Imagination Technologies has 'strong legal case', analysts say alternative is 'fatal'

Apple has claimed to have design its own version of a graphics processor (GPU) that does not use Imagination's intellectual property, with its stated plan to stop using the IP within 15-24 months.

The US tech behemoth, which Imagination stated has not presented any evidence to show it will not be infringing on any intellectual property when it moves to its own in-house offering, accounted for £60.7m of Imagination’s sales in the the 2016 financial year and the company expects it to represent circa £65m of sales in 2017.

On the simplest view, Apple has indeed built a workable alternative to IMG’s IP and so the Hertfordshire company's receipt of royalties from Cupertino, California will rapidly dwindle from the second quarter of 2019 at the earliest, Jefferies said, looking at the worst case where "survival, let alone value, is in question".

This would imply losses of up to £65m as profit is deducted and while "IMG may be able to fight on patents", Jefferies suggested it may be a bargaining move, moving to a 'hold' rating and a price target of 95p after the shares collapsed from almost 270p to as below 86p at one point on Monday.

An alternative hypothesis from Jefferies analyst Ken Rumph is that Apple is actually flexing its muscle to bargain for a lower royalty rate, which is "not a happy picture, unless IMG actually has strong IP and Apple is bluffing".

If Apple cannot, as IMG suggests, replace the GPU without infringing its IP, the London-listed company has reserved its right to do fight the case.

"Proving infringement, and fighting the case could be expensive and difficult for such a David vs. Goliath battle. Financing it would require backers confident of the strength of the case," he said, adding that a final and "byzantine" option of a takeover "seems a long shot".

Analyst Nick James at broker Numis argued that, based on his experience of patent litigation -- "which can often be quite tenuous but yield massive settlements", the case against Apple "would be very strong if it tried to go it alone without a commercial agreement".

James said he believed any such agreement would be highly valuable to Imagination "and that the end result would more likely be Apple's outright acquisition of the company, giving it full ownership and control of the IP, combined with a semiconductor engineering team of scale with talents in key strategic areas".

With the two group's discussing potential alternative commercial arrangements for the current license and royalty agreement, James speculated that an option under consideration would be a one-off payment for a perpetual license to the patent portfolio.

"While it might appear that IMG is in a weak position, we would argue the opposite given the importance of the GPU to a number of Apple products, most importantly the iPhone," James wrote.

A doomsday scenario where no agreement is reached, he suggested IMG would need to sue Apple for patent infringement once the existing agreements roll off in late 2018.

"There have been precedents for very large settlements in similar cases, including Marvell paying $750m to Carnegie Mellon in 2016 for patent rights relating to hard disk technology and RIM paying $613m in 2006 for rights relating to a backup system."

Adding to the options suggested, JPMorgan Cazenove thought it was realistic that Imagination could sell its graphics IP to Apple or sell the right to use the graphics IP to Apple while continuing to maintain its own graphics IP business to other customers along with its MIPS and Ensigma businesses.

The alternative of getting the chop from Apple would be "potentially fatal" for the British company and would mean the only rescue would be a distress sale.

"In fact, we think it virtually impossible to build a model for the company without Apple revenue," the bank said in a short note.

But a break up of the company would only reap any proper value from the graphics IP, the bank said, "though breaking up the assets could potentially generate some more value than that reflected in the stock today after the announcement, though the cost will be in terms of how long this break up takes to execute".