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After rising 33% in 3 months, is now the time to buy back into this stock?

A couple of years ago there was a big fuss and plenty of excitement surrounding British-based processor designer Imagination Technologies (LSE: IMG), but the party came to an abrupt halt amid a flurry of profit warnings. Many investors will have walked away and forgotten all about the company. But lately however, it has been showing signs of renewed life. Is now the time to go back to the future?

Show some Imagination

Investors fell for Imagination Technologies because they hoped it would become the next ARM Holdings, an innovative, fast-growing UK tech giant that designs and licenses chip designs for use in iPhones and other modern devices. Especially since it was forecasting juicy long-term operating margins of 30%-40%. Imagination even came equipped with an ARM-style valuation too, trading at a reassuringly expensive 35 times earnings. But the future didn’t quite happen, with a string of broker downgrades in 2014 and three years of falling earnings per share (EPS) and profits.

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At the start of 2015, analysts were optimistically forecasting 2015 earnings growth of 39%, but as the year progressed things started to go wrong. The multimedia and communication technology company’s half-year report, published last December, warned of a slowdown in semiconductor and smartphone markets and ramp-down of customer’s legacy chips, which would hit short-term royalty revenues. Group revenues fell sharply from £82.2m to £71.1m, with the company’s operating loss doubling from £10.3m to £20.8m, overshadowing management claims that “the fundamental medium-term demand drivers remain strong.

Smart work

Despite all the misery, the company valuation remained toppy at around 25 to 30 times earnings, and it looked like investors were paying for a future that wasn’t there. Apple was said to be considering buying Imagination Technologies, then changed its mind. Falling royalty payments and delayed licensing deals culminated in job cuts, restructuring and plans to offload its lossmaking Pure digital radio business. Yet suddenly this year, sentiment changed. Why?

The shares have revived despite a string of disappointing reports and further losses. July’s final results were disappointing, with a 23% drop in revenue from continuing operations to £120.8m, although cash generation rose to £16.7m and net debt fell slightly to £33m. The summertime sale of ARM Holdings to Japanese telecoms group Softbank for £24.3bn gave Imagination a major lift, stirring speculation that it could be next, as its PowerVR graphics business, a key strategic technology used by Apple, could tempt buyers.

Tech trouble

Nothing has come of the takeover speculation so far but at least Pure has been sold off cheaply for £2.6m, allowing new chief executive Andrew Heath to focus on the firm’s intellectual property business, and claim the company has now put its difficulties behind it. Currently, it trades at 43.3 times earnings, which looks pricey given its recent history of problems.

There may be hope for the longterm, with earnings per share forecast to rise 35% in the year to 30 April 2018, and operating margins forecast to recover from minus 51.2% to 11.6%. But it would take a lot of imagination to treat this as the British technology company to replace ARM.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK owns shares of Imagination Technologies. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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