Shares of struggling graphics intellectual properly vendor Imagination Technologies Group (NASDAQOTH:IGNMF) caught a bid on May 9 following the disclosure that Tsinghua Unigroup had purchased a 3% stake in the company.
Shares were up more than 11% on strong volume, reversing some of the declines it saw during the month of April. In light of this news, does the investment thesis around this company change for the better? Let's take a closer look.
The business is still in rough shape
Imagination faces a number of significant headwinds. Firstly, one of its largest customers, Apple (NASDAQ:AAPL), is currently experiencing year-over-year declines in smartphone shipments. If Apple is down, Imagination certainly gets hit.
Beyond that, Imagination faces strong competition in the broader, non-Apple smartphone market. Many smartphones use graphics intellectual properties from either larger rival ARM Holdings (NASDAQ:ARMH) or Qualcomm (NASDAQ:QCOM), a system-on-a-chip builder that develops its own graphics processors.
With heavy Apple exposure, strong competition for the non-Apple smartphone spots, and an overall smartphone market that's seen a dramatic slowdown in growth, it's not hard to see the challenges that this Apple supplier faces.
Does a 3% stake mean much?
A 3% stake in the company at its current market capitalization is worth approximately $20 million (assuming exchange rate of 1.44 USD to 1 GBP). Relative to some of the other investments that Tsinghua has made, this isn't a ton of money. Furthermore, a 3% stake is quite small.
Some analysts, such as the folks with Liberium Capital (via The Guardian), think that this move could "ignite a sale process" of Imagination to Apple. It's worth noting that Apple confirmed reports earlier that it held talks with Imagination about a possible acquisition.
"We presume Apple (owns 8%) would not let Imagination's technology go to China," the analysts write.
Does an Apple buyout of Imagination make sense?
Apple has generally placed high value on the graphics performance of its A-series processors. Graphics enables a whole host of compelling user experiences, from accelerating elements of the user interface to enabling increasingly realistic 3D video games.
Historically, Apple has integrated some of Imagination's highest performance graphics processors into chips destined for the iPhone and iPad, respectively. Apple is also often the first out of the gate to implement Imagination's latest graphics designs.
At the end of the day, Apple likely wants to continue to offer up leadership graphics performance in its smartphones, particularly if it seeks to boost the display resolutions on future iPhones.
There is significant evidence in the public domain that the company is building its own graphics processors (i.e., plenty of job listings point to an in-house graphics processors). If this effort is ultimately successful, then Apple should be able to reduce its reliance on Imagination and its technology.
However, if Apple is unable to build world-class graphics processors in-house, then it will need to continue sourcing graphics processors from a third party -- most likely Imagination. I can see why Apple may have been interested -- the Imagination team is quite capable, and having that technology all to itself (backed by Apple's very deep pockets) would be quite valuable.
If Imagination gets snapped up by another entity (like Tsinghua), perhaps one uninterested in continuing to license graphics processors to third parties, then Apple could be in a bit of a bind as it would need to transition to graphics from another vendor (probably ARM). This could put Apple into a bit of a bind.
Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.