Imagination IMG LN S W
October 25, 2016 - 11:49am EST by
2016 2017
Price: 2.41 EPS 0 0
Shares Out. (in M): 280 P/E 0 0
Market Cap (in $M): 675 P/FCF 0 0
Net Debt (in $M): 40 EBIT 0 0
TEV ($): 714 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Imagination Technologies (IMG LN) provides semiconductor intellectual property for graphics processors (PowerVR division – 73% of revenue), IOT architectures (MIPS division – 25% of revenue) and network architectures (Ensigma division – 2% of revenue). Apple is IMG’s largest customer and is estimated to account for 60% of IMG’s revenue and likely all of its operating income in GPU royalties (extremely high margin). For reasons discussed below, we believe Apple is moving towards an in-house graphics processor, disintermediating IMG, leading to permanently structurally declining earnings. At the very least, the threat of a potential in-house design should increase IMG’s discount rate and reduce the earnings multiple to account for this risk. We believe IMG LN should trade down 60%+ to 91p.


Apple’s iPhones and iPads have licensed and used PowerVR GPUs from Imagination Technologies for graphics. Just as Apple began by licensing standard ARM CPU cores but now designs its own, we believe the company has similarly shifted from licensing PowerVR to designing a custom GPU. This new GPU first shipped in the A8 processor that is in the iPhone 6, and its descendents are also in the A9 and A10 Fusion processors in the iPhone 6S and 7.


The Three Components of a GPU and Evidence of Apple’s Internal Design Shift


The three main parts of a GPU are as follows:

  1. Fixed Function Graphics Hardware – This includes dedicated silicon for graphics functions such as triangle setup and clipping, triangle rasterization, raster output and blending

  2. Shader Core – This is the engine of the GPU and executes programmable shaders (e.g., vertex, geometry, pixel, and compute shaders) written by developers. For example, applying a blur to create depth of field to a scene, or applying a convolution for a facial recognition neural network.

  3. Graphics Driver – Conceptually the OS for the GPU. This software runs on the CPU and coordinates the activities of the GPU.


Visual and machine learning applications such as Apple Maps use the Metal or OpenGL ES API to access the resources of the GPU. The graphics driver (3) acts like the operating system for the GPU and translates Metal or OpenGL ES into commands that run on the fixed-function hardware (1) and shader programs that run on the shader cores (2). One of the graphics driver’s (3) largest components is the compiler which transforms shader programs into machine instructions that run on the shader cores (2).


Apple Shifts to Proprietary Graphics

Since 2009, Apple has been hiring graphics architects and driver developers from industry leaders such as AMD, Intel, Google, and Nvidia. Currently, Apple has posted over 50 open positions for graphics engineers working on hardware (e.g., architecture, bring-up)and software (e.g., drivers, compilers) design. (See below for a some of Apple’s job posts.)


Based on public evidence such as optimization guidelines, Apple has designed custom shader cores (2) that are more efficient and higher performance for key workloads (e.g., graphics, image processing, machine learning) than the shader cores in Imagination Technologies’ PowerVR GPU.  Apple also wrote their own graphics driver (3) and shader compiler to fully leverage the unique capabilities of the custom architecture. We believe that Apple’s GPU continues to use some of Imagination’s PowerVR fixed-function graphics hardware (1). In summary, Apple’s GPU  uses some PowerVR IP, but overall it is a unique and proprietary design that offers superior performance and efficiency for critical applications.


Evidence of Apple’s Design Change

In order for developers to take advantage of the GPU, they have to understand how to write shader programs for the Metal and OpenGL compilers. At WWDC 2016, Apple engineers gave a presentation “Advanced Metal Shader Optimization” that contains the most detailed tuning guidelines and architectural details to date on the custom GPU. The architecture for the PowerVR Series 6 GPU is also poorly documented, but Imagination Technologies has shared some basic compiler and optimization manuals. Comparing the available details for the two make it clear that they are very distinct. In particular, (1) Apple’s register file and (2) data conversion functions are better suited for performance and power-efficiency and are an easier compiler target.

  1. Register File – The two major formats are 16-bit half precision and 32-bit single precision calculations. While 16-bit is generally less accurate, it is accurate enough for graphics since most displays range from 8-12 bits per pixel. The register file for Apple’s GPU is composed of 16-bit registers. Apple’s engineers emphasized that using 16-bit offers twice the performance and twice the power efficiency of 32-bit, making it clear that their architecture is focused on 16-bit primary design point. In contrast, the IMG PowerVR Series 6 and 7 GPUs use 32-bit registers, further evidence that Apple is moving away from Imagination’s graphics design.

  2. Data Conversion Function – While 16-bit has the advantages described above, it’s often not precise enough for large blocks of color. From Apple’s presentations to developers, we know they offer seamless conversion between 16-bit and 32-bit at the hardware level which is advantageous for developers. On the other hand, Imagination’s PowerVR’s optimization manual states that data conversion has a cost (not as seamless) and recommends developers write programs to minimize the number of conversions. What this means is that Apple’s is clearly using their own data conversion functions which are superior to Imagination’s.


