For the last decade Imagination Technologies (IMG) has enjoyed a comfortable revenue stream from licensing the intellectual property of its PowerVR graphic hardware to Apple (US: AAPL). But that relationship is soon to come to an end. The US tech giant has announced that it has developed an alternative to the PowerVR for use in future generations of its phones and tablets and, within 24 months, will cease to license Imagination’s technology. This news wiped nearly £500m off Imagination’s market capitalisation this week as shares crashed more than 60 per cent in one day.
That share price reaction is testament to Imagination’s reliance on its Apple contract. Although management have always refused to disclose the exact proportion of revenue from Apple – in itself a bit of a concern – it is expected to be about half. A worrying line from the group’s 2016 annual report reads, “there are no parties with whom the group has contractual or other arrangements which are essential, except the contract with Apple”. But management has been diversifying its customer base through investment in its two other products; connectivity solution, Ensigma and general process processing product, MIPS.
So what now for Imagination?
It would appear the group is not going down without a fight. Management do not think that Apple will be able to develop its own graphic processors without infringing Imagination’s IP and are considering challenging this in court. Broker Numis agrees and thinks the “near impossible” task of replicating the PowerVR without infringing its patent leaves Imagination in a strong position.
However, if Apple has not sidestepped Imagination’s patent, why has it announced the termination of its contract? Broker Jefferies lays out three scenarios. First, the US tech giant is bargaining for a lower royalty rate. Second, Apple has made a mistake in the development of its own tech. Or third, it has attempted to wallop Imagination’s valuation with a view to making a takeover offer at a later date. But, in reality, all three of these suggestions are highly unlikely and Jefferies thinks the future for Imagination will in-fact see Apple revenues dwindle to just those earned on old models of the iPhone or iPad.
True, if Imagination sues (surely the epitome of a David and Goliath battle) it could enjoy a nice one off payment from Apple. But even then, it will still be without its “essential” source of revenue. Then there’s the issue of debt. Just 10 months ago Imagination was forced to pay a one-off fee to its credit supplier HSBC after it breached its banking covenants. Without Apple revenue, Imagination is sure to move back into a loss making position, which puts its lending contract in even greater danger.
