Synaptics (NASDAQ:SYNA) is expected to receive significant sales growth from the virtual reality market. If market conditions continue to be beneficial for the Internet of Things industry, Synaptics will likely drive the revenue growth up. Even considering risks coming from client concentration and unsuccessful integration of acquisitions, I believe that the stock price could be trading at higher price marks. Under my DCF models, the company does look like a buy.
Synaptics presents itself as a leading worldwide developer or semiconductor solutions. The company believes that it is helping in changing the way humans share data and exceptional experiences.
Synaptics currently includes System-On-Chips, high-definition video, and other devices for the Internet of Things revolution, personal computers, and smartphones. I believe that these target markets are already growing at a significant growth rate. With that, management is trying to migrate to markets growing at a larger pace. Keep in mind that in the most recent quarterly report, the company reported continued traction in the virtual reality market. The global virtual reality market is expected to grow at a CAGR of more than 44.8% from now until 2028:
The global virtual reality market size is expected to reach USD 84.09 billion by 2028, exhibiting a CAGR of 44.8% during the forecast period. The technological innovations in 5G technology and the adoption of immersive technologies can have a tremendous impact on the virtual reality market growth in the coming years. source: globenewswire.com
Besides, management also announced new wireless docking solutions, and 60% revenue growth in the IoT products. The numbers look quite impressive:
With the previous information about new markets, in my view, it makes a lot more sense that management continues to increase its guidance for the next quarterly sales. With all this information in mind, I believe that it is a great moment to review the company’s revenue growth.
With Sufficient Acquisitions And Successful M&A Integration, Synaptics Is Worth Between $191 And $234 Per Share
After the acquisition of assets from Broadcom (AVGO) for $250 million and DisplayLink for $444.0 million, I believe that we can expect more acquisitions in the coming years. If inorganic growth continues to accelerate, in my view, we could see more net sales growth than the target markets’ growth:
On July 2, 2020, we entered into definitive agreements with Broadcom to acquire certain assets and assume certain liabilities of, and obtain non-exclusive licenses relating to, Broadcom’s existing Wi-Fi, Bluetooth and GPS/global navigation satellite system, or GNSS, products and business in the IoT market, or the Broadcom Business Acquisition, for an aggregate consideration of $250.0 million in cash that closed on July 23, 2020. Source: 10-k
On July 17, 2020, we entered into a definitive agreement to acquire all of the equity interests in DisplayLink Corporation, or DisplayLink, a leader in high-performance video compression technology. The acquisition closed on July 31, 2020. As of March 27, 2021, our purchase consideration was $444.0 million. Source: 10-k
In my view, the company has sufficient cash for product development. Under normal circumstances, I assumed that Synaptics will continue to design and increase its property portfolio. With more solutions, revenue growth will likely trend north:
We plan to utilize our extensive intellectual property portfolio, engineering know-how, and technological expertise to extend the functionality of our current product solutions and offer new and innovative product solutions to customers across multiple markets. Source: 10-k
With a significant number of existing clients, Synaptics will be able to offer new IoT voice, audio, and video solutions. The company announced new solutions for these clients. Under these assumptions, I believe that the company’s economies of scale may help the company report more free cash flow:
We plan to offer IoT voice, audio, and video solutions, wireless connectivity solutions, touch and display driver solutions, and fingerprint sensor solutions, as well as design tools, technical support and documentation to assist in the development of human experience designs in products such as PC peripherals, digital entertainment devices, smartphones, notebooks, and other applications. Source: 10-k
Finally, I expect that new strategic relationships could lead to better value-added semiconductor product solutions, and perhaps a new target market. Management highlighted this possibility in its more recent annual report:
We intend to develop and expand our strategic relationships to enhance our ability to offer value-added semiconductor product solutions to our customers, penetrate new markets, and strengthen the technological leadership of our product solutions. Source: 10-k
In the past, Synaptics’ working capital/sales, D&A/sales, and capex/sales were close to 3.4%, 5%-9.8%, and 1.6% respectively. In my view, future financial figures will likely stay around these figures.
