WOLFSON MICROELECTRONICS (WLF)

Analysts at investment bank Dresdner Kleinwort now estimate that around 70 per cent of Samsung's and LG's phones also contain Wolfson’s audio codec chip design. That's because these Korean manufacturers, like other mobile handset makers, are pushing harder into music phones to head off the threat from Apple’s iPhone. Wolfson's new chief executive, Dave Shrigley, is therefore confident that Wolfson can win a new handset customer this year. The battered Motorola, which desperately needs a new hit phone, may present an opportunity. So, too, could its rivals, such as Nokia or Sony Ericsson. And Wolfson’s designs are almost certainly in the iPhone, too, so the company wins either way.

A nice new contract would certainly balance the risk of a profit warning driven by problems within the semi-conductor industry. These have been caused by the global backlog in consumer electronics, and have given technology investors a hair-raising few months of late. It seems the industry’s transition to a 'just-in-time' supply chain and better stock control has made demand more volatile. So in this respect, even with a broadening portfolio, Wolfson is cursed as well as blessed by its strength in consumer audio products.

Backing the wrong horse in the games market hasn’t helped. Wolfson supplies the chips for Sony's PlayStation Portable, which hasn’t sold half as well as Nintendo’s rival product. Still, industry whispers of a new version of Sony’s product could yet boost this division.

It's not a major problem, either. Games and older products, such as DVD players, may be performing poorly, but they now make up a smaller proportion of revenues. So Wolfson’s first-quarter results in April – accompanied by confident noises from Mr Shrigley – were well received. A 16 per cent increase in multimedia mobile handset revenues on the previous quarter was particularly impressive against the overall handset market’s decline of over 12 per cent. At the same time, inventories were down around 10 per cent and the gross profit margin held up well enough, although cost increases ate into operating profits. It didn't help that most of Wolfson’s engineering costs were paid in pounds while its revenues were in dollars, nor that some wages were paid in shares (which affected profits but not cash flow).

So, one of Mr Shrigley’s first tasks is to cut the company's management costs, which may involve moving more operations to Munich - it's easier to find new engineers there than in Edinburgh. He also believes he can achieve revenue growth in 2007 through careful focus on certain customers, despite first-quarter revenues falling 12.5 per cent year-on-year. “A lot of effort was put into design wins that can generate revenue later in the year,” he explains. The release of new combined audio and power-management chips in the fourth quarter should help. These offer higher average selling prices, which could offset the normal erosion of microchip prices.

Of course, Wolfson is still a risky bet in some ways. A new iPod range might move to higher-quality audio than Wolfson can provide, for instance. Revenues from other consumer electronics can be unpredictable, too. However, with the semiconductor cycle accelerating this year, Wolfson’s shares should continue their steady recovery. What's more, winning a new handset customer could have a big effect on the group's share price. Trading on 15 times forecast earnings for 2008, though, Wolfson's shares seem to price in only the risks. Buy.

BULL POINTS

• A big winner from iPods and music-playing mobiles

• Major new handset customer expected this year

• New management streamlining

• Reassuring first-quarter results

BEAR POINTS

• Games console chips performing poorly

• Volatile demand for microcips