Apple pulls plug on Imagination Technologies, sparking patent tension

Apple has informed Imagination Technologies Group that it plans to stop using the UK-based group's processor chips in its new products within the next two years as it had developed its own version of the hardware, leading the latter to seemingly hint at potential legal action.

Apple, which is Imagination Technologies' largest customer, told the smaller company that it has been working on a separate, independent graphics design in order to control its products and will be reducing its future reliance on Imagination's technology in 15-24 months' time.

The US technology giant has been using Imagination's graphics core at core of the operating system since of the iPhone, iPod and iPad since they were first manufactured.

"It has formed the basis of graphics processor units (GPUs) in Apple's phones, tablets, iPods, TVs and watches," Imagination said.

But Apple, which has used Imagination’s designs across its range from iPhones to Apple Watch and even owns an 8% stake in the company, told the London-listed company that has been working on a separate, independent graphics design and will be reducing its future reliance on Imagination's technology.

There have been reports in recent years that Apple has a team of around 200 people working on graphics to adapt and optimize the Imagination graphics core.

Asked to provide evidence to back up its assertion that it will no longer require Imagination's technology without violating Imagination's patents, intellectual property and confidential information, the California-based company has apparently declined to provide this.

"Imagination believes that it would be extremely challenging to design a brand new GPU architecture from basics without infringing its intellectual property rights, accordingly Imagination does not accept Apple's assertions."

The Hertfordshire group said it had begun discussions with Apple over "potential alternative commercial arrangements" for the current license and royalty agreement, and said it has reserved all its rights in respect of Apple's unauthorised use of Imagination's confidential information and intellectual property rights.

In its last financial year Imagination was paid £60.7m from Apple in license fees and royalties, which is expected to rise to £65m for the year ending 30 April 2017.

As Imagination has minimal direct costs associated with this revenue stream, Apple income drops almost entirely through to the bottom line.

The company expecting sales from Apple of around £65m for the current year, with an expected contribution of at least £60m for 2019, when analysts had been forecasting profits of £39m.

Shares in IMG fell more than 70% in the first hour of trading on Monday to below 80p for the first time since 2009, before easing off to 99.19p by 1130 BST.

"It’s the worst nightmare for Imagination," said analyst Neil Wilson at ETX Capital, with Apple accounting for about half its revenues. "You simply cannot easily replace a customer of that scale in a hurry."

He added: "Imagination seems to be hinting at legal action, saying Apple would likely be in breach of its intellectual property rights if it walks away. But there could be a compromise, with Imagination stressing ‘potential alternative commercial arrangements’.”

Investec said "we see a risk of future legal battles" and said the material financial impact from a loss of its largest customer "could raise the risk of other customers not signing future licences with Imagination until the situation with Apple is resolved".

Morgan Stanley's Francois Meunier said his reading of the announcement was that "we believe Apple has designed its own graphics core", not using the rival Mali technology from ARM Holdings.

Although it is not the first time that Apple has dropped a supplier unexpectedly, the difference here, Meunier said, was that Imagination holds significant patents around graphics cores, in particular those which allow lower power use, and it is these that it is around those for which it is considering discussing different commercial arrangements with Apple.

Steve Clayton, a fund manager at Hargreaves Lansdown, said the market has been spooked by the real chance that Imagination could soon swing into substantial losses if Apple do indeed sever their ties.

"Imagination’s financial track record has been unpredictable over the years even before this. Last year, exceptional restructuring costs pushed them deep into the red and the hope was that they were now on the road to recovery," he said.

"Their problems now are a great example of the risks in having too many eggs in one basket. Apple’s contribution to Imagination’s turnover was about 50% last year. Only once has Imagination declared an operating profit of more than £20m, so it seems possible that without Apple’s contribution, Imagination might never have been profitable."

Morgan Stanley also noted that IMG has a credit facility with HSBC that was breached in 2016 and later renegotiated.

"We do not have insight in the new agreement but think it likely involves property of the group. The previous conditions of the agreements implied the company needed to keep a ND/EBITDA of less than 3x."