Under this case scenario, I assumed 9%-10% sales growth from 2023 to 2025, which is close to the growth expectations for the semiconductor market:
The 2021-2026 CAGR for total opto, sensor, discretes (OSD devices) is projected to rise at a healthy rate of 8.0% and total IC sales are expected to increase at a slightly lower pace of 6.9%. CAGRs among major semiconductor product categories are forecast to range from a high of 12.3% for sensors/actuators to 3.1% for discretes. source: Semiconductor Sales To Rise
Under my assumptions, I included 2026 sales of $2.6 billion and an EBITDA margin of 38%, so 2026 EBITDA would stand at $976 million. If we also assume depreciation and amortization around 1%-2%, 2026 EBIT would be $729 million.
Now, with a capex/sales ratio of 1.6%-1.1%, free cash flow will likely grow from $424 million in 2022 to $654 million in 2026. The company’s free cash flow margin would stay close to 24%-25%, which we have seen in the past.
Now, if we also use a cost of capital of 9.62% like other analyst2026 discounted free cash flow would be $654 million, and the net present value would stand at $1.4 billion.
According to Seeking Alpha, the industry appears to be trading at 12.2x forward EBITDA. If we use this multiple for our exit multiple, the total equity would stand at $9.27 billion, and the implied price would be $234.
Now, if we are a bit more conservative with our exit multiple, we could use a valuation of 9.7x EBITDA. In this case, we obtain a fair price of $191, which is still larger than the current stock price.
Synaptics’ Client Concentration And Unsuccessful New Solutions Could Drive The Stock Price Down To $78 Per Share
Synaptics’ client concentration is a bit scary. Management reported that three clients are responsible for more than 10% of the total amount of sales. If one of these clients decides to discontinue its relationship with Synaptics, net sales decline could be substantial.
During fiscal 2021, we had three OEM customers that integrated our products into their products representing approximately 22%, 17% and 11% of our revenue. Source: 10-k
Management promised to obtain significant sales growth thanks to growing markets like the IoT. Future solutions may not be as successful as expected. In the worst-case scenario, revenue growth may be lower than expected, which would lead to fewer free cash flow expectations. As a result, we could envision a decline in Synaptics’ market capitalization.
Our product solutions may not be successful in new markets. Various target markets for our product solutions, such as IoT, may develop slower than anticipated or could utilize competing technologies. Source: 10-k
I believe that sales growth of 5% from 2023 to 2026 appears sufficiently catastrophic for my assumptions in this case. I also included a declining EBITDA margin from 35% in 2023 to 25% in 2026. The results would include the 2026 operating margin of $505 million.
If we also assume an effective tax of 21.5% and capital expenditures of about 1.32%, the free cash flow would decrease from around $395 million in 2023 to $315 million in 2026.
If we increase the cost of capital to 12.5% because of the detrimental results, the net present value would stand at $0.78.
With an exit multiple of 8.5x, the implied equity would be close to $3 billion, and the implied price would be $78.
Balance Sheet: $502 million In Cash
As of December 31, 2021, Synaptics reported $502 million in cash and an asset/liability ratio of 1x-2x. In my view, Synaptics has sufficient liquidity to finance further product development and a few acquisitions.
With long-term debt close to $983 million, Synaptics’ net debt does not exceed 1x-2x free cash flow. I wouldn’t be worried about the current amount of leverage.
Currently investing in growing industries like the virtual reality market and with a step also inside the IoT sector, Synaptics will likely grow. In my view, if management also buys other competitors and signs new partnerships, I would be expecting sales growth close to 9%, and significant upside potential in the stock price. Yes, I see certain risks coming from client concentration and unsuccessful new solutions. However, I believe that the stock is currently quite undervalued even assuming very pessimistic assumptions.