Apple's Vertical Integration Spree Continues
Apple (NASDAQ: AAPL) has long sourced power management IC, or PMIC, products from a small company called Dialog Semiconductor (NASDAQOTH: DLGNF). This business has been lucrative for Dialog, which indicated in its most recent annual report that about 77% of its sales in 2017 came from Apple.
Unfortunately, the fact that Dialog relies so heavily on sales to Apple created a significant customer concentration risk. That risk factor seemed to play out when Dialog revealed that Apple would be using a main PMIC from another supplier for one of the three iPhones that launched earlier this year (a teardown report from TechInsights showed that iPhone XS Max has an Apple-designed main PMIC).
Image source: Apple.
On Oct. 11, Dialog announced that it had signed a licensing agreement with Apple related to PMIC technology. Let's take a closer look at exactly what's going on, here.
Cash for tech -- and more
Dialog says it'll get $300 million "in cash for the license of certain PMIC technologies and the transfer of certain PMIC assets and employees, payable upon closing."
The company revealed that "over 300 employees -- representing 16% of Dialog's global workforce" will move over to Apple. Apple will also take over "certain Dialog facilities in Livorno, Swindon, Nabern and Neuaubing."
On top of that, Dialog added that Apple is going to prepay $300 million "for products to be delivered over the next three years."
What does this mean for Dialog's business?
Dialog explains that while it expects to keep shipping main PMIC chips to Apple for the designs that it's already in, it stated that "[no] new revenue contribution [is] expected from main PMICs for 2019 iPhone models and for 2020 iPad or Watch models."
In other words, Apple has designed Dialog out of the main PMIC spots in its iPhone, iPad, and Apple Watch products over the long term. That's certainly going to lead to a reduction in Dialog's revenue.
With that said, Dialog indicated that it "expects to continue shipping current and future generations of sub-PMICs for all platforms to Apple." As you might recall, Dialog CEO Jalal Bagherli said on the company's Aug. 2 earnings call that Dialog has "two chips in the upcoming [iPhone] cycle, one is across all three and one is across two models." (The chips in question appear to be a main PMIC and a sub-PMIC.)
Additionally, Dialog says that it has been "awarded a broad range of new contracts" at Apple that "include the development and supply of power management, audio subsystem, charging and other mixed-signal integrated circuits for high-volume applications."
Per the company, that "[revenue] from new contracts is expected to be realized starting in 2019 and accelerate in 2020."
Dialog showed in a slide deck accompanying this announcement that while roughly 75% of its revenue in 2018 came from Apple, it expects that by 2022, sales to Apple will make up between 35% and 40% of its revenue.
Investor takeaway
Given that Apple had successfully designed a main PMIC for the iPhone XS Max, it wasn't a stretch to think that Apple could apply future main PMIC chips more broadly across its iPhone product portfolio over time. That's exactly what's set to happen, and as an added bonus, Apple is also poised to bring its Apple Watch and iPad main PMICs in-house, too.
However, Apple and Dialog appear to have managed to work out a deal so that this isn't a game-ending development for the latter.
Moreover, even though Apple is apparently moving its main PMIC technology for all of its mobile products in-house, Dialog isn't left completely out in the cold, as it'll keep generating revenue from sales of sub-PMICs to Apple as well as from the "broad range of new contracts" that it has inked with the trillion-dollar consumer electronics giant.
More From The Motley Fool
Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.
