Imagination Technologies Group (IMG) announced yesterday that Apple, it’s largest customer, had notified it that they plan to stop using IMG’s technology in future products. Apple represents more than 50% of IMG’s revenue and the share price promptly fell by 62%.
IMG provides Graphic Processing Units (GPUs) to Apple who have apparently been developing alternative solutions, possibly with the assistance of former IMG employees. IMG suggested that Apple would likely be infringing its patents or other intellectual property so that suggests that legal action may be in prospect. The best headline on this news was undoubtedly in the Daily Telegraph this morning which ran a story leading with “Imagination needed to get chip maker out of this hole”.
Imagination has been one of the leading standard bearers for UK technology so it’s devastating news for shareholders in the company. But was it ever the kind of company to invest in? I will argue that it was not.
Electronic hardware companies are notoriously vulnerable to lumpy profits because their products can be leapfrogged by competitors who invent better or cheaper alternatives. They are particularly at risk if they are “one-product” companies and IMG have been clearly very reliant on the Apple chip, even though their revenues are primarily from licenses rather than actual manufacturing. In reality there is little assured “repeat” revenue and no way they can lock in their customers to ensure future profitability and above average returns on capital. The latter has historically been quite abysmal at IMG.
There are other aspects of the business that should also have put off investors who seem to have been enamoured of the link to Apple. For example, the last half-year results reported “Group returned to profitability” but that was on an EBIT basis alone and ignoring discontinued businesses. There was in reality an overall loss of £10 million including a loss of over £5m on discontinued operations. The last full year results also reported a loss of £40m on revenue of £125m with lots of exceptional provisions and impairments.
Has the company historically generated real profits? In other words cash profits which is what really matters. No it produced negative free cash flow per share in every year since 2013 according to Stockopedia’s financial analysis.
Even after the latest share price fall, and before any change to analysts forecasts the prospective “normalised” p/e is about 17. So this is one “hot” technology stock that will remain too hot for me because it’s the kind of business I have learned to avoid.