Has This Apple Inc Supplier Just Shot Itself in the Foot?

At first sight, Cirrus Logic (NASDAQ: CRUS  ) looks like a can't miss investment. It trades at just 13.6 times last year's earnings, and derives around 80%-90% of its revenue from Apple (NASDAQ: AAPL  ) . In addition, the company impressed the Street with its fourth-quarter results last month, trumping the analyst estimates by $0.09 per share. Also, Cirrus' outlook was strong. 

Recent news focuses on Cirrus acquiring U.K.-based microchip maker Wolfson Microelectronics for a sizable $489 million to bolster its audio division. This decision must have gone down well with investors as Cirrus was being blamed for being too reliant on Apple and this acquisition would probably help it add Samsung to its client list. In fact, Cirrus was so eager (think desperate) to diversify its revenue base that it's paying a premium of 75% for Wolfson.

A very risky bet
Now, Cirrus will need to borrow money to close the deal since it has just under $300 million in cash. The news is that Cirrus will borrow $225 million, and then use its cash to fund this new purchase. The downside is it will muddy up its balance sheet. Till now, Cirrus has been a debt-free and cash-rich company, but this days are over.

Moreover, there's no guarantee that the Wolfson purchase would bring much to Cirrus in the long run. Of course, the acquisition will be accretive to earnings immediately after the deal closes, and Cirrus will finally have access to Samsung. However, it looks like Cirrus paid too much for a company that is in the decline.

According to the Financial Times, Wolfson had a market capitalization of 630 million British Pounds back in 2006 when it used to supply audio components for Apple's iPod. Before the acquisition was announced, Wolfson's market cap was just 160 million British Pounds. Further, Wolfson's revenue in its last-reported quarter, that ended on March 30, was $29 million, a sharp decline from the $48 million in revenue that it reported last year. 

Of course, Wolfson is a supplier to Samsung and its chips are present in the Galaxy S5, but why would revenue fall year over year? Well, Wolfson management cites the "faster-than-anticipated transition from 3G to 4G (LTE) smartphones" as the reason behind its downfall, and expects its relationship with vendors in China to lead to improvements in the future. So, effectively, it seems that the relationship with Samsung didn't work for Wolfson in the previous quarter.

There might be some respite as Wolfson gains traction in the Chinese market, but Cirrus paid way too much for a company that just saw a big drop in revenue, is trying to make a comeback, and appears to be past its prime.

Even Cirrus is past its prime
While the estimate-beating results and strong outlook look good, digging deeper into the company's financials will reveal some concerns. Its revenue was down almost 28% year over year, while earnings were halved from $26.4 million to $12.6 million. 

Fool contributor Adam Levy says that Cirrus improved its margins 8.6 percentage points from the year-ago period, probably driven by an improvement in Apple's product mix. Apple's iPhone sales were better than expected last quarter, while lower than expected iPad sales didn't affect Cirrus since it had lost an amplifier spot in the tablet to Maxim Integrated Products.

However, it should be noted that Apple's revenue in the last quarter was up year over year, while Cirrus' crashed comprehensively. Also, Apple's iPhone sales came in at 43.7 million units in the second quarter, up from 37.4 million last year. Thus, it doesn't make much sense to compare the financial performance of the two companies. Apple might be paying less to Cirrus for its solutions than it has in the past, and an increase in iPhone shipments won't necessarily mean an increase in revenue for Cirrus.

Apple's product refresh, which might include bigger iPhones, could provide some relief for Cirrus. However, an increase in iPhone sales wasn't enough to boost Cirrus' financial performance last time: So why should it be counted on this time?

Stay away
Ultimately, the Wolfson acquisition might not bring much to Cirrus Logic. According to Fool analyst Evan Niu, Apple's contribution to Cirrus' top line will still be a huge 70% after the acquisition. Further, Cirrus isn't making any progress in its operation. Its revenue and earnings are taking a solid beating, despite an increase in iPhone sales. As such, it would be wise to stay away from this stock until it shows the ability to grow its core business.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 19, 2014, at 11:29 AM, melegross wrote:

    I'm not so certain that Cirrus chips are so unique that Apple couldn't move away from them if Cirrus looks to be weakening too much. No manufacturer wants to be constrained by a manufacture they can't count on in the future. Design work takes a year, or more, for the more complex, and successful designs. And

    Cook, along with his successor, Williams, are experts in supply line management.

