One chip supplier that depends heavily on Apple (AAPL 0.64%) is Cirrus Logic (CRUS -0.26%), which produces key audio chips, known as codecs, found in the former's iPhone, Mac, and other product lines.
There had been reports and speculation that Apple would tap Cirrus Logic for a specialized chip to perform noise-cancellation functions for the former's second-generation AirPods wireless earbuds. However, as Craig-Hallum's analysts observe, citing teardown reports from iFixit, the codec inside of the latest AirPods -- marked as the Apple 338S00420 -- looks similar to the Maxim Integrated Products (MXIM) 98730EWJ audio codec found inside of the first-generation AirPods.
Image source: Apple.
This, the analysts conclude, means Cirrus Logic didn't win the spot after all. Moreover, the analysts claim that Cirrus Logic stock had risen significantly year to date because investors thought Cirrus Logic would win the second-generation AirPods codec spot.
Here's why this probably isn't as big of a deal as the analysts with Craig-Hallum seem to think it is.
Rewinding back
About a year ago, analyst Christopher Rolland published a research note in which he indicated that Cirrus Logic had, in fact, won the spot inside of the next-generation AirPods. The impact to Apple's financial performance, he estimated, would be a $50 million bump in revenue and a far more significant $0.50 boost to the company's earnings per share (EPS).
The reality is that Cirrus Logic would probably have been better off if it were supplying the codec into Apple's latest AirPods, but I don't think the business would have been large enough to make this a game-changer.
Diving into the numbers
Right now, Cirrus Logic's main issue is that Apple's iPhone shipments are clearly falling short of expectations, which is putting significant pressure on the company's revenue. Indeed, analysts project that for this year, the company is going to suffer a 24% drop in revenue and about a 44.3% plunge in EPS.
Let's take a more quantitative look at what's going on here. Right now, analysts expect Cirrus Logic's revenue to drop by $390 million. Suppose this is entirely due to the decline in iPhone-related revenue, and further suppose this revenue carries a gross margin of 50%. This means the drop in gross profit as a result of the iPhone drop should be in the ballpark of $185 million.
Now, let's further suppose that Cirrus Logic winning the AirPods codec spot meant $50 million in incremental revenue at well above-average gross margin -- let's call it 60% for the sake of argument. The total gross profit contribution from the AirPods win would have contributed about $30 million in gross profit, or just over 16% of the gross profit that Cirrus Logic stands to lose this year as a result of iPhone sales declines.
While I'd hardly call a 16% offset a "drop in the bucket," what I can conclude is that the main driver of Cirrus Logic stock isn't going to be whether it wins or doesn't win a spot in the AirPods. Cirrus Logic's business is still fundamentally dependent on the success of Apple's iPhone, so if iPhone sales rebound sharply, Cirrus Logic's business stands to benefit.
Investor takeaway
Over the long term, Cirrus Logic is trying to diversify its business by trying to supply audio codecs into mid-range smartphones from non-Apple vendors, and by increasing its dollar content in smartphones through things like its voice biometrics chips. It's also trying to expand into smart-home applications, and of course, the company is quite bullish about the market for smart accessories, which includes devices like Apple's AirPods.
Cirrus' ability to gain traction in these areas beyond Apple's iPhone will be an important part of its long-term growth story, but frankly, I don't think the company not winning a spot in this year's AirPods (remember that Apple will surely release many iterations of the product in the coming years) is necessarily a reason to change one's investment thesis on the stock.
