Are Apple's Trickle-Down Economics Failing?

Apple (Nasdaq: AAPL) sold 35.1 million iPhone 4S in the second-quarter -- 35.1 million! That's an 88% increase over the previous year, and in just a matter of two months after releasing the 4S, Apple was able to drastically close the market-share gap between Google's Android operation system and the Apple iOS to just 2.4% from nearly a 40% market-share gap.

Yet for all of the iPhone's success and the jubilation expressed by shareholders of the component makers for the iPhone 4S, Apple's trickle-down economics seems to be failing.

This isn't to say every component maker is down, as Cirrus Logic (Nasdaq: CRUS) and Skyworks Solutions are both within reaching distance of a new 52-week high. But have a look at what's going on with Apple's other component makers:

Sources: Yahoo! Finance, 9to5mac.com.

Just what the heck is going on here?
Broadcom maintained its socket contract from the iPhone 4 to the 4S and actually increased its importance by winning the contract for its new Wi-Fi/Bluetooth/FM radio chipset. It's practically assured a spot in the iPhone 5 (or whatever Apple wants to call the next-generation iPhone), and it's trading for less than 10 times forward earnings.

Nuance Communications is seeing its role as Apple's speech-recognition software only increase in value, as plans are for Siri to make a debut in upcoming iPad models via Apple iOS 6. ARM Holdings continues to provide the basic architectural backbone behind the dual-core A5 processor powering the iPhone with its sector-leading power efficiency. Even TriQuint Semiconductor was a big winner, with Apple choosing the company's amplifier module and duplexer module in the 4S.

In short, these companies should be reaping the rewards of strong iPhone 4S sales ... but they aren't.

So why are these suppliers performing so poorly?
Supply-chain worries could account for some of the downdraft. Flooding in Thailand interrupted the supply chains of numerous tech companies, but according to Citigroup analyst Richard Gardner, the effect should be negligible on Apple. Thailand is home to nearly two-thirds of all printed circuit boards, but according to Gardner, Hon Hai Precision is likely well ahead of the game in terms of PCB production for the iPhone. Guess we can cross that one off the list.

Perhaps investors are skittish about having Apple change vendors for its next-generation iPhone release? While these fears are plausible, the propensity of Apple to change vendors is actually pretty low. One notable exception is Sony, which predominantly replaced OmniVision Technologies as the image sensor in the 4S. But in reality, the vast majority of changes take months, if not years, to take effect. It's therefore much more likely that as long as there are no major supply-chain or quality issues, a vast majority of the component suppliers you see now in the 4S will be around for the next-gen model.

Possibly the only plausible reason for the sell-down relates to Apple's role as a percentage of revenue. For a company like Sony, which has major issues with its television division, the Apple contract doesn't mean much in the overall context of its business. Having Apple as a primary customer has both its benefits and risks. For Cirrus Logic, a company that derives 70% of its revenue from Apple, rapid growth in iPhone sales has propelled it toward new highs. Conversely, if it were to lose Apple as a customer, the stock would probably be absolutely crushed.

What does this all mean?
With few notable exceptions -- TriQuint's projected growth rate and ARM's relatively high forward P/E ratio -- many of Apple's component suppliers have retraced back to some very attractive levels. Broadcom, STMicroelectronics, and Nuance all have growth projections from Wall Street that currently exceed their forward earnings multiple.

Sources: Morningstar, Yahoo! Finance.

As long as iPhone demand remains strong -- and I really see no reason why it wouldn't – there's really no reason not to be digging deeper into these iPhone component suppliers as possible investments.

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