In the early innings of the smartphone boom, ARM Holdings (ARMH +0.00%) and Imagination Technologies (NASDAQOTH: IGNMF) saw impressive rises in their respective share prices. ARM's architecture became the standard processor architecture in mobile computing, and Imagination Technologies, a provider of graphics processor designs, saw its PowerVR line of graphics processors integrated across many key mobile designs, most notably the iPhone.
However, while ARM faces very little competition from alternative architectures in smartphones today, Imagination sees meaningful competition in graphics. For example, ARM's Mali GPU designs have become very popular, with ARM claiming that more than 400 million chips implementing Mali were shipped during 2013. This growth has likely been helped by ARM's ability to offer licensees both graphics and processor IP in one package.
Additionally, Qualcomm (QCOM 0.38%), which, according to Strategy Analytics, enjoyed 54% of smartphone applications processor revenue share in 2013, builds its own graphics processors for its Snapdragon line of mobile processors. This means that both ARM and Imagination are locked out of the graphics portion of about half of the smartphone market.
While these market dynamics have proven challenging for Imagination, Apple (AAPL +0.11%) uses Imagination's PowerVR graphics architecture exclusively in the chips that it designs for its iOS devices. As a result, the iPhone 6 launch could be a big deal for Imagination.
Share gains for Apple likely mean share gains for Imagination
Apple generally competes at the high-end of the smartphone market. While ARM estimates that this market is set to grow at a 4% compounded annual growth rate through 2018, Apple could outgrow that through share gains. If Apple gains share at the high-end, Imagination will almost certainly gain mobile graphics processor share.
At the high-end of the market, the smartphone vendors that typically use applications processors from third-party chip vendors, like HTC, LG, and Lenovo, will more often than not use Qualcomm's Snapdragon series of processors.
Even Samsung, which designs and builds its own applications processors, known as Exynos, relies on Qualcomm's Snapdragon processors for phones sold in some regions, such as North America. Additionally, in its own designs, Samsung has increasingly favored ARM's graphics architectures over Imagination's.
For example, the international version of Samsung's recently announced Galaxy Alpha smartphone is powered by an Exynos 5430 system-on-chip, which AnandTech reports uses ARM's Mali T628MP6. All of this means that every additional iPhone that Apple can ship in place of a high-end Android phone should be welcome news to Imagination.
iPhone 6 could mean both unit and royalty upside for Imagination
According to Imagination Technologies' most recent earnings report, it collected royalties on 530 million non-MIPS processors in the full-year period ending on April 30. Apple reported that it had shipped approximately 248 million iPhone, iPad, and iPod devices between its fiscal 2013 third quarter and its fiscal 2014 second quarter -- nearly half of Imagination's non-MIPS unit shipments.
While Apple's iPhone shipment growth due to iPhone 6 is tough to guess at, Apple is probably going to use a higher-end, next-generation PowerVR graphics core in the chip that powers it. This could potentially mean a higher royalty rate per unit, leading to some growth for Imagination, even in the absence of underlying unit growth.
However, while richer mix is nice, unit growth -- which indicates longer-term demand trends -- is even better. If Apple can grow its share of the high-end of the market significantly with a next generation iPhone -- or, as is widely rumored, a pair of them -- Imagination would see the immediate benefits of increased royalty revenue.
Additionally, should Apple gain share, Imagination benefits in one more way. Apple's customer retention rates are quite high -- The Wall Street Journal reported that 76% of iPhone users planned to go with an iPhone for their next upgrade -- so once a user is in the iPhone/iOS ecosystem, he or she is probably going to stick with Apple, and thereby Imagination, for future generations.
It's not all risk free, though
Though the story is pretty attractive, investors should also keep in mind that it's not risk free. The obvious risk is that Apple doesn't actually gain the share that many expect. The other, and potentially much bigger, risk is that Apple eventually moves away from Imagination for an in-house design longer term.
In fact, while Apple and Imagination announced the extension of their multi-year licensing agreement (the link to the official Imagination press release has been taken down, but Apple Insider, among many others, reported on it), Apple has been hiring graphics IP designers and managers for quite some time.
In fact, in a LinkedIn job listing posted on what appears to be August 11, Apple indicated that it is looking for a "Site Manager" for its Orlando team. According to the listing, Apple is "[r]ecruiting, hiring and building a world-class GFX IP development team."
When, exactly, Apple will deploy its custom graphics IP, and what impact it will have on Imagination, remains to be seen.
Foolish bottom line
Under the assumptions that Apple uses more expensive graphics IP in its next generation mobile system-on-chip, and that iPhone 6 will allow Apple to grow high-end smartphone share, Imagination could be set to see its business improve significantly during the coming year.
