For many years, Dialog Semiconductor (NASDAQOTH:DLGNF) has produced the power management integrated circuit (PMIC) chips for Apple's (NASDAQ:AAPL) popular iPhones. The business relationship has been lucrative for Dialog Semiconductor and its stockholders, driving the shares up immensely over the last decade.

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DLGNF data by YCharts.

However, for quite a while now, rumors have swirled that plans were in the works for an Apple-designed PMIC that would be used in at least some future iPhones. Evidence on Apple's website indicated that it was, in fact, aiming to build those components in house.

Phil Schiller describing the A11 Bionic chip on stage

Apple is increasingly designing its own silicon. Image source: Apple.

And now, this huge risk for Dialog Semiconductor -- which earned 77% of its fiscal 2017 revenue from sales to Apple during its fiscal 2017 -- is apparently materializing.

Dual sourcing ... for now

On May 31, Dialog Semiconductor posted a business update on its investor relations website in which it said that it "has been provided with a reduced share of the volume forecast from Apple for the main Power Management IC (PMIC) for the 2018 smartphone platform."

The company made sure to highlight that its "projected volume for the sub-PMIC in the 2018 smartphone platform and all other PMICs including those for tablets, wearables, notebooks, remains unchanged."

Dialog also made it clear that this reduced projected order volume isn't due to, say, Apple cutting its own volume shipment predictions dramatically, but instead due to a "dual sourcing" arrangement. Dialog didn't explicitly name the second PMIC source, but it's widely believed to be an in-house Apple design. 

Financial impact

The company said in its investor update that it expects Apple's in-sourcing move to reduce Dialog's fiscal 2018 revenue by about 5%.

At first glance, that doesn't sound so bad, right? Unfortunately, this is only the tip of the iceberg. To start with, while Apple has only reduced its orders to Dialog Semiconductor by 30% for this product cycle, it's quite possible that as it gains expertise and confidence in building PMICs, it'll increasingly rely more on its own components and less on Dialog's. Over time, Dialog could see its PMIC sales for iPhones drop to zero. 

Additionally, since Apple seems to have long-term aspirations to bring technologies in-house, there's no guarantee that it will keep sourcing all of the sub-PMICs required for its iPhones and other products from Dialog -- Apple could certainly start building its own sub-PMICs too.

The reality is that the bulk of Dialog Semiconductor's revenue base is at severe risk from Apple's vertical integration efforts, and that this risk will only become greater over time as Apple's internal component-manufacturing teams gain experience and confidence. This is not a drill. 

Investing takeaway

At this point, I think that Dialog Semiconductor's fate is very likely to be similar to that of Imagination Technologies, which was forced to sell itself after Apple signaled it would stop licensing the company's graphics processors and switch to in-house technologies. Dialog Semiconductor might spend a while thinking that it can defend its position within Apple's products, and management may start talking more aggressively about its customer diversification efforts, but I ultimately don't think it'll be enough.

If you're a speculative investor, you might be interested in buying the shares now in the hopes that management is working frantically to find a buyer for the company. That strategy might work out, but if I were a potential acquirer, I'd wait to scoop Dialog Semiconductor until it's in a position of total weakness so I could get a better deal. 

So, for now, I'm staying far away from the shares. This isn't the kind of drama that I want to get involved in.

Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.