A High-Octane Apple Play

Cirrus Logic (CRUS 1.18%) is a fabless mixed-signal IC vendor whose primary claim to fame is that it supplies components like audio CODEC and power amplifier chips to Apple (AAPL 0.52%). For a long time, Cirrus Logic's stock price tended to track Apple's pretty closely -- at least when things were going exceptionally well for the Cupertino giant. When things started to get rough for Apple, Cirrus shares cratered and are still well more than 50% off their all-time highs. Apple, in contrast, is only 22% down from its all-time high. The question now is whether Cirrus shares are set to perk up and catch up to Apple, or if that "relationship" is finished?

Let's be honest, Apple holds all of the cards
A significant percentage -- some estimate more than 80%) -- of Cirrus's revenue base is tied to Apple. That means if Apple decides to take its ball and go home -- something Apple can very well do --  Cirrus Logic would trade at a fraction of what it does today. This is something that management works feverishly to avoid by catering to Apple's every whim and making sure those CODECs are superb. But, at the same time, this does mean that Apple can pressure Cirrus's gross margins.

Is it likely that Apple ditches Cirrus for the high-profile CODEC chips? Probably not. Losing that contract would just about kill Cirrus's business. However, Cirrus also provides audio amplifiers for Apple's iPhone and iPad lines. One of the recent big scares, though, was when it was revealed that Cirrus had actually lost the audio amplifier socket in the iPad Air to competitor Maxim Integrated Products (MXIM). Despite a solid quarter and guidance, the market was still spooked enough to send Cirrus back into the $19s -- just a few dollars away from its 52-week low.

What will change sentiment?
Cirrus has been diversifying its business beyond Apple and even beyond the smartphone/tablet audio CODEC chip market by trying to go after things like LED controllers, a highly fragmented market with many players. With that in mind, Cirrus has also sought to win more smartphone/tablet sockets at other vendors -- although given its concentration at Apple, these sales aren't anywhere close to "de-risking" Cirrus' business to warrant a higher multiple.

Further, a look at analyst estimates shows that there's a lot of uncertainty going into the next fiscal year. Revenue estimates vary wildly from $694 million to $860 million and earnings-per-share estimates see a similarly broad range, from $1.42 to $2.45.

If the company starts its fiscal year ending in March 2015 with a bang, then the estimates are likely to come up, and the shares will trade higher. If the next fiscal year starts off weak, then the estimates will trend toward the low end of the range. At $19.59 per share as of the Dec. 13 close, it seems that the market is willing to pay just under 11 times the consensus EPS estimate of $1.80 for the year ending in March 2015.

The risk/reward
While this is just a decent guess, it looks like Cirrus' share price has a good shot of essentially being 11 times what the most likely fiscal 2015 numbers come out to be. So, if the market thinks Cirrus is going to come in at the high end of this estimate range, then a share price in the $26-$27 range wouldn't be too unreasonable, at 11 times $2.45.

If things start off ugly, then the market will begin to price in the worst, In that case, a share price in the $15-$16 range -- 11 times $1.42 -- would probably be more appropriate. From a risk/reward standpoint, $4 of downside for $7-$8 of upside seems pretty good.

However, the game is further rigged in favor of a long position because it's very likely that Apple will have a great year in 2014. As a result, it's probable that the numbers will be at the higher end of the range than the lower. I any evidence that Apple won't design Cirrus out of any additional sockets starts to surface -- think iPhone 6 and iPad Air 2 tear-downs -- then the shares could also be rewarded a meaningfully higher multiple.

Foolish bottom line
Cirrus isn't for everyone. It's a higher-risk, higher-reward play on Apple. Just buying and holding shares of Apple is probably the safer way to play Apple's success and is likely more appropriate for most investors. But there's the allure of Cirrus potentially knocking it out of the park, particularly on the diversification front, that makes it worth the added risk for some, including this Fool.