At current prices, Synaptics offers something rare in today's environment: a reasonably priced secular growth story in technology hardware with the potential for substantial "beat-and-raise" financial performance over the next 2-4 quarters. This potential is driven by a new technology hardware trend: fingerprint sensors becoming a "must have" feature for high end smartphones and tablets. Two years ago, Apple acquired Authentec, locking up the leading fingerprint sensor company to supply Apple devices only. Apple introduced its first product including a fingerprint sensor with the iPhone 5S in 2013, and Samsung dutifully followed suit by introducing a fingerprint sensor (believed to be from Synaptics' Validity Sensors acquisition) in its Galaxy S5 line unveiled at MWC last week. Many technology analysts predict that fingerprint authentication will be at the center of new initiatives by Apple and Google to push secure mobile payments forward. I believe that the Galaxy S5 is the first of a wave of Android smartphones and tablets that will include fingerprint sensors, the lion's share of which will be supplied by Synaptics. From my unscientific sampling of Wall St. SYNA models, I believe that analysts have limited fingerprint sensor revenue included in their projections and the fingerprint sensor revenue will be largely incremental to revenue and earnings (after making allowances for corporate gross margins), making SYNA appear cheap in hindsight. There is also a subtle twist to the story that could make the impact to SYNA's financials dramatic: the first wave of sensors including the Galaxy S5's are "swipe" sensors that cost approximately $1.50 per unit but to match Apple's technology capabilities as embodied in the iPhone 5S I believe that SYNA will introduce an "area" sensor with an ASP over $4.00 even as the attach rate to Android devices is increasing substantially. To add further fuel to the fire, the stock currently has a large short interest that I believe is based on outdated or incorrect perceptions about the company's market position and a short squeeze could result.

 

Synaptics describes itself as a "leading worldwide developer and supplier of custom-designed human interface solutions that enable people to intact more easily and intuitively with a wide variety of mobile computing, communications, entertainment and other electronic devices". Synaptics is essentially a semiconductor company that supplies touchscreen controllers along with firmware and software to enable touch sensing in smartphones, tablets, PCs and other devices. Its customers include virtually every smartphone, tablet and PC manufacturer with the notable exception of Apple, which is believed to use internal software combined with a Broadcom chip. The company was an early leader in PC laptop touch pads and expanded to touch interfaces for phones and tablets. If you look at a long-term chart of SYNA, you'll notice that despite the huge increase in touchscreen adoption among smartphones and the emergence of tablets, the stock was essentially flat between 2008 and 2012, inclusive. During the period, SYNA went through a number of difficult transitions. First, it went from supplying touchscreen modules that included components other than the touchscreen controller to simply supplying controllers, which pressured ASPs even as volume was ramping. Second, the company's market share was challenged in PCs by Elan (a Taiwanese competitor) and in smartphones and tablets by broader microcontroller suppliers Cypress and Atmel. Indeed, certain executives at these two companies would confidently predict that their companies would crush SYNA in touch screen controllers. These two issues led to a considerable short interest in SYNA during these years, which I was a part of at certain points.

 

However, over the course of 2012 and 2013 Synaptics regained its lead in touch controllers for smartphones and tablets, partially by being the first company outside of Apple to enable an "in-cell" touch solution, where the sensor electronics are patterned inside of the LCD glass. The company further benefited from the increase in "touch" content in Windows PCs (especially laptops) as an increasing number of PCs are incorporating touchscreens to take full advantage of Windows 8. The larger touchscreens involved in PCs lead to higher controller ASPs and are additive to the touchpad controller revenue. Secular growth in smartphones and tablets, increased market opportunity in PCs and share gains have led to solid financial and share price performance over the last year. My channel checks indicate that at least so far Cypress and Atmel has been unsuccessful recapturing touch controller share, and indeed it seems clear in retrospect that Synaptics was always investing more in pure touch R&D so perhaps this should not be surprising. In the most recent quarter, PC revenue (35% of sales)  grew a solid 17% year on year while non-PC revenue (65% of sales) grew a stellar 64% for overall revenue growth of 44%. Earnings growth has also been solid although R&D has been growing due to further investments, including fingerprint sensors. Due to the cyclical and competitive nature of the semiconductor industry, despite this rapid growth the stock trades at 15x Wall St. consensus FY June 2015 EPS, or about 12x ex $10.70 per share in net cash. Wall St. expects growth to slow down considerably over the next twelve months after a great calendar 2013, but I think the high growth may persist for another two years due to fingerprint sensors, as I will detail below.

