesis risks?
In case of the unlikely event of Apple’s departure, Dialog might not be able to find alternative customers, which can make the 100% upside thesis null and void. Moreover, overheads can put serious pressure on earnings if Apple departs.
Investors might lose their principal if the company writes-off its goodwill in case it decides to sell the PMIC business in distress.
Bottom line
To sum up, Dialogue offers asymmetric reward to risk. On one hand, the stock has an upside of more than 100% in case Apple decides to keep some of its power management IC business with Dialog in the long run. On the other hand, there’s no downside at all if Apple leaves given the high book value per share of the company, the possibility of re-positioning the mobile business towards Android and double-digit growth in other segments. Nonetheless, the possibility of Apple leaving altogether is remote as evident from lack of patent applications relating to PMIC from Apple as discussed in the first part. All in all, Dialog is a good value buy at the current price amid its asymmetric risk-reward profile.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
