On July 31, investors saw Synaptics stock price (SYNA) lose roughly a third of its value after the company reported earnings for its fourth quarter ending June 30.  The company actually posted strong earnings of 47 cents per share which was 57% higher than the fourth quarter of fiscal 2008.  However, as management issued guidance for the upcoming first quarter, analysts were very disappointed with the outlook.

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Management told investors to expect revenue to fall in the range of $113 to 119 million which is relatively even with the first quarter last year, and significantly below analyst expectations of $127 million.  For the full year, the picture actually looks better with management guiding for revenue of $495 to $525 million compared with 2009 revenue of $473.3 million.  However, it appears that investors have a very short time horizon and are only willing to consider the most current quarter in their pricing of the stock.

A significant change in management certainly didn’t help investor confidence as Francis F. Lee announced that he would step down as CEO and named Thomas J. Tiernan (currently the Chief Operating Officer) as his successor.  Mr. Lee will remain as the firm’s Chairman but expects to turn the day-to-day management and strategic decisions over to Mr. Tiernan.  While management changes can often signal a new direction and better profitability for growth companies, it also can send a negative signal to long-time investors who have grown to trust the existing management team.  It was difficult to absorb both the disappointing quarterly guidance along with the uncertainty of this change in leadership.

Synaptics is stronger and better positioned than at any time in its history and as I am interested in dedicating more of my time to my family, my foundation and other charitable and civic endeavors, I feel this is the right time for me to step down as CEO. Tom and I have worked closely together to spearhead the company’s growth over the past three years, and the Board and I have confidence in Tom’s ability to lead the company through its next stages of growth. ~Francis F. Lee, Chairman and departing CEO

One of the concerns voiced after the earnings announcement is that Synaptics is beginning to see its revenue shift from high margin module products to chip solutions which have lower profitability.  While it certainly is important to keep an eye on profitability, the diversification into different solutions is actually part of the company’s plan to add stability to its revenues.  Management noted a growing pipeline of design opportunities in both PC and non-PC.  The diversification benefits may be slight as most of SYNA’s business will be related to general technology trends, but having a number of different clients in PC, handset, and other technology solution businesses can help to smooth out some of the spending cycle.

At the end of the quarter SYNA was sitting on $192 million in cash and had a backlog of $62.8 million in orders.  This backlog is going to be an important metric to watch as it will have to pick up if the company is going to regain confidence from its investors.  Another interesting item will be what happens with the company’s Auction Rate Securities (ARS) which represent about $28.8 million of “non-current assets”  These are the securities that many companies held with the assumption that the securities were essentially cash alternatives.  The sudden lack of liquidity late last year turned the table on these investments as auctions failed and companies were stuck with no way to liquidate these positions.  It is believed that the principal balance is still secure but it will take some time before SYNA will actually be able to get its hands on this capital.

Currently the stock is trading just above $25 with analysts expecting earnings of $2.00 this year and $2.32 in fiscal 2011.  While the growth rate has declined from the strong growth of the past two years, these expectations are likely overly conservative after the disappointing guidance.  I believe that there is an opportunity to pick up this Wall Street darling at a significant discount and hold it for 9 to 12 months while waiting for investors to regain their optimism.  Even without any revisions to 2011 estimates, the stock could easily rise to $35 with a modest PE of 15.

More conservative investors could consider buying at current prices and selling the December $27.50 calls for about $2.30.  If the calls are not exercised, the premium would give you an 8.9% buffer, helping to offset potential losses in the stock.  However, if the stock trades higher over the next four months to where the calls are exercised, the resulting return for the period would be a 16% return in just four months.  The overall economy may be in a difficult period, and earnings growth is not guaranteed, but Synaptics offers an interesting inexpensive opportunity to participate in any economic recovery.

FD: Author does not have a position in SYNA

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