Why I’m avoiding Imagination Technologies Group plc

Does Apple’s exit signal the beginning of the end for Imagination Technologies Group plc (LON:IMG)?

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What a difference a day makes. The day in question is Monday 3 April, 2017. Shareholders in Imagination Technologies (LSE: IMG) woke up to the news that US tech giant Apple had notified the UK chip designer that it would no longer use the group’s intellectual property in its new products in 15 months-to-two years time, and hence Imagination would no longer be eligible for royalty payments under the current agreement.

A dark day

The reaction? Imagination’s shares opened the day at exactly 100p, some 168.25p lower than Friday’s close of 268.25p. During the course of what will be a dark day in the company’s history the shares continued to plummet to 76p, a level not seen since 1 March 2009, some eight years earlier. That’s a whopping 72% lower than the previous closing price.

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Apple is without doubt Imagination’s most important customer, contributing around half its revenues. The Hertfordshire-based group’s technology and intellectual property forms the basis of Graphics Processor Units in iPhones, iPads, and iPods, as well as Apple’s TV and watch offerings. Apple claims that it has been working on its own separate independent graphics design in order to control its products, and will be reducing its future reliance on Imagination’s technology.

Long-term survival

However, the UK chip designer is not convinced, with Apple yet to provide any evidence that it will no longer require Imagination’s technology, without violating its patents, intellectual property and confidential information. Imagination is now discussing potential alternative commercial arrangements for the current license and royalty agreement with Apple. The way I see it there are a number of possible outcomes:

First and foremost, it’s possible that Apple has indeed developed its own alternative technology without infringing Imagination’s intellectual property rights. If this was the case, then the UK business would lose around half its revenue by April 2019. Many believe that this could lead the company back into a lossmaking position, which could eventually bring its long-term survival into question.

Takeover?

Secondly, Imagination could take Apple to court, claiming infringement of intellectual property. The general consensus is that Imagination would have a pretty strong case, in which a one-off settlement would still leave the UK firm without its biggest customer in the long term.

Thirdly, Apple could take advantage of the decimated share price and launch a full-blown takeover. The US giant already owns 8% of the company and there have been many takeover rumours in the past. Some sceptics believe this has been Apple’s plan all along.

Finally, there is the possibility that current discussions will lead to a compromise, where Apple could use the threat as a bargaining chip (pun intended) to reduce royalty rates. This would still leave Imagination with lower revenues than previously forecast.

Things could get messy

None of the scenarios above would return Imagination Technologies to the way things were prior to 07:00 on 3 April. Some contrarian investors may be tempted by the heavily discounted share price, but I think that without Apple’s long-term support, the company may well find itself in a lossmaking position once again whichever scenario plays out. Add high levels of debt to the mix, and Imagination Technologies could even cease to exist.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool UK owns shares of Imagination Technologies. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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