Landing a huge contract with a tech titan is surely the stuff of dreams for most small-cap firms, not to mention the latter’s investors. That dream may be about to become reality for Cardiff-based IQE (LSE: IQE) — a leading global supplier of advanced semiconductor wafers. There is growing speculation that the AIM-listed business will shortly announce a deal with Apple (NASDAQ: AAPL.US) that will see its technology feature in the Cupertino-based behemoth’s latest incarnation of the iPhone, due for launch in September.
Having your products in what is likely to become the most coveted gadget going can’t be bad for business. If rumours prove true, the impact on IQE’s fortunes would surely contrast with those of Imagination Technologies, recently put up for sale after being told by Apple that it would stop using the former’s technology. Earnings estimates would be speedily revised, increasing the likelihood of IQE’s share price rocketing.
Of course, buying shares in a company just based on rumour can be a risky strategy. Since there are no guarantees when it comes to investing, there’s always a chance that no deal will be forthcoming. As such, it surely makes sense to scrutinise the investment case of IQE as it stands today, without the inclusion of a transformative deal with Apple. Let’s do that.
Strong results
Back in March, the company released a record-breaking set of full-year figures to the market. Over 2016, revenue climbed 16% to £133m, with all key markets — photonics, wireless and InfraRed — showing evidence of organic growth. A beneficiary of favourable exchange rates following last year’s shock referendum vote, adjusted operating profit at IQE climbed by 17% to £22.1m.
In addition to these encouraging numbers, the company remarked on how more investment was being seen in the sector due to compound semiconductors being regarded as critical technology for exploiting growth areas (such as big data, autonomous vehicles and the Internet of Things).
Under the bonnet, IQE’s balance sheet still looks decent enough with fairly manageable levels of debt. Operating margins, returns on investment and cashflow have all improved over the past couple of years. But as to be expected with small companies with high-growth strategies, IQE doesn’t pay a dividend.
A price worth paying?
Since those numbers came in just over three months ago, shares in IQE have stormed ahead 71%. They now change hands on a fairly frothy valuation of 27 times earnings based on an expected 24% rise in EPS this year, reducing to 25 in 2018. Naturally, this is all subject to change if a deal with Apple is announced. Expect the forecast price-to-earnings (P/E) ratio to drop significantly if this occurs.
So, would I buy the shares right now? Without a deal in the bag, the valuation is a little too rich for me at the current time, particularly as investors are beginning to question whether this bull market can continue in the face of political and economic uncertainty. Should markets wobble as a result of concerns that are unlikely to impact on the company’s prospects however, I would certainly be tempted.
And if this dip just happens to occur before a deal is announced, the queue for IQE’s shares might be even greater than those outside its new client’s stores when the phone goes on sale.