 

Synaptics entered the fingerprint sensing business with its acquisition of Validity Sensors in November 2013. The listed acquisition price is $128M including $37M of estimated contingent consideration that could be worth up to $162.5M if all goals are hit. Validity was considered the second leading mobile fingerprint sensor company after Authentec by some sources but the pro forma disclosure indicates the company generated little revenue at the time of acquisition. Competition in fingerprint sensors is limited with Apple vertically integrated and the next leading player a publicly traded Swedish company (Fingerprint Cards AB) with a small amount of revenue and no major smartphone customers. The combination seems to have solid industrial logic behind it, Synaptics is already a key supplier to the customer base Validity was pursuing and the companies have similar supply chains. It seems possible that the touch sensor and fingerprint sensor could be combined down the road, perhaps enabling fingerprint sensing to be built into the touchscreen itself instead of requiring a discrete sensor. Some contacts have speculated that Samsung encouraged Synaptics and Validity to get together, wanting to buy the fingerprint sensors from a key existing supplier instead of counting on an unproven startup with limited revenue for a new feature on its all-important Galaxy line of smartphones. Samsung indeed showed a "swipe" fingerprint sensor on its Galaxy S5 introduced at MWC last week, and while I saw some references to it I was surprised that Wall St. analysts did not devote more attention to the implications. Indeed, SYNA stock sold off after its January 23rd earnings call as some investors had expected a higher guide if the company had indeed won the Samsung Galaxy S5 fingerprint sensor business. I read SYNA's March quarter guidance as very conservative and probably not inclusive of the fingerprint business at Samsung, either because Samsung did not make the decision on whether or not to include the fingerprint sensor until the last minute or because SYNA did not want to pre-announce a feature by guiding to significant fingerprint sensor revenue before Samsung had a chance to introduce the S5.

Therefore, I believe there is likely to be upside to the March 2014 quarterly revenue, and potentially significant upside to the current June 2014 consensus of $231M. In fact, I think that Samsung might build 25M Galaxy S5s in the June quarter, leading to $38M (16% revenue upside) in un-modeled fingerprint sensor revenue, with a greater impact on earnings as I believe somewhere between 30 to 50% of this revenue will drop to the operating income line. It gets more exciting in fiscal 2015, as analysts have growth modeled at 16%, a significant slowdown to the growth in fiscal 2013 and 2014 despite the ongoing growth in smartphones and tablets and the adoption of touchscreens in PCs. I think that the other leading Android OEMs will follow Apple and Samsung's lead to include fingerprint sensors in high end phones released in the second half of calendar 2014 and beyond. During fiscal 2015 the fingerprint sensors may also mix shift to the higher ASP area sensors, leading to upward pressure on the overall fingerprint sensor ASP. If fiscal 2015 had 50M sensors shipped to Samsung and 50M to other Android OEMs and the average ASP increased to $2.50, there would be $250M of largely incremental revenue. If we assume 150M units (which would still be a relatively small portion of the smartphone market) at a $3.50 ASP in 2016 as area fingerprint sensors experience widespread adoption, 35% incremental operating margin, 15% taxes and 39M shares O/S, the incremental EPS could be $4.00. Add this to current 2016 consensus of around $5.00 per share, and it is not hard to imagine a stock price in excess of $100 without assuming a crazy multiple or short squeeze.

 

• Atmel, Cypress or Elan taking share in touch controllers
• SYNA's fingerprint sensors not working "as advertised"
• Further fingerprint sensor competition
• General slowdown of growth in the smartphone market or faster shrinkage in PCs
• The short interest- while I think it will be a help to the share price if my thesis plays out, it is always possible the shorts have figured out something I haven't

Disclaimer

I am long SYNA. This may change at any time without notice. Nothing I write should be construed as investment advice or a recommendation to buy or sell specific securities. Please do your own research. While everything I write is factually correct to the best of my knowledge, I encourage you to notify me of any mistakes or oversights in the comments section.

• Upside to March 2014 quarter earnings from Galaxy S5 fingerprint sensor ramp
• Analysts incorporating significant fingerprint sensor revenue into fiscal 2014 and 2015 estimates
• Introduction of further smartphones with fingerprint sensors
• The transition from "swipe" sensors to higher ASP "area" sensors
• Shorts capitulating