Shares of Synaptics (NASDAQ:SYNA) soared after hours on news that it agreed to acquire Renesas SP Drivers on Tuesday. The acquisition also comes with a raise on fourth-quarter revenue guidance from management to $300 million-$310 million, where analysts previously expected $282 million, on average.
While many are focusing on the potential for Synaptics to win new designs with Apple (NASDAQ:AAPL), the deal also increases the potential for Synaptics to gain share in entry-level and mid-range markets, which competitor Cypress Semiconductor (NASDAQ:CY) has been attacking aggressively, integrating Renesas SP technology with its own.
A fantastic price for a fantastic company
Renesas is the market leader in display driver integrated circuits, or DDICs. Over the last 12 months, the company generated $650 million in revenue and cash flow of $100 million.
Synaptics will pay $475 million for the company, with $300 million financed through debt. This is outstanding valuation for a company, which Synaptics thinks it can grow even further. $475 million represents just 0.73 times sales over the trailing twelve months, and it's 4.75 times cash flow. Comparatively, Synaptics traded for 2.78 times sales prior to the acquisition announcement.
Additionally, Renesas SP's margins are strong. Although its gross margin is in the low-30s, it makes up for that with strong operating profits. Synaptics recorded gross margin of 45.2% last quarter, but operating margins have declined, going red last quarter. Management believes the acquisition will provide operating efficiencies that will improve operating margin.
Winning back Apple?
Synaptics used to supply the click wheel on Apple's iPods, but that relationship ended when Apple introduced the iPod Touch. With the Touch, Apple moved its touch technology internally, but the iPod maker still relies on panel suppliers to use Renesas SP display driver chips.
The opportunity at Apple is undoubtedly huge. The iPhone maker is expected to ship about 180 million units of its smartphone in fiscal 2014. With every unit going to Renesas SP, and the ASP between $1-$2, according to Synaptics CEO, Rick Bergman, that's a significant addition the company's revenue.
Whether Synaptics can win new designs at Apple, however, remains questionable. As Bergman said in a news conference after announcing the acquisition, "Our better opportunities are really complementary technologies to what they do internally." Apple already moved touch internally, along with fingerprint scanning as well.
To be sure, the addition of Apple as a customer through Renesas is a great development for Synaptics. The real opportunity, however, is for Synaptics to accelerate its integration of driver chips with its touch screens.
Benefitting entry-level customers
Synaptics has done an excellent job of attracting high-end device makers with its touchscreen solutions, but it has typically been priced out of the low-end and mid-range units, where cost is of greater priority than performance.
Competitor Cypress Semiconductor has decidedly gone after Chinese chipmakers, which are able to produce very low-cost chips. Cypress' strategy is to simply out-engineer the competition by devising low-cost solutions that offer equal or better performance at lower prices. Last quarter, Cypress saw a bit of weakness in Asia, where low-end smartphones dominate, but management expects to bounce back in the region this quarter.
Synaptics sees a better way to attract value-conscious OEMs. The company is working to integrate its touchscreens with display drivers to produce a single product -- touch-and-display driver integration, or TDDI. On the conference call following the acquisition, Bergman pointed out that TDDI offers better performance, lower component count, and supply chain simplification.
As a result of the integration, Synaptics may be able to attract OEMs in the low-to-mid-range market and help them reduce overall costs. This approach ought to alleviate margin pressure, compared to competing on price. Meanwhile, Cypress has seen its gross margin decline over the last few years, but that's not entirely tied to price competition in Asia.
Expanding the market
With the acquisition, Synaptics estimates that it immediately expands its addressable market by 50% to $4.5 billion. With the integration of Renesas SP driver chips and Synaptics touchscreens to create TDDI, Synaptics can capture a larger part of the market. Additionally, Synaptics' relationships with companies outside of Renesas SP's current customers will help grow the display driver business further.
In the long run, the Renesas SP acquisition will help Synaptics integrate its fingerprint-scanning technology into the touch display. This could lead to yet another round of excellent growth at the company.
Adam Levy owns shares of Apple. The Motley Fool recommends Apple and Cypress Semiconductor. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.