Remember when an Apple product event used to be exciting? Waiting on pins and needles for that “one more thing” to be pulled out of a hat by Steve Jobs? Those memories made yesterday’s product intros just plain depressing (slightly better iPads! Slightly better phones! Guess what price our streaming service will be!) … but that’s OK, being boring is not necessarily the end of the world for a massive cash machine like Apple.
If you force me to make a call on that stock, I’d tell you it’s overvalued now after being seriously undervalued for most of the past five years… but it’s far from an egregious overvaluation, particularly with their ability to buy back more stock and pay higher dividends. But today we’re not forced to make a call on Apple’s stock price following their product announcement… today we’re looking into a Motley Fool teaser about an Apple supplier.
Remember those? We used to see breathless teasers washing across the internet in the months before new Apple product announcements — the company that supplies the click wheel for the iPod! The stock behind the iPhone’s NFC chip! The display maker that will earn millions after it was chosen for the iPhone! So many chipmakers and partmakers saw their fortunes rise or fall based on being called to the big leagues and earning a slot in the latest iPhone design, but those days, too, seem to fade into memory.
Until now. The Motley Fool is back, and again this week was promoting an Apple supplier that they think will be a better play on the next iPhone sales surge than Apple itself. Most people are just sitting back and waiting (hopefully) for Apple to introduce its 5G-capable iPhone next year, when a lot of cities will have pretty decent 5G coverage, and see a huge upgrade cycle starting then, but the Foolies apparently have an idea for making some moola before then.
Here’s how yesterday’s version of the ad got started…
“In just a few short hours, Apple will crowd the Steve Jobs Theater for an incredible announcement that could finally unleash the iPhone Tsunami Forbes predicted earlier.
“Industry experts have followed this with fervor, after Apple presented the most revolutionary phone in history last year.”
And they throw in a couple big names…
“‘Apple is the greatest products company in history,’ said Jim Cramer. ‘…it should be valued at well north of $280.’
“David Gardner agrees as well. After all, he recommended shares of Apple back in 2008, leading to almost 1,000% returns since then.”
Jim Cramer did say that, in case you’re wondering, but he said it a little over a year ago… arguing that AAPL should be valued like a “cyclical industrial” company and get a mid-20s PE ratio (instead of 17, which is what it had at the time).
For what it’s worth, that opinion might still be rational (though not timely, and I don’t know how Cramer feels today)… Apple is still trading at a forward PE of about 17, and Industrial companies and similar cyclical stocks are still largely in the low-20s, on average.
So what’s the buy?
“… we think that the real winner of this conference isn’t Apple…
“But a small company that is 1/450th the size.
“One that you’ve probably never heard of.
“And if our research is correct, then this small company could be the investing story of the year.”
Apparently David Gardner has recommended this “small components company” since 2011… and he says it is built into the iPhone…
“… the technology they have perfected, and the patents they own, will be present on Apple’s new phone.
“And this company gets paid every time an iPhone gets sold.
“How many of your friends and family own an iPhone.
“Now, not only does this small company get paid when an iPhone gets sold…
“It goes back to shareholders as well.”
So they’ve presumably been paying a dividend… or at least buying back stock, which helps to narrow it downa little bit.
And, of course, they call this a “flash sale” — though that’s pretty silly and is just a way to push you to buy buy buy. Stock Advisor gets put on sale for $49 a year like this all the time, with all kinds of different promos, so there’s no reason to make a hasty decision to beat the deadline… you can think it over.
Any other clues? Yes, thankfully a reader got a different version of the ad and forwarded it along… it included these hints:
“In fact, this company’s market cap is less than the total number of Apple shares available!
“This small company handles the lasers inside Apple’s cameras that can handle the augmented reality capabilities that Apple dreams of.
“Not only do they provide these state-of-the-art lasers, but this company has components for the coming 5G revolution, AND driverless car technology.
“Essentially, they are an ‘all-in-one’ company.
“And with some analysts calling for a Hail Mary for Apple’s 5G initiative, this company could stand to benefit.”
