Tech geeks everywhere are clamoring over the new Apple (NASDAQ:AAPL) MacBook design unveiled earlier this month. Apple made a controversial choice by including just one port aside from the headphone connector. The USB Type C port supports the transfer of power, data, and video and is certainly versatile enough to replace all of the ports in previous MacBook designs.
More importantly, USB-C seems to have a better chance of becoming an industry standard than Apple's Thunderbolt connector. Nokia already adopted it for one of its tablets, and Google included the connector in its new Chromebook Pixel model. Google plans to include USB-C in its Android phones as well, and it hopes other Android manufacturers follow suit.
This is all great news for the company behind USB-C: Cypress Semiconductor (NASDAQ:CY).
Strengthening a struggling division
USB connectors are part of Cypress' data communications division, which has seen revenue fall for four straight years. USB-C has the potential to change that.
It's important to note that Cypress has a 100% share of the USB-C market, but it's still concerned with keeping its selling price low as to attract as much volume as possible. As such, its first-generation model chips -- like those in cables and dongles -- sell for an average of $0.40 to $0.80 each, according to management, and the chips in computers, phones, and tablets sell for $2 to $5.
Analysts at Sterne, Agee, & Leach believe Apple received Cypress' best pricing, and it's paying just $2 for each USB-C port chips. Considering Apple's strengthening position in the laptop market, and the potential for it to exact change throughout the entire industry, it's no surprise that Apple is getting a deal.
Apple's decision to include just one port opens the door for a lot of aftermarket dongles and cables. Both applications typically include two USB chips, so that adds another $1 or so in revenue for Cypress for each aftermarket USB-C accessory sold to accompany a MacBook.
Maintaining margin and fending off competition
CEO TJ Rodgers told investors on the company's fourth-quarter earnings call in January that they should think of USB-C as an opportunity in profit margin. Last year, the company achieved a gross margin of 50.1%. That's a slight improvement from 2013, but well off the mid-50% range the company saw at the beginning of the decade.
With its 100% share of the market, Cypress can ensure that its USB-C controllers achieve a higher average gross margin. But competition is coming, so it's already working on a second-generation controller that will have an average cost of $0.12 to $0.13, which means it will be able to cut the price 25% to 50% and still achieve a relatively high gross margin.
The second generation will be key, as it needs to be priced low enough to fend off pending competition while maintaining profitability.
The big opportunity
Cypress expects the Type C controller market to grow from $65 million in 2014 to $350 million in 2019. To put that in perspective, Cypress's entire Data Communications Division generated just $70 million in revenue in 2014 out of roughly $725 million total revenue, according to S&P Capital IQ data. The adoption by Google and Nokia as well as Apple bodes well for the market to grow into a big moneymaker for Cypress.
If the market extends into smartphones and tablets, as Google and Cypress both expect it to, that's a 2 billion-unit market for Cypress to sell into. Of course, it's cannibalizing its own USB 3 chips as USB-C (3.1) proliferates, but the higher average selling price and gross margin opportunity bodes well for Cypress' Data Communications Division going forward.