Monday, December 3, 2012

How To Profit From The New iPad: 7 Investment Ideas

The launch of a new Apple (AAPL) product is not only of great importance to Apple and its customers, but also to its suppliers. A contract to supply Apple with components for its iDevices can be one of the most lucrative design wins a technology company can have.

With the new iPad now in stores, we can take a look to see which companies have a presence in it. Thanks to iFixit, we once again have a detailed teardown of the iPad, and can see which companies have made it into the new device. These companies, which we highlight below, all have healthy balance sheets (cash per share amounts are derived from the most recent quarterly earnings release and represent fully diluted amounts). While many of them are approaching consensus price targets on the Street, we think that in the weeks to come, they will see increases in earnings estimates and price targets as analysts adjust their models to account for the impact of the iPad on their bottom lines.

We chose not to include ARM Holdings (ARMH) at this point in time, it should be well known that ARM is the company that is more at the center of the smartphone and tablet revolution than any other, given that the vast majority of mobile devices run on its processing technology.

  • Qualcomm (QCOM): As one of the largest semiconductor companies in the world, and the second largest by market capitalization [behind Intel (INTC)], Qualcomm is a dominant force in the mobile world. With its 3G and 4G patents, Qualcomm dominates the networking chip space, and the iPad is no different. Qualcomm has 3 of its chips present in the new iPad. The first is a power management chip, the second is the 3G/4G transceiver and the third is the 3G/4G wireless modem. Given that one of the new iPad's strongest selling points is its 4G LTE connectivity, there should be a much higher proportion of cellular iPads sold this time around, relative to previous versions. Analysts at FBR Capital agree, and note that the new LTE iPad could generate up to $650 million in incremental revenue for Qualcomm this fiscal year, which translates into an EPS boost of 10-11 cents. For the record, Qualcomm's EPS for fiscal 2011 was $2.52. Qualcomm has $21.978 billion in cash on the balance sheet, which works out to $13 per share in cash. The Reuters average price target for shares of Qualcomm currently stands at $69.88, representing upside of 6.83%.
  • Broadcom (BRCM): Perhaps no major semiconductor company is as levered to Apple as Broadcom. Apple is Broadcom's largest customer, accounting for 13.1% of sales in 2011, up from 10.9% in 2010. While some may worry about what would happen should Broadcom be displaced in Apple's iDevices, we think that is a remote possibility. Broadcom's technology is too integral and advanced to be easily replaced by a competitor. Broadcom has 3 chips present in the new iPad, including the baseband and radio chip, the I/O controller, and a microprocessor. In addition to its presence in the iPad, Broadcom is working hard to make inroads in the low-end Android market, where supplier profits depend on volume, and not the profits of their OEMs. Given that collectively, Android smartphones outsell the iPhone (even though Apple has the vast majority of profits), this presents another opportunity for Broadcom. At the end of 2011, Broadcom had net cash of $4.009 billion on the balance sheet, which represents about $7.12 per share in cash. The Reuters average price target for Broadcom currently stands at $41.13, representing upside of 8.78% at current prices.
  • Avago (AVGO): Avago is a Singapore-based semiconductor company that is a relatively new presence in the iPad ecosystem. Avago has 2 chips present in the new iPad, the A5904 (processing), and the A7792 (logic board). For Avago, these design wins are an incremental positive, for the company will benefit from the increase in LTE adoption and wins in 3G connectivity as well, taking its share of that segment from essentially nothing in the iPad 2. Avago has $819 million of cash on the balance sheet, and no debt, which works out to $3.24 per share in cash. The current Reuters average price target for Avago is $41.19, which represents upside of 8.68% from current levels.
  • Skyworks Solutions (SWKS): Skyworks Solutions is continuing its history of being in the iDevice ecosystem, with 2 of its chips present in the new iPad; the SKY77468-17 front-end module and the Skyworks 77469 chip. DA Davidson believes that Skyworks has the most to gain from the new iPad, and rates the stock as its "Pick of the Year," with a $32 price target (Skyworks is at $28.05 as of this writing). Like the companies above, Skyworks looks healthy with $429.825 million in cash on the balance sheet, which is equal to about $2.27 in cash per share. The current Reuters average price target for Skyworks Solutions stands at $29.94, which represents upside of 6.74% at current levels.
  • Cirrus Logic (CRUS): If there is one company that can be defined as a pure play on Apple's iDevices, then it is Cirrus Logic. In fiscal 2011 (which ended in March 2011), Apple accounted for 47% of Cirrus Logic's sales. While this is a much larger proportion of sales from Apple than Broadcom, Cirrus Logic has a market capitalization ($1.6 billion) that is almost 13 times smaller than that of Broadcom. Although Cirrus Logic has just one chip in the new iPad-- its audio codec chip, given the fact that almost half of Cirrus Logic's sales come from Apple, each additional iPad sold has more of an impact on Cirrus Logic. However, this does present additional risk. While Cirrus Logic is the leader in this particular segment and has had a presence in the Apple ecosystem for a long time, there is no guarantee that it will continue to be present in Apple's iDevices. As such, any loss of business at Apple will be far more serious for Cirrus Logic than the companies described above. Cirrus Logic has $157.444 million in cash on the balance sheet, and no debt, which works out to $2.35 per share in cash. The current Reuters average price target for Cirrus Logic currently stands at $28.80, representing upside of 19.75% at current levels.
  • Fairchild Semiconductor (FCS): Fairchild is seen by many as the founder of the semiconductor industry, for it was founded in 1957 by a group of 8 men that included Robert Noyce and Gordon Moore, who would go on to found Intel. The first commercially practical integrated circuit was invented at Fairchild. Fairchild has found its way into the new iPad, which includes Fairchild's FDMC 6683 power management chip. Fairchild has $23.2 million in net cash on the balance sheet, which works out to 18 cents per share in cash. The Reuters average price target for Fairchild Semiconductor currently stands at $16, which represents upside of 10.8% at current levels. We should note that while Fairchild has a balance sheet that is relatively weak compared to the companies mentioned above, investor perceptions of the company could likely improve as the addition of Apple as a customer begins to show up in the company's income statements.
  • OmniVision Technologies (OVTI): Shares of OmniVision have been on quite a ride in the past year, which serves as proof of what happens when a company loses a supplier position in one of Apple's iDevices. The shares have dropped over 36% in the past year, due in large part to the fact that Omnivision lost out on the image sensor spot in the iPhone 4S to Sony (SNE). Since then, there has been intense speculation as to whether or not Omnivision will remain in Apple's other devices. The teardown of the new iPad reveals that OmniVision has won the primary image sensor contract. In addition, OmniVision is also supplying the secondary image sensor on the new iPad's front camera. OmniVision has $314.25 million in net cash on the balance sheet, which works out to $5.59 per share in cash. The current Reuters average price target on shares of OmniVision is $19.29, which represents upside of 2.17% at current levels. The fact that OmniVision trades this close to the consensus price target can be interpreted as a sign of the Street's lingering skepticism about OmniVision's future as an Apple supplier. We recommend that investors evaluate their interpretation of OmniVision's place in the Apple ecosystem before they decide whether or not to invest in the company.
  • We should note that there are 4 other companies that have a presence in the iPad: TriQuint (TQNT), Toshiba, Elpida, and Texas Instruments (TXN). However, we do not think these are companies worth investing in based on the iPad alone. TriQuint has a spotty track record of maintaining profitability. In a year when almost every semiconductor company posted record profits, TriQuint's profits plunged from $1.17 per share in 2010 to $0.27 in fiscal 2011. We do not have enough confidence in TriQuint's financial position at this time. However, we will monitor the company's results in the quarters to come to see if it has steadied itself.

