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Morningstar | Synaptics Makes Progress Toward Becoming a More Diversified Semiconductor Firm; Shares Undervalued

Synaptics reported in line fourth-quarter results, while announcing it will be restructuring its optical fingerprint business for the mobile market. We had previously been positive on the firm's in-display fingerprint sensors, particularly as original equipment manufacturers increasingly make devices with end-to-end displays. However, many of these infinity display smartphones have placed the fingerprint sensor on the back of the phone (or completely eliminated it as in the iPhone X with Face ID). While Synaptics' in-display solution would have allowed for a slimmer and more elegant design, the high costs involved have prevented the broad adoption management had been anticipating. Consequently, management felt the optical fingerprint market wasn't a sticky highly differentiated one and would be prone to harsh pricing erosion. We foresee the firm doubling down in opportunities for advanced touch and display controllers (OLED) and consumer Internet of Things devices. Our $64 fair value estimate for no-moat Synaptics is intact and we believe investors with the patience to deal with the volatile nature of the semiconductor component space may find current levels attractive.

Fourth-quarter sales were $388 million, down 9% year over year and 1% sequentially due to broader weakness in the smartphone component market. We note the firm's more diversified portfolio allowed it to weather the 36% year-over-year revenue decline in mobile, partially offset by Internet of Things and PC products. Notably, the firm recorded solid sequential gross margin expansion of 160 basis points to 32.8%, thanks to a richer product mix. For fiscal 2018, revenue fell 5% to $1.63 billion, as weaker mobile revenue was partially offset by strength in Internet of Things and PC.

Management expects first-quarter revenue to be at a midpoint of $410 million, down 2%. Sequential growth in mobile is expected to be offset by sequential declines in Internet of Things and PC. Meanwhile, the firm continues to experience a shortage in its integrated touch and display driver products that will amount to a near-term revenue shortfall of roughly $15 million. The firm will be reinvesting the R&D from optical fingerprint into Internet of Things, including voice recognition digital signal processors used in smart home products from the likes of Amazon, Google, Samsung, and Baidu. We note this segment is gross margin-accretive while the optical fingerprint products were margin-dilutive. Despite the current fluidity of its product portfolio, we believe Synaptics is appropriately focusing on more differentiated areas that should mitigate its exposure to cut-throat commoditized markets in the future.