Last week wasn’t a fun one for my portfolio, thanks largely to one particular holding: Dialog Semiconductor. On November 3oth it was revealed that Apple may begin producing its own power chips from 2018, and Apple is Dialog’s largest customer (74% of revenues). The following Monday, a statement was released from DLG confirming that Apple are in a position to begin producing their own chips. The share price is down by over 35% since this news first came to light. So today I am admitting I haven’t kept my eye on the ball with this particular holding. Let’s look at what happened.
The West Wing
The first thing I thought of when I heard this news was the political drama, ‘The West Wing’. If, like me, you’re a fan of the show, you may recognise this story from season one’s “Take This Sabbath Day”:
“You know, you remind me of the man that lived by the river. He heard a radio report that the river was going to rush up and flood the town, and all the residents should evacuate their homes.
But the man said, “I’m religious. I pray. God loves me. God will save me.” The waters rose up.
A guy in a row boat came along and he shouted, “Hey, hey you! You in there. The town is flooding. Let me take you to safety.” But the man shouted back, “I’m religious. I pray. God loves me. God will save me.”
A helicopter was hovering overhead and a guy with a megaphone shouted, “Hey you, you down there. The town is flooding. Let me drop this ladder and I’ll take you to safety.” But the man shouted back that he was religious, that he prayed, that God loved him and that God will take him to safety.
Well, the man drowned. And standing at the gates of St. Peter, he demanded an audience with God. “Lord,” he said, “I’m a religious man, I pray. I thought you loved me. Why did this happen?” God said,
“I sent you a radio report, a helicopter, and a guy in a rowboat. What the hell are you doing here?”
Investing is of course not a life-or-death matter (if it is, please seek help). However I appreciate the parallel to my situation here. There have been three separate warnings now regarding the future of Dialog Semiconductor, and yet I still hold. Lest we also forget, Imagination Technologies also fell foul of the might of Apple. So in truth, what the hell am I doing here?
I first bought Dialog in August of 2016. At that time, the share price had fallen somewhat from it’s peak a few years earlier, and so valuation metrics looked appealing. The company also met a lot of my investment requirements. A strong record of growth, generous free cash flow generation, and high returns on invested capital. The company was cash generative, and had no debt on its balance sheet. All told, a good business.
However as mentioned, the bulk of revenues were derived from one customer: Apple. Why did I choose to overlook this key piece of information? Well, I figured ‘a good business is a good business. DLG are growing at a decent rate in a cutting edge industry. No doubt they’ll diversify their revenue base as they pick up new customers’.
That may still happen, but it hasn’t yet. Therefore DLG remain vulnerable.
Dialog: April 2017
The first warning came in April of this year:
“There is strong evidence that Apple is developing its own power-management integrated circuits and intends to replace the chip made by Dialog at least in part” – Karsten Iltgen, Bankhaus Lampe.
It was only a week prior to this that shares in Imagination Technologies fell more than 60%, following news that Apple would no longer be using their graphics technology. There was also the suggestion that Apple had been poaching engineers from both Imagination Tech and Dialog.
Boom. Dialog shares down 20%.
Dialog: Thursday November 30th
Heading into the Christmas season, Apple dropped a bombshell. They have the capability to develop the power management chips currently supplied by Dialog Semiconductor. One anonymous source said:
“Based on Apple’s current plan, they are set to replace around half of its power management chips to go into iPhones by itself, starting next year.”
There had been some question as to exactly when they will begin bringing everything in house, but this was cleared up in part by Dialog’s CEO the following Monday:
Dialog: Monday December 4th
The company’s official statement was as follows:
“Dialog recognizes Apple has the resources and capability to internally design a [power management integrated circuit] and could potentially do so in the next few years,”
CEO Jalal Bagherli confirmed however that revenues for 2018 were already locked in, and that they were still working with Apple on plans for 2019.
Dialog: What Now?
I’m seldom one to act rashly with investments (occasionally to my detriment). I can see two directions the price will now take. One, it drifts lower and lower based on this negative sentiment. Two, the share price begins to recover based on the strong financial position and the likelihood this selloff is overdone.
I haven’t yet decided what I want to do, but there are a few influences weighing on my mind.
Firstly, as mentioned the company remains in a strong financial position. Imagination Tech were hit hard because they were not. This news us undoubtedly a big blow to DLG, make no mistake, however they are well placed to weather the storm.
Secondly, the company have declared that they will know more in March as to the extent of the impact of this news. Revenues are booked for 2018, and if, as suggested, Dialog are still working with Apple on plans for 2019 this gives some breathing room to decide what to do.
Thirdly (and interestingly), Chinese chip company Tsinghua Unigroup have used this opportunity to begin building a 7 per cent stake in the business. Could they go the same way as Imagination Tech and be taken over? I’m not sure. They aren’t in as desperate a position.
So all told, I’m continuing to hold and will review as and when news is released. The company is down 42% year-to-date, and my holding sits currently at -27.71%.
I’ve been sent my warnings. If I lose money on this investment I’ve only myself to blame.
Leave a comment below, or find me on Twitter @BritishInvestor.
Disclosure: Dialog Semiconductor & Apple are constituents of the portfolio.