Peregrine Semiconductor Takes A Hit, But Is It Warranted?

| About: Peregrine Semiconductor (PSMI)
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Peregrine Semiconductor (NASDAQ:PSMI) is a small-cap semiconductor name that I recently profiled as a "Top Idea" less than a month ago. While it seemed that things weren't likely to get too much worse (and, to my credit, even after a particularly heavy downgrade, the stock is down just under 8% from the date of publication), a cut to "hold" by Deutsche Bank on the belief that Peregrine's position within Apple (NASDAQ:AAPL) is weakening managed to send shares back into the penalty box.

Some Background

In order to understand the Peregrine story (and why the shares are down), it's important to note that the "big" loss that the company recently suffered was that of exclusivity of the main antenna switch in the iPhone 5s. Many of my readers have asked me for a more detailed explanation of what's going on here vis-a-vis the iPhone, so allow me to take a slight detour to shed some more light on what everyone's so worried about.

So, in a smartphone, there is a bunch of RF content used to perform the various functions that a cellular device needs to. In the iPhone 5, Peregrine managed to win the following two sockets:

  • Main RF switch
  • Diversity RF switch

Peregrine had these two sockets exclusively in every model of the iPhone 5. Unfortunately, when the tear-downs from Chipworks of the iPhone 5s came in, it was revealed that Peregrine had held on to exclusivity of the diversity switch but had lost exclusivity of the main switch (it is shared with two other vendors). Of course, this means lower average revenue per iPhone and therefore the stock price (and the company's revenue) took a hit.

What's The New Fear?

Interestingly enough, Deutsche Bank downgraded shares of Peregrine from "buy" to "hold" and took its price target down from $10 to $8. The rationale of the downgrade is expressed in the following excerpt:

As we noted last February, post MWC, our checks indicated the company lost a key socket, the main antenna switch, in the then next iteration of the iPhone (5s). This time we feel the company could be at risk of losing its other socket, the diversity switch, with the next iPhone upgrade. While we believe Peregrine's long history in the space and IP portfolio is a key strength, especially as we move carrier aggregation, we think the potential loss at Apple could make it hard for the company to meet the top-line growth target its valuation is built upon.

So, the big new fear is that Peregrine will end up losing exclusivity of the diversity switch socket over at Apple. Now, note carefully that Deutsche is claiming that Peregrine LOST the main switch in the 5s and that the company is at risk of LOSING the diversity switch. While it is true that Peregrine lost exclusivity (i.e. Apple sourced from multiple vendors) of that socket, it didn't lose it completely. This is an important distinction.

That said, yes, there is a chance that Peregrine will lose exclusivity of the diversity switch socket in upcoming smartphone models (but the odds of losing it entirely are very low). Apple (and Samsung (OTC:SSNLF)) drive their component vendors exceptionally hard and work tirelessly to get the best pricing. Peregrine has made it clear that its strategy isn't necessarily to sell the cheapest part but, instead, to offer the best performance/features and try to get paid for it to the extent to which it can.

Why Remain Bullish?

While Peregrine's "claim to fame" has been, in no small part, its wins over at Apple, it's important to realize that the market for LTE/LTE-Advanced products is growing and growing rapidly. Further, whether these phones are low end or high end, they still require some pretty substantial RF content. An example that Peregrine's management likes to give (and one that is, frankly, very good) is that the iPhone 5s and 5c have substantially the same RF content despite one being a higher end phone than the other.

So, whether Peregrine loses exclusivity of the diversity switch socket or not, the bigger picture here is that the demand for ever more sophisticated RF content in handsets will continue to increase - a trend that certainly favors Peregrine. On top of that, Peregrine has been aggressively pursuing a fully integrated CMOS RF front end. By the 2015/2016 timeframe, if the company manages to successfully develop such a product, then its content share per phone could grow fairly substantially. The "risk", however, is that Qualcomm (NASDAQ:QCOM) - which is the world leader in smartphone silicon - is pursuing something similar.

Conclusion

I remain unshaken by the recent downgrade from Deutsche Bank, although I do acknowledge that there is risk that the next generation iPhone really does source its diversity switches from multiple vendors. With that in mind, it's important to note that if this were to occur, the "damage" done by such a move would be far less dramatic than losing exclusivity of the much more expensive main switch. Further, the stock seems to have priced in this pessimism in quite thoroughly. The risk is now to the upside and I remain bullish on the company's long-term prospects, even if there are short-term speed-bumps along the way.

Disclosure: I am long PSMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.