Microchip companies have ridden high on global demand for smartphones, tablets and other electronic devices in recent years. But as established markets have slowed, the likes of Arm (ARM), Imagination Technologies (IMG) and CSR (CSR) are seeking out growth in nascent areas such as connected vehicles, smart homes and wearable devices, while rivals are seeking growth and safety in acquisitions.
A number are gaining exposure to the 'Internet of Things' space through acquisitions. For example, Infineon Technologies (Gr: IFX) recently bought another specialist in power semiconductors, International Rectifier, while Cirrus Logic (US: CRUS) completed its purchase of Scottish chipmaker Wolfson Microelectronics last month. Others have been less successful. Wireless connectivity and audio specialist CSR recently turned down a buyout offer from Microchip Technology (US: MCHP), while power-management chip specialist Dialog Semiconductor (GE: DLG) failed to agree a merger with sensor expert ams (SWI: AMS.S).
Industry dealmaking has been fuelled by low interest rates, reasonable valuations and a positive environment. Moreover, chipmakers increasingly need a broad product suite to cater to complex devices that demand power, visual, audio and connectivity components. Tie-ups also offer more than just diversification - parties can combine their customer bases, lower costs by boosting production volumes and use their larger size to negotiate larger discounts with suppliers.
Microchip companies may also be wary of overreliance on particular customers. For example, Dialog, Cirrus and Imagination derive around 80, 73 and 30 per cent of their respective revenues from Apple (AAPL). Apparently part of Wolfson's appeal to Cirrus was that, after being dropped as an iPhone supplier in 2008, it has substituted several manufacturers for Apple.
Of course, being one of the Californian giant's favoured suppliers is no bad thing. Apple's offerings are notoriously 'sticky', meaning customers rarely leave its product and service ecosystem once they join it. Moreover, the higher-value chips in the upcoming iPhone 6 and Apple Watch should drive up average royalties for Arm, Imagination and others. And the current stream of new devices from LG, Samsung and numerous others should provide a steady tailwind for chipmakers.
The inclusion of Near-Field Communication (NFC) technology in Apple's new devices will undoubtedly benefit Dutch chipmaker NXP Semiconductors (NV: NXPI), which helped create the technology. And if Apple succeeds in popularising biometric sensors and wearable computers, connectivity and sensor specialists such as CSR and ams should benefit.
But the Silicon Valley giant is notoriously fickle with its partners, unceremoniously ditching them if it finds a better deal elsewhere. That effectively limits component-makers' pricing control and depresses their margins. Wolfson isn't the only victim of Apple's whims - audio specialist Audience saw its revenue from Apple plummet from over four-fifths in 2010 to less than 1 per cent after it was excluded from the iPhone 5.
There's more to chipmakers' prospects than their exposure to Apple, though. Only 5 per cent of Arm's revenues stem from Apple, yet it has almost quadrupled its licensing revenues since 2009. That should translate into a rich flow of royalties in three to five years' time once the designs it has licensed out begin to appear in new products.
Chipmakers that are active in the automotive and industrial markets have done well this year, according to broker Numis Securities. That supports our buy advice on Infineon, which earned just over €2bn - 64 per cent of total sales - from those two segments in the nine months to 30 June. Numis also notes growing evidence that the Internet of Things is "real rather than hype" as it continues to boost demand for components such as microcontrollers. Companies that have carved out a presence in that space, such as Arm, Imagination and CSR, should benefit.