Apple is not a “hail mary” company, of course, so nobody expected them to rush out a 5G iPhone this year (and they didn’t) — Apple wasn’t the first one to introduce contactless payments, they weren’t the first with a better camera, wireless charging, or waterproofing, among other advances and new features that have become de rigeur in the smartphone world… and they won’t be first with 5G (there are a couple 5G phones available already). They generally wait until the technology works, is proven, and has a clear demand before they include it, and they don’t tend to take as many chances as Samsung does in its efforts to claim a technological lead or be first. Apple generally seems to work from the principle that good design, reliability and ease of use are more important than being first with a particular feature.
So no, there was nothing new and shocking in the new iPhone release announcement yesterday, at least on the “breakthrough technology” end — probably the most notable news was that the prices were lower than expected for the new phones. The screens area little better, including a bigger super-retina display on the top-of-the-line iPhone 11 Pro, the water-resistance is a little better (now the top phone can spend half an hour in the pool, not just in a puddle), and that top phone also added a third camera (adding ultra-wide to the wide and telephoto “lenses” that were already available)… and, in perhaps the most important update for day-to-day use, they improved the battery, that top hone now provides, they say, up to 20 hours of video playback on a charge.
But if these new products do provide at least a little bit of an upgrade cycle for folks who don’t want to wait until 5G comes, probably next year, that would help all the Apple suppliers… so which one is the Motley Fool teasing here?
Well, it could really only be one of two companies that are both suppliers of optical equipment (like those sensing lasers) for the iPhone… Lumentum (LITE) and II-VI (IIVI). Both of them have a wide range of optical and laser equipment for a variety of different industries, including sensors for self-driving cars and high-end equipment for fiber-optic networks. Lumentum almost meets most of the clues, it’s got a market cap of about $4.5 billion and that’s pretty close to Apple’s 4.5 billion share count, though it’s a bit too big to have ever been 1/450th the size of Apple at any point in the past few years… but if it’s a stock that David Gardner has been recommending for Motley Fool Stock Advisor since 2011, the choice is clear: This must be II-VI (IIVI). Lumentum didn’t exist as an independent company until 2016, when it was spun out of the old JDS Uniphase (now Viavi Solutions (VIAV)).
II-VI was teased by a different Motley Fool service (one of their special “emerging opportunity” portfolios) back in June, this is what I said about it at the time:
II-VI (IIVI), the optical equipment company that is one of the triumvirate of 3D sensor firms supplying Apple and other major manufacturers — most interesting at the moment because they are buying one of the other ones (Finisar (FNSR)) in an attempt to scale up and create two-way competition with Lumentum (LITE), which has apparently gotten the lion’s share of Apple’s 3D sensor business so far.
II-VI did report 200% growth in 3D sensor shipments late last year, though that is far from being the overall revenue growth of the company. I’ve seen a few forecasts about 3D sensing being relatively slow to “take hodl” in smart phones, like this one from Trendforce, and most of them also rely heavily on guessing about what kind of impact the next iPhone upgrade cycle will have. This is still a technology that’s not even in 10% of phones yet, let alone widely used for AR, so in many cases we’ll remain in the dark until word of what advancements will come in the next iPhone and whether that creates a big upgrade cycle, and a real high-volume demand driver for these sensors.
The Fool definitely recommends IIVI for some of their services, that’s confirmed in the disclosures in this free article they posted last month, and it’s the best match for these clues, though LITE will likely be driven by the same market forces and will probably have similar performance. For what it’s worth, the Fool does not apparently have any active recommendations on Lumentum or Finisar.
What has happened since then? Not a whole lot on the product or fundamentals front, but quite a bit on the “story” side — IIVI is not as tied up in the Huawei story as Lumentum is, since it wasn’t as large a supplier to Huawei (they announced back in May, when Huawei went on the “entity” blacklist, that the impact would be minimal)… but IIVI has a very large Chinese business, and they have to have approval from Chinese regulators in order to consummate their merger with Finisar and achieve the same scale as Lumentum, and it’s entirely possible that approval could become part of the tit-for-tat trade war (that approval process has recently been a bit delayed, as II-VI announced at their last earnings report, though it’s not a huge deal in the context of global US-China trade, and won’t likely generate a lot of headlines).
