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InvenSense Inc.'s Risky Reliance on Apple Inc.

By Ashraf Eassa - Nov 8, 2016 at 10:00AM

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This chip company generated more than half of its revenue from Apple last quarter. Here's why that could be a problem.

Motion sensor specialist InvenSense (INVN) told investors on its Nov. 3 earnings call that during its most recent quarter, 58% of its revenue came from its largest customer. That customer is believed to be none other than Apple (AAPL 0.17%).

InvenSense is highly dependent on Apple's iPhone. Image source: Apple. 

Although InvenSense certainly benefits from having Apple as a major customer, there are significant risks associated with being so dependent on a single customer. Let's go over a big one. 

Partial or total Apple share loss

Although InvenSense has won motion sensor spots inside multiple generations of iPhones, investors shouldn't dismiss the possibility that one of the two following scenarios could coming to pass:

  1. Apple decides to second-source the accelerometer and gyroscope chips in a future iPhone, dramatically reducing its potential revenue from iPhone sales.
  2. Apple completely designs InvenSense out of a future iPhone, putting InvenSense's Apple-related revenue trajectory on the path to $0.

Both scenarios would be catastrophic to InvenSense's business, with the latter potentially putting the company on the path to insolvency.

Let's take a closer look at each of these scenarios individually.

What a partial Apple share loss would mean for InvenSense

Last quarter, InvenSense reported $79.8 million in revenue, with roughly $46.3 million of that figure from Apple. It also tallied gross profit of $33.53 million and operating expenses of $43 million, for an operating loss of $9.48 million.

What happens if InvenSense is forced to split that revenue 50/50 with an alternative supplier? Reworking this quarter's results to factor such a share loss, InvenSense's quarterly revenue would have been just $56.65 million.

Apple's business probably comes at much lower margins than the rest of InvenSense's business, so if we assume InvenSense's gross profit margin increased to around 46% as a result of share loss at Apple, and if we also assume InvenSense's current operating expense run rates hold, that revenue level would have led InvenSense to post an operating loss of $17 million. 

Losses like that aren't sustainable for very long for a company of this size. In that case, the company would have to dramatically scale back its operating cost structure to avoid burning cash too rapidly. 

That would curtail InvenSense's ability to invest in new markets, such as the Internet of Things opportunity that the company's management team appears bullish on.

What a total Apple share loss would mean for InvenSense

Imagine now the scenario in which Apple completely dumps InvenSense. This one is much less likely, assuming InvenSense can continue to execute, but Apple has dumped suppliers wholesale in the past. It did so with Samsung (NASDAQOTH: SSNLF) and its A-series chip manufacturing, PortalPlayer in the iPod, and Infineon in older iPhones.

Investors also shouldn't forget that InvenSense was designed out of the Samsung Galaxy S7, even though it had successfully secured spots in Samsung's flagships in the past. 

If InvenSense's Apple-related revenue simply vanished in its most recent quarter, then the motion-processor specialist would have reported just $33.5 million in revenue. Even at a 50% gross profit margin, that level of revenue -- again, assuming constant operating expenses -- would have had InvenSense losing approximately $26 million.

In this case, just as in the case of partial share loss, InvenSense would need to open some large, alternative revenue streams quickly or be forced to rapidly slash operating expenses. The cuts in this scenario would probably need to be significantly larger than they'd need to be in the partial-share-loss situation.

In either case, though, InvenSense's future would look much bleaker.

Should management sell the company now? 

The problem with InvenSense is that even with a lot of revenue coming from its win at Apple, it's still not able to consistently generate a healthy operating profit. The company's operating expense structure is quite high, and it's not clear when InvenSense's significant investments in the future will begin to pay off.

Management said on its most recent earnings call that it expects a return to "healthy year-over-year growth in fiscal 2018, driven by several market trends and new design wins in progress," but I'm going to be cautious about taking management's optimism at face value.

Indeed, Reuters recently reported that InvenSense is "exploring strategic alternatives, including a possible sale."

If InvenSense's management and board of directors were so optimistic about the company's future, why would they be looking to sell the company? More importantly, why would they be looking to do it when InvenSense shares trade for less than they did when the company first went public?

There may be some upside to InvenSense stock from here if the company is successful in finding a buyer, but that's far from guaranteed. Reuters, for one, says "there is no certainty that the sale process will result in any deal." The business just seems too risky at this point for me to buy the stock. 

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