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Imagination Technologies worth holding as a takeover play

Published: 10:45 04 Apr 2017 BST

Uncle Sam stealing a wallet
Is it a bargaining ploy by the massively wealthy Apple?

If you did not sell your Imagination Technologies Group PLC (LON:IMG) shares in yesterday’s panic, broker Jefferies reckons you might as well hold them.

Jefferies has moved its own recommendation down from ‘buy’ to ‘hold’, while the target price has been slashed from 219p to 95p, following the blockbuster news that the graphics chip designer’s largest customer, Apple, has served notice it will stop using Imagination’s designs.

Taking Apple's statement at face value, the iPad maker has an alternative to Imagination’s Intellectual property (IP), which means that the UK company’s royalties from the world’s biggest company (in terms of market value) will rapidly dwindle from around the middle of 2019.

Legal battle or one-sided renegotiation?

Jefferies notes that Imagination could retaliate by suing Apple if it can prove the tech giant has infringed its patents. Apple has very deep pockets, and Imagination does not, so this is not a very appetising scenario for Imagination shareholders.

Another scenario is that this is just a bargaining ploy by Apple.

The Cupertino-based iPhone maker may be sitting on a huge pile of cash but “you can never be too rich or too thin”, as the old saying goes, and maybe Apple is simply looking for a discount on the royalties and licensing fees it pays Imagination.

For now, Jefferies is working on the basis that Apple will pull the plug, which implies looming losses for Imagination in 2020, or even before that, and opens up the possibility of what the broker calls “a financing crunch” unless debt can be paid down before banking covenants are breached.

One for the conspiracy theorists

Finally, for conspiracy theorists, there is the possibility that Apple, which mulled making a bid for Imagination a year ago, made this announcement to trash the share price and force Imagination to accept a low-ball takeover offer.

“A version of this [scenario] would see Apple standing by to acquire IMG’s IP in any future crisis – perhaps at least providing a safety net to value,” Ken Rumph on the Jefferies retail team suggested.

“This seems a long shot,” Rumph concluded.

Liberum Capital Markets also questions the wisdom of Imagination getting into a legal battle with Apple.

“Though Imagination questions Apple's ability to develop products without using its patented technologies, negotiation and litigation with Apple is expensive and prolonged as seen with InterDigital, Ericsson and Nokia,” Liberum’s Janardan Menon observed.

A buy-out may be the best solution

“We believe a potential sale over the next one to two years maybe the best outcome for Imagination,” the analyst suggested.

“We believe its technology and IPR is valuable in a number of areas, including graphics, self-driving cars, AI, machine learning, AR/VR and connectivity. There are likely to be a number of potential buyers in our opinion including Intel, CEVA, Synopsis, Mediatek, Tsinghua and others,” Menon goes on to say.

Valuations in the sector average five to ten times' annual sales, with the “bid premium” effect typically pushing valuations towards the top end of that range.

Imagination's sales excluding Apple are around £70mln.

“Any positive outcome in the negotiation or litigation with Apple could provide further upside to the buyer,” Menon opined.

Shares in Imagination were up 8.2% at 111.47p.

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