Optical equipment and lasers are both growth businesses, as is 3D sensing for all kinds of consumer products, so there should be a good runway for both LITE and IIVI for the next several years as long as the trade war doesn’t disrupt business too much. Assuming Finisar really does merge into II-VI next year at some point, the analyst projection is that the combined company would have EBITDA of about $750 million and an enterprise value of a little over $5 billion. That’s a pretty reasonable valuation for a large player in an industry that seems to be somewhat of an oligopoly (not many players, so price competition should not be that fierce).
The value of the deal to Finisar shareholders, if it closed today, would be almost exactly $25.50 per share (the deal is for $16.50 in cash per share, plus 0.2218 shares of IIVI, per the original announcement last November). FNSR is right around $23 right now, so you could always be an arbitrageur, too, and bet on the target company — you’d get a little less exposure to gains if IIVI soars higher (if IIVI climbs 25% to $50, for example, FNSR should only rise about 20%), but would have much of the upside and some support on the downside, assuming the deal is approved in China and goes through, because of that $16.50 per share in cash FNSR shareholders will get in the transaction. If the deal doesn’t go through, FNSR would presumably drop… all else being equal (which it never is).
I don’t know how to handicap the future of Finisar, Lumentum and II-VI during the trade war — they’re all inextricably linked with China in some ways, with major customers in China and major manufacturing operations in that country, so their business could certainly be disrupted with the next Trump tweet or the next trade meeting. The biggest risk for IIVI is not the Huawei ban, though that is apparently having a meaningful impact on Lumentum sales, it’s that any backlash could impact the II-VI Finisar merger… and, of course, if the merger does go through they will have the risks and costs associated with combining large and complicated companies (they anticipate substantial cost savings over a few years, and did guide that the deal would be accretive to non-GAAP earnings in the first year… though that was almost a year ago, and the world has changed quite a bit in the interim).
Right now, II-VI is quite reasonably valued — probably thanks to the trade war/merger concerns. They’re expected to grow earnings by about 12% this coming year, growing (presumably because of both growing end markets in optical networks and 3D sensing and because of the merger) by almost 20% the year after. Averaging out the earnings growth for the next few years to something in the mid-teens makes the current valuation of 16X trailing earnings look pretty good… so if you can stomach the China risk, I wouldn’t try to talk you out of this one.
Oh, and no, neither Lumentum nor II-VI “returns cash to shareholders” in any meaningful way — they have both done buybacks, with IIVI doing some relatively large ones a year or two ago that might be what the Fool is referring to, but neither has done enough buying-back of shares to outpace the rate of employee stock option grants, and neither pays a regular dividend.
And, of course, do note that this is probably not a particularly timely story — yes, the ad came out this week because of the “Apple celebration” angle the Fool could use to get your attention… but it’s not a new recommendation of theirs and might not even be a recent re-recommendation, the story they’re telling about this stock hasn’t changed much since we covered it in June. If David Gardner recommended it in 2011 and is still holding, as is fairly typical for the Fool, that means they’ve held through a near-50% drop once already so, as is also typical for them, they’re not super price-sensitive with their recommendations or their Stock Advisor portfolio… and this particular stock has done substantially worse than the broad market since that initial recommendation, even if you track it from the low point of 2011 (up 120% since December of 2011, versus 180% for the S&P 500 or 270% for the Nasdaq average). That could change, of course, their current prospects look good other than the China risk… and that kind of patience might be good for the long-term investor, and the Fool does have a good track record… but sometimes readers who get excited about overheated teaser ads have (understandably) very different expectations for short-term gains.
If II-VI turns out to be a real barn-burner over the next year, it will probably be because a lot of other tech equipment stocks are also doing quite well and the China disputes have either settled or cooled — it’s probably a reasonable opportunity here for the risk-taker, given the solid growth and the decent valuation, but I haven’t bought shares.
It’s your money, though, so it’s your call — what do you think? Excited about II-VI or any of the other laser or optical equipment companies? Think there’s something exciting about what Apple announced yesterday that will make you some money? Let us know with a comment below… thanks for reading!
Disclosure: Among the companies mentioned above, I own shares of Apple