Strategic Advantages of a Custom Design

Apple’s history with the iPhone is clear – the long-term trend is towards propietary solutions that give the company more platform control and differentiation. In early designs, Apple used standard ARM CPU cores designed and manufactured by Samsung. Starting with the iPhone 5, Apple switched to a custom CPU that is internally designed and now has best-in-class performance – eclipsing ARM, Qualcomm, and Samsung.

We believe that a custom GPU provides 4 strategic advantages for Apple:

  1. Deliver superior performance and power efficiency. Apple’s iPhone 6S has the best performance on almost every smartphone benchmark and doesn’t suffer any overheating problems like the competition. The iPhone 7 is 40-50% faster for graphics, giving the company clear differentiation. Apple’s developer tools also take advantage of the GPU for image processing and machine learning applications and are accessible to third party developers. For example, Instagram could use Apple’s tools to improve the filters on pictures.

  2. Develop new features and fix bugs in their custom GPU without helping competitors. Imitation is a sincere form of flattery and with a standard licensed GPU from Imagination, changes are available to Samsung, Mediatek and others. Apple’s proprietary design is harder to copy and preserves differentiaion for the company.

  3. Improve time-to-market and lower schedule risk. With an in-house design, Apple can invest as much in engineering as necessary to hit product release dates. In contrast, Imagination simply has less resources available. Developing products and ramping to high-volume is inherently iterative. A bespoke GPU reduces the number of external dependenceis and is easier to iteratively experiment with and fine-tune for production. Apple can also guarantee higher standards for quality control by investing more in validation and verification.

  4. Reduce dependence on suppliers. Apple avoids single-source components and always encourages alternate providers (e.g., choosing Intel’s LTE modem for iPhone 7 as an alternative to Qualcomm). Apple has already built a large GPU design and software team, which could develop fixed-function graphics hardware if necessary. An internally designed GPU is a highly effective second-source, which gives the company excelleng leverage in negotiations.

Why Does Apple Still Pay IMG if the Switch Happened Beginning with the iPhone 6 (2014)?

While we do not know the terms of Apple’s agreement with Imagination, we know it was extended for a mult-year period in February 2014 (before the launch of the iPhone 6). However, it’s very apparent that IMG is providing less value to Apple today vs. pre-2014 and Apple is continuing to make their own GPU better with each iteration (and expanding their internal team). It’s clear that IMG is losing leverage with Apple as they move away from IMG and the discount rate on the stock should reflect this. Given that this is a multi-year agreement that began February 2014, we should expect by 2017/2018, the renewal economics (if any) should be lower.


Rumors of Apple’s Buying IMG?

  • Purchase price is too high – The shader core and graphics driver are the hardest parts to design. Apple has already designed these two parts of the GPU (discussed above) and the fixed function graphics hardware is used for only 2D/3D graphics. This is very easy to do and we estimate Apple can simply hire 20 engineers at $500k/engineer to build this. We estimate this based on Nvidia’s team consisting of 10 engineers. Since Apple has already designed the hardest parts of the GPU, it is unlikely they will pay $1bln for IMG when they can do it in-house far cheaper.

  • Apple doesn’t want MIPS and Ensigma – these divisions are not interesting to Apple and they would have to sell/close them down


Basically, Apple would pay $1bln for a small design team to design 1/3 of a chip that it can easily do in-house for 2-3% of the purchase price of IMG.



Valuation based on the thesis above is fairly simple. IMG currently trades at 35x 4/2018 PE on net income of 20m GBP. Per UBS estimates below, Apple should pay IMG $90-100m USD (70-75m GBP) in revenue. Should Apple’s payments to IMG decline, the company could not sustain operations and the stock would fall at least 50-75%.


What’s the Right Discount Rate?

Assuming a 7% LT growth rate (extremely aggressive), at 35x PE, the market is putting a 10% discount rate on IMG. Given that there’s a high likely the company may not exist in 3 years and is at the whim of a single customer that has designed out 2/3 of IMG’s product, we think that’s absurd. At a 15% discount rate, IMG’s multiple should be 12.5x (again on an aggressive 7% long term growth rate) on a 1/r-g formula. This would value IMG at 91p or at least 62% downside.


Again, we cannot guarantee that Apple will fully design out IMG but believe that it is very likely and the market multiple does not properly reflect this risk and therefore should contract significantly.

Worked in tandem with David Kanter of RealWorld Tech -
David is available to speak through GLG and direct consulting relationships. 



[1] Fiona and Alex Kan, Advanced Metal Shader Optimization. WWDC 2016.

For details concerning 16-bit registers, see p68

For details concerning data conversion, see p69

[2] PowerVR Series6 Compiler Instruction Set Reference. March 17, 2016. see p7 for element selection within 32-bit registers, p8 for FMAD, FMUL, and FADD definition and 16-bit variants

[3] PowerVR Performance Recommendations. March 17, 2016. see p19

[4] MetalPerformanceShaders Framework.





I hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Apple's revised deal with IMG

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