Small Stock gets a Big Boost from Apple

UK smaller company Imagination Technologies rose to the top of the FTSE 250 after it announced that it had extended its multi-year license with Apple

Morningstar News Team 6 February, 2014 | 10:19AM

Imagination Technologies (IMG) rose to the top of the FTSE 250 Thursday morning after it announced that it had extended its multi-year, multi-use license agreement with Apple (AAPL).

Under the agreement Apple can use Imagination's range of current and future PowerVR graphics and video IP cores in its smartphones, tablets and other devices.

Imagination will receive on-going license fees and royalty revenues on the shipment of systems-on-a-chip using its intellectual property in Apple's products.

Shares in Imagination were trading up 15% at £1.86, making it the top gainer on the FTSE 250.

Morningstar Stock Analysis: Undervalued

Imagination Technologies is a leading provider of intellectual property used in graphics processing in semiconductors. While the company's IP customers sell chips to a wide variety of end markets, much of Imagination's fortunes will be tied to the booming smartphone and tablet end markets. Imagination captures both an up-front license fee from its customers as they pay for the rights to use the firm's IP, as well as ongoing royalties based on a percentage of the sale price of each chip to the end customer. Key licensees include Intel, Apple, and MediaTek, among others. Intel and Apple own 15% and 9% of shares outstanding, respectively, which we think is a good indicator of the strategic importance of the company's IP.

We expect the firm to see strong revenue growth, not only from general smartphone and tablet demand, but also as customers' gadgets, such as Apple's iPhones and iPads, gain share within these markets. Furthermore, Intel's and Apple's ownership stakes in the firm give credence to Imagination's strategic importance with these tech titans. We also like Imagination's relatively fixed-cost structure, which should enable most of the firm's future revenue growth to flow directly to the bottom line.

Our main concern is that several other large mobile chipmakers, such as Qualcomm, have their own internally developed graphics capabilities and are unlikely to emerge as significant Imagination IP licensees in the years ahead. Others, such as Samsung, Intel, and even Apple, may bring this IP in-house in the future.

Further, ARM seeks to drive adoption of its competing solution, Mali, and its current ecosystem surrounding its mobile processors could help promote this solution over time. If any of these firms gain share from Imagination, its customers, or both, in the years ahead, the company's revenue growth might be constrained. These alternative solutions are the biggest reason we assign a no moat rating to Imagination at this time.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Apple Inc193.55 USD1.12
Imagination Technologies Group PLC  -

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