Capuski
When it comes to semiconductors, whatever the market gives during the booms it can take away during the busts, and Synaptics (NASDAQ:SYNA) shareholders have been experiencing that over the past year as the shares have been hammered on weakening consumer electronics markets. Down about a third since my last update, the shares have erased significant outperformance over the SOX index and are down more than 70% this year.
I understand the concern over weak PC and mobile demand, not to mention weakening consumer IoT demand. Likewise, I understand the fears that the aggressive pricing realizations that Synaptics took in 2021-2022, and that boosted gross margins above management’s prior long-term targets, will unwind. Those fears are fair to a point, but I think the share price now overlooks the longer-term opportunities in IoT that management has already shown it can successfully target. It may take another six months or so for investors to come back to this name, and maybe longer, but the valuation here.
A Major Cut To Guidance Underlines The End-Market Difficulties
The quarterly results that Synaptics reported for the fiscal first quarter (the October quarter) weren’t bad relative to expectations, but the company’s end-markets continue to erode at an alarming pace, with the company slashing guidance for the next quarter.
Revenue rose 20% year over year as reported and fell 6% quarter over quarter, just missing sell-side expectations. The IoT business grew 67% as reported and 3% sequentially, and now makes up over 70% of total revenue, as the company has continued a full-on pivot toward this segment. Mobile revenue declined 49% yoy and 36% qoq on weaker handset demand, particularly with Korean and Chinese customers, and PC revenue declined 26% yoy and 20% qoq as PC units continue to weaken.
Gross margin improved 460bp yoy and 150bp qoq to 62.6%, beating expectations by more than two points. Operating income rose 41% and fell almost 4% qoq, with margin up six points year over year and one point sequentially, beating by two points.
Given the reports from companies like AMD (AMD), Nvidia (NVDA), and Qorvo (QRVO), investors were braced for more weakness in consumer-facing markets, and the sharp cut to guidance seems to be getting viewed as of this writing more as a “clearing event” than an ominous sign about the future of the business.
Management guided to a revenue midpoint more than 18% below the October level, almost 20% below published sell-side estimates going into the quarter. Within that, IoT revenue is expected to decline about 22% as demand for VR-related products and other consumer IoT products continues to weaken. Gross margin guidance came in at 61.0% at the midpoint, above the Street but down sequentially by 160bp.
Waiting For The Re-Acceleration And The “New Normal” For Margins
The key question for Synaptics now is how much worse end-market conditions will get before they get better again. I believe Synaptics could see weak sequential revenue performance through this physical year (FY’23) and possibly into FY’24. Wi-Fi 6 is a credible opportunity for Synaptics’ IoT connectivity business, and I likewise see share gain potential on the back of the company’s relatively new “triple-combo” connectivity product.
On the other hand, I could see ongoing weakness in mobile lasting a little while longer. OEM inventories still look high, and weak demand could be exacerbated by an economic slowdown next year. On top of that, there’s already been evidence of more intense price competition in display driver integrated circuits (or DDICs) for OLED phones, and this could intensify if weaker rivals try to overcome softer unit volumes by taking share on price. I’m likewise not especially bullish on the near-term prospects for the PC market, given demand pulled forward in the pandemic.
Looking more at the IoT opportunities, I think the long-term outlook for edge intelligence devices in applications like smart speakers and smart appliances is good, and I likewise think that VR is still in its infancy. But the vast majority of these indications are, in my opinion, luxuries (or toys/gadgets) at this point and susceptible to weaker consumer confidence. I do see a better outlook for the auto side of this business, as I continue to expect more touch sensing and display content in newer models.
I also want to note a small deal that Synaptics announced just prior to the earnings report. The company announced that it was acquiring the Emza Visual team from Himax (HIMX), and given no mention was made of the purchase price (and that Himax will continue to have access to Emza Visual’s algorithms for certain applications), it’s likely not a significant event from a balance sheet perspective. Still, I like the idea of adding ultra-low-power AI visual sensing algorithms to the Katana AI SoC platform to enable human presence detection in edge devices.
The Outlook
Synaptics management has been actively reshaping the business and refocusing it on the larger, higher-margin opportunities in IoT, including connectivity, edge intelligence, and audio/video. Edge intelligence and connectivity are going to be increasingly valuable features in new IoT devices, and I expect significant long-term growth for VR-enabled systems for entertainment, health care, and industrial applications. On top of that, Synaptics has differentiated itself with high-bandwidth, low-power capabilities, and that’s key in the IoT market. Of course there will be competition, from the likes of Silicon Labs (SLAB), NXP Semiconductors (NXPI), Cirrus (CRUS), and STMicro (STM) among others, but Synaptics had made itself into a credible contender.
I’m taking a very conservative approach to near-term modeling, expecting further sequential erosion this year and some declines continuing into the fiscal year after that. I do expect a significant rebound in FY’25, though, and long-term revenue growth in the neighborhood of 5%. While I do believe the IoT business will outgrow that average rate, I expect further erosion in the PC and mobile businesses over time.
Margins could be a source of weakness, as pricing was a strong driver last year (up 24% in IoT and 16% in PCs), and I think it will be difficult to maintain pricing in a more challenging demand environment (pricing is also part of my below-Street revenue expectations for FY’23 and FY’24). Management didn’t raise their long-term margin targets in response to over-earning during the boom, so erosion back into the high 50%’s for gross margin and low 30%’s for operating margin is a possibility. Longer term, I still believe FCF margins will get into the 20%’s, driving long-term FCF growth in the high single-digits.
The Bottom Line
However bright the future may look for Synaptics, the reality is that semiconductor stocks trade far more on the six-to-18-month outlook than long-term discounted cash flow. To that end, I do expect long-term total annualized returns from here in the mid-teens, and the valuation looks too low on the basis of trough margins (and forward multiples appropriate for trough multiples), but the shares may remain out of favor a little while longer.
Semi stocks have in the past moved about six months ahead of the financials, so if conditions in Synaptics’ core end-markets should improve late in 2023 or early in 2024, the shares may stay under a cloud until mid-2023. Given the longer-term growth potential of the IoT business, I think this is an out-of-favor name worth a look from more contrarian-minded investors.
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