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Stock Strategist

Synaptics Regains Its Footing

This smartphone component provider is at the leading edge.

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 Synaptics (SYNA) develops human interface solutions for electronic devices such as smartphones and personal computers. Its products include integrated circuits that enable touch-based interaction between user and device. The firm has shifted away from PCs to mobile devices in recent years; with Internet browsing, social media, and other applications driving smartphone adoption and usage, Synaptics is well positioned to capitalize on this opportunity with its advanced offerings.

Competition among smartphone component suppliers can be cutthroat, as up-and-coming firms strive for market share via price wars with incumbents. In contrast, mature companies look to spur growth with consolidation as a means of offering original-equipment manufacturers more comprehensive solutions. Synaptics has pursued the latter, and after some well-executed acquisitions--Validity Sensors (fingerprint) and Renesas (display drivers)--it now boasts a broader product portfolio with touch, display, and fingerprint capabilities. We believe Synaptics has the tools to drive innovation and increase its presence in devices while staving off the commodification that frequently consumes comparable entities.

Integrating touch and display functions represents the surest path to technological relevance for Synaptics, in our opinion. The firm is considered the market leader in touch and display driver integration, or TDDI. Advantages of TDDI include a simplified design process with manufacturing, cost, and supply chain benefits in addition to a slimmer form factor with better display and battery performance.

In an environment rampant with data breaches, the need for secure devices has never been greater. The proliferation of smartphone use, particularly for information-sensitive applications that include mobile payments, has only compounded this need and will require methods for safeguarding identities. Biometrics figure to be the most likely candidate, and we believe Synaptics can leverage its fingerprint sensor along with TDDI to drive growth.

Technology Lead Isn’t Surmountable
We believe Synaptics does not have an economic moat. Its technology lead in touch, display, and fingerprint solutions is not insurmountable, and product design cycles tend to be relatively short for smartphones, which account for a majority of total revenue. As a result, competitors may be able to undercut Synaptics on price if able to develop a comparable product.

Although the firm’s customer concentration is more aligned with that of the market itself, recently acquired Renesas historically relied on one customer (Apple) for the majority of sales, while legacy Synaptics depended on Samsung for close to 15% of total revenue. Together, the combined company has a better chance of withstanding the loss of a major customer, but the trend for tier-one smartphone providers to develop in-house solutions for touch, display, and fingerprint or to strong-arm suppliers on price hurts Synaptics’ case for a moat.

Aiming for Diversification
We assign Synaptics a high fair value uncertainty rating because of the competitive smartphone component market and tendency for tier-one customers to develop in-house solutions. Currently, the smartphone market is inherently concentrated, dominated by Apple and Samsung, with Xiaomi, Huawei, and LG making up the second tier. Synaptics’ revenue sources mimic this concentration, leaving the firm susceptible to the significant risk of being left out of an upcoming design. Additionally, competitors may develop similar TDDI solutions that would reduce Synaptics’ current competitive advantage.

Synaptics has focused on diversifying its customer base, primarily in up-and-coming original-equipment manufacturers that serve China. While the product design cycle for smartphones is fairly short and the component supplier business can be ruthless, we believe Synaptics has taken the proper steps toward a healthier mix of customers that would serve to alleviate the risk of losing a highly concentrated customer.

Synaptics is in solid financial shape. At the end of the fiscal second quarter, the firm had $347 million in cash and equivalents, compared with $210 million of debt on its balance sheet stemming from its Renesas acquisition. The company has not historically operated with great leverage, but even if it chose to do so, we would expect it to maintain an adequate cash cushion to withstand the cyclical troughs to which semiconductor firms are prone to while maintaining investments in the business to stay competitive.

Abhinav Davuluri does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.