    Is Apple already looking beyond Cirrus? Possibly, as Cirrus is lower in the product mix now than they were before. If Apple drops them, they may not survive, particularly with this new debt.

  • Report this Comment On May 19, 2014, at 2:13 PM, deemery wrote:

    Seems to me any chip company looking to depend on Samsung for long-term business is taking a huge risk. Samsung's great strength is vertical integration, they're much more likely to grow this capability internally and then toss some outside suppler as quickly as possible. (And that's before taking any consideration of Samsung's business ethics.)

  • Report this Comment On May 19, 2014, at 8:11 PM, TSaxon wrote:

    "Till now, Cirrus has been a debt-free and cash-rich company, but this days are over."

    Are your proofreaders on strike?

  • Report this Comment On May 20, 2014, at 12:01 PM, dgalbers wrote:

    The amount of debt CRUS took on to purchase Wolfson is close to insignificant.

    The real question is why did CRUS buy Wolfson at all?

    Apple and CRUS are working on projects for products 3 to 5 years down the road NOT for the Sep 2014 release of iPhone 6.

    So why did CRUS CEO J. Rhodes buy Wolfson?

    J. Rhodes has said in the past that the cash wasn't burning a hole in his pocket and that CRUS would only consider a purchase that made sense.

    So what products might Wolfson be working on that CRUS would want or need?

    Just for Samsung? I doubt it.

    Just because CRUS lost a slot to MXIM does NOT mean that CRUS isn't working hard to either recapture that slot or is moving on to something bigger and better.

    J. Rhodes has stated that the AAPL relationship is much more complex than people realize. So if AAPL likes CRUS, and every indication is that it does, why wouldn't AAPL toss CRUS a bone by having CRUS work on AAPL's next blockbuster project?

    There is all this talk about tightly coupled business partnerships. Now that CRUS and AAPL have such a relationship all the pundits are busy either denying it exists or trying to toss it on the ash heap.

    Perhaps, just perhaps, AAPL and CRUS are collaborating on something that no one knows about. I am more willing to believe that NO pundit really knows what is going on behind the doors at AAPL. So what can the pundits really say or accurately forecast?

  • Report this Comment On May 21, 2014, at 12:09 AM, tomtk wrote:

    The margin improvement was completely artificial as I explained in my reply to Levy's article, "You can't compare the margin this quarter to the year-ago quarter, because the latter's low margin was due to a one-time inventory reserve as explained in the shareholder newsletter. Margins have typically been 48-52%. Long term, they keep projecting mid-40's margins. Perhaps more significantly, look at how revenues have decreased over the last year even as Apple has shipped more product, which suggests Apple has been squeezing them on ASPs."

    You mentioned Wolfson being in Samsung's S5, but apparently that's limited to the Exynos version. According to iFixit, the Qualcomm versions use:

    Galaxy S4 = Qualcomm WCD9310

    Galaxy S5 = Qualcomm WCD9320

    The HTC One M8 is using the WCD9320, which iFixit didn't identify, but you can see it in the huge Step 9 photo partially hidden under some metal framework. The original HTC One used the WCD9310, which again iFixit didn't identify, but you can find it in the Step 10 photo in their teardown. Just googling those part numbers, Anandtech says the Nexus 4 used the 9310, and the LG G2 flagship used the 9320. So Qualcomm seems to be pretty popular these days.

    As for Apple and Cirrus, Cirrus described their relationship in the Jan 2014 shareholder newsletter as "outstanding with design activity ongoing" whereas the prior three newsletters (and possibly more, but three is all I have) described it as "outstanding and new design activity is robust". The Apr 2014 newsletter repeated the new language. To me, the old language sounded better, and I figure they changed it for a reason.

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