Following the release of two InvenSense (INVN +0.00%)-powered iPhones, it seems that shares of the motion processing solutions company can't catch a break. Part of this weakness is due to some sell-side analysts predicting doom and gloom for the company's newly won Apple (AAPL +0.54%) business.
There also may be a "sell-the-news" effect that's going on right now. However, if you're a long-term investor, it pays to look past the near-term noise and focus on the company's longer-term story.
In an earlier article, I gave my rationale for opening a position in the stock, and Fellow Fool Evan Niu also wrote a piece laying out why he's planning to buy in. In this article, though, I'd like to step back and review the fundamentals of the InvenSense story to help you better understand the business you've bought, or are thinking about buying.
A brief look at the story so far
InvenSense essentially makes sensors -- gyroscopes, accelerometers, and digital compasses -- that go into devices such as smartphones, tablets, and other electronic devices. By far the largest opportunity for the company has been the smartphone market, which has seen explosive growth since the introduction of the iPhone.
InvenSense now supplies chips to Apple, and has counted Samsung among its major customers for quite some time. The good news is that InvenSense is likely poised to continue to generate significant revenue from the sale of chips to these two vendors.
The bad news, though, is that growth-hungry InvenSense investors must be asking themselves, "OK, but what's next?"
That's a really good question
Some of the major growth vectors that management cites in its Aug. 2014 corporate presentation are the following:
- Wearable devices, such as smartwatches
- Mid-range and low-end smartphones, notably in China
- Broader adoption of optical image stabilization
Taking a broader view, InvenSense estimates that the total addressable market for motion sensors looks to be $2.236 billion during 2014, and should grow to $2.441 billion in 2015, then to $2.565 billion in 2016.
InvenSense is, per analyst consensus, set to generate $372 million in revenue this year. This implies market share of about 15%. If InvenSense can grow its market share to something more along the lines of 25%-30%, it can substantially outgrow the market during the next few years.
That's a big if, though. InvenSense has proven that it has solid technology for the high-end of the mobile device market; but my expectation is that the market-share battles in the more price-sensitive low-end and mid-range markets could prove fiercer.
InvenSense's proposed operating model
In its investor presentation, InvenSense presented its long-term target financial model. While there's no guarantee that the company will actually hit this model over the long run -- I can't tell you how many times I've seen such models turn out to be complete and utter pipe dreams -- it's worth trying to figure out what InvenSense's long-term earnings power could ultimately prove to be.
The proposed model, each as a percentage of revenue, is as follows:
- Gross margin: "mid-50's%"
- R&D: 13%-15%
- Sales, General and Administrative: 9%-10%
- Operating margin: "25%+"
- Tax rate: 15%
If InvenSense were able to grow revenue to $800 million during the next few years, this would imply $200 million in operating profit. At a tax rate of 15%, this could lead to about $170 million in net income.
One point to consider
I do not believe InvenSense will actually achieve a "mid-50%" gross margin level over the long run. The company's corporate gross-margin profile has actually declined from 56% in fiscal year 2012 to 51% in fiscal 2014. I think that it will stabilize here, or get slightly worse as the company tries to gain market share.
A good example that I like to look at for future gross-margin potential is Cirrus Logic (CRUS +0.48%). Cirrus reportedly generates more than 80% of its revenue from sales of chips to Apple, and guided for a long-term gross margin profile in the "mid-40s."
While InvenSense doesn't quite have that kind of customer concentration -- InvenSense sells into a number of major smartphone vendors, including Apple and Samsung -- I do think that being heavily dependent on a handful of players likely means a limited opportunity for gross margin expansion. Over the long run, I'd expect a High 40% to low 50% range, leading to a lower net income estimate than what was given above.
Foolish bottom line
I like InvenSense's longer-term prospects. The smartphone market is obviously growing, tablets are probably going to continue to grow, and there could be some nice incremental opportunities in wearable devices.
The big thing to watch, though, is for share gains for InvenSense. The underlying market for InvenSense's products is obviously growing; but in order to continue to post healthy double-digit revenue growth, InvenSense will also need to gain meaningful share within its total addressable market.
I think InvenSense's technology is solid, and the wins with Samsung and Apple validate the company's technological strength at the high-end of the mobile-device market. I'm now going to be watching to see if the company can replicate this success in the low-end and mid-range of the mobile-device market.
