Pixelworks: Why Apple May Just Be the Start

Shares jumped nearly 88% in regular trading Thursday and continued to surge after hours after the company disclosed in its 2013 annual report that Apple Inc. (NASDAQ: AAPL) is responsible for more than 10% of Pixelworks’ revenue.

The question that immediately came to mind was what does Apple want from Pixelworks? The short answer is the processors could be used in Apple’s iPhones, iPads or even the Apple TV — assuming Apple develops one. The report does not say what Apple wants, and Pixelworks wasn’t discussing the matter either.

The speculation among investors Thursday was that Apple is interested in Pixelworks’ technology because it produces fantastically sharp images, regardless of size of the device: smartphones, tablets, personal computers or televisions.

While Apple knows smartphones and tablets, its expertise in digital televisions is much more modest. Samsung, its partner and rival, knows a lot about high-definition TVs and doesn’t need the expertise.

So Apple needs Pixelworks, and there was even talk Thursday that Apple might consider buying the company. But Pixelworks is not dependent on Apple. It generates 57% of its revenue from five companies: Hitachi Ltd., Apple, NEC, Panasonic and Seiko Epson. Its chips are used in smart phones, digital projectors and the like.

The business should get better. Smartphone sales are growing, and manufacturers are scrambling to offer new features with each model. Digital projector sales also are growing.

But most important may be television hardware. Sales of flat panel TVs reached some 230 million units in 2013, with smart TVs — those with Internet and wireless connections — reaching some 76 million units.

Prices are coming down fast, and smart TVs are expected to dominate total television sales in the next few years. Strategy Analytics sees smart TVs accounting for 73% of global television sales by 2017. Moreover, the technology is rapidly evolving so that the images are sharper than ever. Pixelworks competes with Nvidia Corp. (NASDAQ: NVDA), Qualcomm Inc. (NASDAQ: QCOM), Samsung, and others.

Pixelworks saw revenue of $48 million in 2013. Sales should hit $64.5 million, up 34%, in 2014 and $82.7 million in 2015, up 28.2% from 2014. Losses under generally accepted accounting should become profits in 2014; the consensus estimate is $0.08 a share.

Pixelworks closed at $9, up $4.20, on Thursday. The stock was up as high as $9.34 in the after-hours trading on Thursday, but was trading around $9.28 in the premarket session on Friday. The shares have nearly doubled so far in 2014 and are up more than 300% from their 52-week low of $2.11 in April 2013.

The company has just one analyst covering it, Krishna Shankar at Roth Capital Partners. His price target before Thursday was $6. He probably will see a lot more people covering the company.

There is of course always one reminder to keep in mind. Apple is notorious for driving a very hard bargain, and its suppliers have often seen their shares punished when deals change or disappear down the road. This is new and therefore not likely fall under that scenario any time soon, but it still should be kept in mind.