    Toshiba's flash memory is in the iPad, but we do not see the company as one to invest in because of the iPad for several reasons. First, Toshiba is a difficult stock to invest in for American investors, given that its ADRs trade on the Pink Sheets. Secondly, while Toshiba's electronics business is larger, it is but one of the many operating divisions of Toshiba, and it will be difficult for sales of the iPad alone to meaningfully boost Toshiba's bottom line. Third, Toshiba's profits are influenced by the yen, which, while lower than its post-war highs, is still presenting challenges for Toshiba and other major Japanese corporations.

    Elpida's RAM is present in the new iPad, but the company is in bankruptcy. It also suffers from the same foreign exchange pressures that other Japanese companies face.

    While we think that Texas Instruments is a fine company and a good long-term investment, the reason we do not highlight it as an iPad investment is because wireless & mobile chip sales account for just 18% of its overall revenue, whereas Broadcom (Texas Instruments' most direct competitor) generates 47% of its revenue from its wireless & mobile business. As such, we do not think the iPad will make a meaningful contribution to Texas Instruments' bottom line at this point in time.

    Conclusion

    While Apple may be the most obvious way to profit from growing iPad sales, it is certainly not the only way. The record profits reported by the companies we mentioned demonstrate that Apple does have a real and material impact on their bottom lines. When Apple prospers, these companies do as well. And we believe that as iPad sales (to say nothing of iPhone sales) increase over time, the profits and stock prices of the 7 companies we highlighted will rise in tandem.

    Disclosure: I am long AAPL, QCOM, BRCM, INTC.

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