Apple (NASDAQ:AAPL) supplier Cirrus Logic (NASDAQ:CRUS) looked all set to take advantage of the iPhone maker's foray into 5G, but recent rumors have cast a shadow of uncertainty over Cirrus' ability to benefit from the expected rollout of 5G iPhones this year. There are reports that Apple may not provide EarPods in the box along with its next iPhone and that could be bad news for Cirrus, as it gets around 75% of its revenue from selling audio chips to Apple, which uses those chips in EarPods, iPhones, AirPods, and headphone dongles.
However, the chipmaker has been in a similar sticky spot before. Apple decided a couple of years ago to ditch the free lightning-to-3.5mm adapter that it used to include with each iPhone, hurting Cirrus' prospects. But the company turned around impressively after that setback thanks to new content gains. Will a similar story unfold this time?
Cirrus Logic investors may have reasons to worry
A 2016 teardown of Apple's Lightning EarPods revealed the presence of Cirrus Logic's audio codecs and amplifiers. That year, Pacific Crest Securities said it expected Cirrus to gain an additional $2.50 worth of content thanks to the lightning EarPods, the adapter, and a stereo speaker. The chipmaker was reportedly getting $1 worth of content from the lightning-to-3.5mm adapter, according to a Barclays estimate.
So it wasn't surprising to see Cirrus' top line move south in 2018 and the first half of 2019 -- when Apple changed its offering -- before things started getting back on track.
Such a situation could rear its ugly head once again if Apple decides to remove the EarPods from the iPhone packaging, as the rumor mill suggests. Assuming Cirrus gets $1 worth of revenue from supplying chips for the EarPods, it could lose close to $200 million in revenue, as Apple shipped 191 million iPhone units last year.
Cirrus has generated close to $1.3 billion in revenue over the past 12 months, so the company's top line could take a hit in the double digits if the rumors are true and the $1 figure accurate. There's no doubt that such a move by Apple could hurt Cirrus' recent momentum, but there are a couple of reasons why investors shouldn't worry much at this point.
Why the fears may be overblown
Apple is reportedly on track to launch four iPhone models this year. While it might make sense for the company to cut costs and lower the price point of the entry-level iPhone to increase its accessibility, new users entering the Apple ecosystem could be put off by an absence of accessories. And it might not be a good idea to skimp on EarPods and a charging adapter for models priced at $1,000 or higher, as premium buyers will probably expect those accessories.
As such, Cirrus investors shouldn't be panicking right now, and the rumors should be taken with a grain of salt. And Apple has already broadened its product lineup with the addition of the affordable iPhone SE. Third-party estimates suggest that this device is selling well, and accounted for nearly a quarter of Apple's sales in China in April, where it sold 3.9 million devices during the month. Counterpoint Research estimates that the iPhone SE was the driving force for Apple's shipments in the second quarter of 2020. This device comes bundled with earphones, and could drive additional revenue for Cirrus Logic, as Cowen estimates that the device's production could increase from 6 million units in the second quarter to 8 million units in the third quarter. For the full year, Cowen estimates 25 million iPhone SE builds.
So the iPhone SE could provide Cirrus with a cushion in case Apple excludes the EarPods on certain models.
Cirrus Logic investors will get a clearer picture when the company releases its fiscal first-quarter results on Aug. 3. Wall Street analysts have low expectations, predicting a year-over-year revenue decrease.
If Cirrus Logic surpasses expectations and delivers solid forward-looking guidance, one could assume that the rumors about Apple ditching the EarPods may just be rumors after all. Or Cirrus may have gained content elsewhere to offset that loss.
In that case, it would be a good idea for investors to stick with Cirrus Logic stock, as it could turn out to be a top 5G play.