Apple Inc. (NASDAQ:AAPL) already designs its own CPUs for the iPhone, iPad and iPod Touch. AAPL licenses the iPhone’s PowerVR GPU — graphics processing unit — from British chipmaker Imagination Technologies (OTCMKTS:IGNMF).
Despite the long-term relationship (and Apple owning a stake in the company), AAPL has decided to go it alone on the iPhone graphics chip. Imagination Technologies confirmed the bad news this morning, triggering a panic sell-off that saw the company’s shares plummet by over 60%.
AAPL’s Long Relationship with Imagination Technologies
Apple has been licensing the iPhone GPU from Imagination Technologies since 2008. Its dependence on the company to provide the iPhone graphics chip led Apple to boost its investment in its graphics partner to a 10% stake in 2009.
In 2014, it was announced that Apple had signed an extended deal with Imagination Technologies, agreeing to continue using its PowerVR GPUs in iPhones for a multiyear period. As the British chipmaker’s largest client, this was a big deal.
However, despite the new licensing deal, the relationship between the two companies began to deteriorate. Last year, MacRumors reported Apple confirmed it had been in talks to acquire Imagination Technologies outright, but decided to pass. From there, AAPL began hiring talent from the chipmaker, and was rumored to be establishing a UK office to develop its own iPhone graphics chip.
Apple to Design Its Own iPhone Graphics Chip
Those rumors became fact this morning when Imagination Technologies posted a statement on its website confirming Apple’s move:
“Imagination Technologies Group … has been notified by Apple Inc. (“Apple”), its largest customer, that Apple is of a view that it will no longer use the Group’s intellectual property in its new products in 15 months to two years time, and as such will not be eligible for royalty payments under the current license and royalty agreement.”
The fallout was immediate, with Imagination Technologies stock dropping over 68% within hours.
Designing a new iPhone GPU from scratch will be a challenge — especially without running into IP issues and while using a team with members from AAPL’s former long-term partner. Imagination Technologies notes this on its statement, saying: “Imagination believes that it would be extremely challenging to design a brand new GPU architecture from basics without infringing its intellectual property rights.”
However, Apple designs its own A-series CPUs for iOS devices, using ARM Holdings technology. Its success on this front shows that AAPL engineers can build customized chips that compete with the best. Ditching PowerVR for its own in-house iPhone graphics chip could give Apple a significant edge over the Android competition using off-the-shelf GPUs.
The Apple Effect Can Turn Around and Bite You…
As Imagination Technologies is discovering, working with AAPL can be risky. There is potential for huge rewards. But there is also the danger that Apple will decide technology is too important to be left with a third party and bring it in-house. Countless app developers have found this out the hard way when iOS gains new features that effectively replaces them.
GT Advanced Technologies (OTCMKTS:GTATQ) has seen the dark side of the Apple Effect. That company was tapped by AAPL to manufacture sapphire crystals for future iPhone use. The Apple deal meant a huge ramp-up for mass production. Unable to meet AAPL’s demands, rather than celebrate a big payday, the company was forced to declare bankruptcy in 2014.
The worst-case scenario here for Imagination Technologies is that Apple does go it alone and develops its own in-house iPhone graphics chip. Half of the company’s revenue disappears within two years. The most positive read is one that was spiked out on today’s statement:
“Apple’s notification has led Imagination to discuss with Apple potential alternative commercial arrangements for the current license and royalty agreement.”
In other words, for Imagination Technologies the best case scenario is renegotiating its deal, convincing Apple to stay be offering more favorable terms. Squeezing its suppliers is another move AAPL is well known for and this move could be just a bargaining tactic. Either way –designing its own iPhone GPU or continuing to use the PowerVR chip for less money– Apple comes out ahead. It always does…
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.