synaptic (NASDAQ: SYNAI) is expected to receive significant revenue growth from the virtual reality market. If market conditions remain favorable for the Internet of Things industry, Synaptics is likely to drive revenue growth. Even taking risks into account due to client concentration and unsuccessful integration of acquisitions, I believe the stock price could trade at higher rates. Under my DCF models, the company looks like a buy.
Synaptics positions itself as a leading global developer of semiconductor solutions. The company believes it will help change the way people 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 rate of growth. In doing so, management tries to migrate to markets that are growing at a faster rate. Keep in mind that in its 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 over 44.8% from now through 2028:
The global virtual reality market size is expected to reach USD 84.09 billion by 2028, growing at a CAGR of 44.8% during the forecast period. The technological innovations in 5G technology and the adoption of immersive technologies could have a huge impact on the growth of the virtual reality market in the coming years. Source: globenewswire.com
In addition, management also announced new wireless docking solutions and 60% sales growth in IoT products. The numbers look pretty impressive:
With the previous information on new markets, I think it makes much more sense that management continues to raise its expectations for the next quarterly sales. With all this information in mind, I think now is a good time to evaluate the company’s revenue growth.
With ample acquisitions and successful M&A integration, Synaptics is worth between $191 and $234 per share
After acquiring assets from Broadcom (AVGO) for $250 million and DisplayLink for $444.0 million, I think we can expect more acquisitions in the coming years. If inorganic growth continues to accelerate, I believe we could see more net sales growth than target market growth:
On July 2, 2020, we entered into definitive agreements with Broadcom to acquire certain assets and assume certain obligations of, and obtain non-exclusive licenses with, Broadcom’s existing Wi-Fi, Bluetooth and GPS/global navigation satellite system, or GNSS, products and companies in the IoT market, or the Broadcom Business Acquisition, for a total consideration of $250.0 million in cash closed on July 23, 2020. Source: 10-k
On July 17, 2020, we entered into a definitive agreement to acquire all equity interests in DisplayLink Corporation, or DisplayLink, a leader in high-performance video compression technology. The acquisition was completed on July 31, 2020. As of March 27, 2021, our purchase price was $444.0 million. Source: 10-k
In my opinion, the company has enough money for product development. Under normal circumstances, I assumed that Synaptics will continue to design and expand its real estate portfolio. With more solutions, revenue growth is likely to move north:
We plan to leverage our extensive intellectual property portfolio, technical know-how and technological expertise to extend the functionality of our current product solutions and offer new and innovative product solutions to customers in multiple markets. Source: 10-k
With a significant number of existing customers, Synaptics can offer new IoT voice, audio and video solutions. The company announced new solutions for these customers. Under these assumptions, I believe the company’s economies of scale can 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 help develop designs for human experiences in products such as such as PC peripherals, digital entertainment devices, smartphones, notebook computers and other applications. Source: 10-k
Finally, I expect that new strategic relationships can lead to better value-added semiconductor solutions and perhaps a new target market. Management highlighted this possibility in its more recent annual report:
We plan to develop and expand our strategic relationships to enhance our ability to provide value-added semiconductor product solutions to our customers, penetrate new markets and strengthen the technology 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 numbers are likely to stay around these numbers.
In this scenario, I assumed revenue growth of 9%-10% from 2023 to 2025, which is close to growth expectations for the semiconductor market:
The 2021-2026 CAGR for total opto, sensor, discretes (OSD devices) is expected to increase at a healthy rate of 8.0% and total IC sales are expected to increase at a slightly slower pace of 6.9% . CAGRs under the major semiconductor product categories are expected to range from 12.3% for sensors/actuators to 3.1% for discretes. Source: Semiconductor sales up
Under my assumptions, I’ve included 2026 revenue of $2.6 billion and an EBITDA margin of 38%, so EBITDA in 2026 would be $976 million. If we also assume depreciation and amortization of about 1%-2%, 2026 EBIT would be $729 million.
Now, with a capex/sales ratio of 1.6%-1.1%, free cash flow is likely to grow from $424 million in 2022 to $654 million in 2026. The company’s free cash flow margin is expected to be close to 24% -25% remain, which we have seen in the past.
If we now also use a 9.62% cost of capital, like other analysts, the discounted free cash flow would be $654 million in 2026 and the net present value would be $1.4 billion.
According to Seeking Alpha, the sector appears to be trading at 12.2x forward EBITDA. Using this multiple for our exit multiple, the total equity would be $9.27 billion and the implied price would be $234.
Now if we were a little more conservative with our exit multiple, we could use a 9.7x EBITDA valuation. In this case, we get a fair price of $191, which is still higher than the current share price.
Synaptics’ customer focus and failed new solutions could push its stock price to $78 a share
Synaptics’ customer focus is a bit scary. Management reported that three customers are responsible for more than 10% of total sales. If one of these customers decides to end their relationship with Synaptics, net sales could drop significantly.
During fiscal 2021, we had three OEM customers integrating our products into their products, representing approximately 22%, 17% and 11% of our revenue. Source: 10-k
Management promised to achieve significant revenue growth thanks to growing markets such as the IoT. Future solutions may not be as successful as expected. In the worst-case scenario, revenue growth could be lower than expected, leading to lower free cash flow expectations. As a result, we can envision a decline in Synaptics’ market cap.
Our product solutions may not be successful in new markets. Several target markets for our product solutions, such as IoT, may develop more slowly than expected or may use competing technologies. Source: 10-k
I think a 5% revenue growth from 2023 to 2026 in this case seems catastrophic enough for my assumptions. I also recorded a declining EBITDA margin from 35% in 2023 to 25% in 2026. Results would include 2026 operating margin of $505 million.
Also assuming an effective tax rate of 21.5% and capital expenditures of approximately 1.32%, free cash flow would decrease from approximately $395 million in 2023 to $315 million in 2026.
If we increase the cost of capital to 12.5% because of the adverse results, the net present value would be $0.78 billion.
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 fund further product development and some acquisitions.
With long-term debt of nearly $983 million, Synaptics’ net debt does not exceed 1x-2x free cash flow. I wouldn’t worry about the current leverage.
Currently investing in growing industries such as the virtual reality market and with a step also within the IoT sector, Synaptics is likely to grow. If management also buys other competitors and signs new partnerships, I expect sales growth of close to 9% and significant upside in the stock price in my view. Yes, I see certain risks arising from customer concentration and failed new solutions. However, I believe that the stock is currently quite undervalued, even on very pessimistic assumptions.