Cirrus Logic (CRUS +0.64%) is a chip company that develops mixed signal/analog semiconductors. In particular, much of its business comes from the sale of audio codes, and in some products, audio amplifiers, to Apple (AAPL +3.26%).
In fact, some estimates suggest that over 80% of Cirrus Logic's revenue comes from the sale of chips to Apple.
So, in light of the recent implosion in GT Advanced Technologies (NASDAQ: GTAT), it's worth exploring why, despite a cheap valuation and apparently stable position at Apple, investors should be mindful of the very real risk that comes with investing in the company.
The doomsday scenario: what happens if Apple dropped Cirrus?
Unlike the case with GT Advanced Technologies, Cirrus Logic wouldn't immediately go bankrupt if Apple dropped Cirrus Logic as a supplier. However, a look at Cirrus' most recent earnings report gives us the following important financial metrics for its fiscal year 2014:
- Net sales: $714.3 million
- Gross profit: $356.2 million
- Total operating expenses: $201.2 million
What would happen if Apple simply told Cirrus to take a hike? Well, the financials would get really ugly, really quickly with an 80% haircut to revenue; they'd look something like this:
- Net sales: $143 million
- Gross profit: $71.5 million (assuming about 50% gross margin)
- Total operating expenses: $201.2 million
This scenario would lead to an operating loss on Cirrus' part of about $130 million per year until it could get its cost structure under control.
Interestingly enough, before Cirrus purchased competitor Wolfson Microelectronics, it had about $268 million in cash and cash equivalents and approximately $40 million in long-term marketable securities. Post-Wolfson acquisition, which cost Cirrus $467 million, the company will be in a net debt position (since the deal was done with cash and $225 million in debt funding).
If Apple dropped Cirrus, I think the company would have a shot at survival if it could cut operating expenses fast enough, but it would get ugly for shareholders pretty quickly.
This is why Cirrus will generally command a low multiple
The purpose of this article isn't to try to "scare" investors; Cirrus is a good company that makes quality products -- its chips have been chosen by Apple for multiple iterations of iPhone and iPad products.
However, this is why the market is so sensitive to any potential socket losses at Apple, and it's why the company is unlikely to command a rich multiple (barring a significant change in its business).
Now, the acquisition of Wolfson Microelectronics obviously consolidates the market and gives Cirrus exposure to a wider base of customers, but remember that Wolfson's revenue base was about $179 million per year and was reportedly losing money at that revenue run rate.
There's some good news, though
Although much of Cirrus' revenue comes from sales of chips to Apple (which gives Apple a large degree of control over Cirrus), the knife does actually cut both ways. Early sales numbers from Apple, coupled with the generally warm reception that the iPhone 6 and iPhone 6 Plus have enjoyed, it does look as though Cirrus -- which, according to iFixit, won the audio codec slot in the iPhone 6 and 6 Plus -- is poised to benefit from the successful Apple product launch.
Further, if the new iPads that are reportedly set to launch on Oc. 16 help reignite iPad growth as a whole, then Cirrus -- which will likely supply the audio codec to those products, as well -- is poised to benefit.
Foolish thoughts
Cirrus Logic is, at the end of the day, a component supplier whose business very heavily depends on the success of Apple products in the market. This is a double-edged sword, with both a very real potential payoff as well as substantial risk.
As the implosion of GT Advanced Technologies showed, the worst case can sometimes come true, so investors shouldn't ignore it when deciding whether or not to invest in Cirrus.
