Should You Buy Or Sell InvenSense At The Current High Earnings Multiple?

Jun.25.14 | About: InvenSense (INVN)

Summary

InvenSense is really expensive at 310 times trailing earnings considering it reported little revenue growth in the last quarter.

However, InvenSense is making aggressive investments in research and development to benefit from the growing application of motion sensing technologies.

InvenSense also is likely to profit from the Chinese smartphone market and a potential rumored contract with Apple for the iPhone 6.

After a weak start to the year, shares of chip maker InvenSense (NYSE:INVN) have finally started gaining some steam. The stock is now up 8% in 2014, despite posting weak fourth quarter results and sporting a high P/E multiple. In fact, InvenSense trades at a sky-high trailing earnings multiple of 310, which seems unjustified for a company that posted just 7% growth in revenue in the fourth quarter. Investors seem to be betting on rumors that InvenSense might land a spot in Apple's (NASDAQ:AAPL) iPhone 6, and also the growth in motion sensor applications in various devices.

However, is the stock worth so much risk? Let's find out.

Aggressive R&D investments

InvenSense has made considerable investments to increase its market share in its core mobile market, according to CEO Behrooz Abdi. As a result, management claims that it now has access to new and exciting opportunities in emerging applications.

InvenSense has seen a steady increase in attach rates of gyroscopes in a wide variety of applications. The company has also extended its presence in the optical image stabilization market, wearables, and fitness devices to drive growth.

Understanding the importance of product innovation, InvenSense is making significant investments in this area. This is allowing the company to deliver highly-differentiated solutions and enabling it to price its products in the premium range to maintain stable margins with further room for improvement.

The company's increased investments in research and development helped it support three primary activities, namely new product development, expansion of its software and algorithm capabilities, and the increased costs associated with extensive new customer qualification activities. Consequently, it has increased the number of system on chips (SOC) integrated in its digital motion processors (DMP), which will allow faster and more efficient algorithm and software.

InvenSense sees opportunity in the wearable market due to its fast-growing nature, and it is able to leverage its high-performance MotionTracking sensors, DMP, algorithms and software to address the needs of this market. The company also announced a joint collaboration with Sonion, which is a leader in hearing aid technology and solutions, to accelerate product development. All these investments should allow the company to profit from the following two prospects.

Smartphones in China

InvenSense is seeing solid growth in China, where its 6-axis MotionTracking solutions and 2-axis optical image stabilization products are gaining traction. Not only this, its gyro attach rates continue to increase in mid- and high-end smartphones such as Xiaomi and OPPO. This is a big opportunity for InvenSense, as the Chinese smartphone market is about to grow at a terrific speed in the coming quarters due to the roll-out of LTE.

According to iSuppli (via phonearena.com):

"...the number of 4G phones shipped to China is expected to soar from 4.6 million units in 2013 to 72.6 million this year, 144 million in 2015, 220 million in 2016, and 300 million in 2017. China Mobile is a lot more optimistic. The operator expects shipments of 4G handsets in the country to reach 200 million this year. Industry watchers expect 100 million of China Mobile's 900 million subscribers to switch to a 4G plan in 2014."

Hence, InvenSense has a big addressable market ahead of it to tap the Chinese smartphone market and it is tagging along with well-known smartphone companies such as Xiaomi, OPPO and Samsung, which are among the leaders in the Chinese smartphone market, to tap this growth.

A potential Apple contract

In addition, several high-end brands have started adopting optical image stabilization solutions (NYSE:OIS). Now, Apple is reportedly planning to include an optical image stabilizer in the iPhone, and this is one high-end brand where InvenSense might land a design win. As reported by BGR:

"Apple's iPhone 6 camera may come with optical image stabilization (OIS) technology from InvenSense, a report from The Motley Fool says, in addition to other sensor components from the chip maker.

Without confirming whether it will provide components to Apple's new iPhone, InvenSense CFO Alan Krock said during the company's third conference call that "in our fiscal 2015, we are well positioned to enjoy a year-over-year rate of (revenue) growth similar to the past two fiscal periods of between 25% to 35%. This outlook opportunity excludes potential market share gains or losses."

The Motley Fool believes this is an indication InvenSense may provide certain components to the iPhone, on top of its existing contractual obligations to other smartphone makers. The company provided about "50% of Samsung's design wins," amounting to 157 million component units of the total number of 314 million shipped Samsung smartphones."

InvenSense expects its 6-axis MotionTracking SoC product line to continue growing at a terrific pace in the future. Also, management is positive about its prospects and believes that fiscal 2015 will be another year of growth for the company.

As a part of its strategic move, it plans to increase its inventory, which will enable the company to increase its capacity. If InvenSense is really gearing up to supply chips to Apple, then it better be prepared with a higher production capacity since the Cupertino-based company is expected to sell a whopping 80 million iPhone 6 units this year.

Looking beyond the valuation

While it is true that InvenSense is trading at a high earnings multiple and close to its 52-week high, the company is slated to profit from growth in wearable devices, smartphones and a potential rumored contract from Apple. Moreover, InvenSense trades at a forward P/E of just 23, which seems quite cheap considering that its earnings are expected to grow at an annual rate of 22.40% for the next five years.

The company is investing aggressively in research and development, and has cut its losses in half in the previous quarter. Considering InvenSense's potential, it might be a good idea to buy some shares as the stock can soar to new highs in the future.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.