When it comes to running a business, from a small local store to a large multinational company, diversification of customer base can be essential to long term survival.

In economic terms, a market dominated with a very powerful buyer is called a Monopsomy. When a single buyer has large control over the supplier, this can damaging for the supplier.

Imagination technologies (IMG), the UK based company which is the main supplier of the graphics chips in most of Apples mobile devices, learned this the hard way.

Recently, Apple (AAPL) decided that they will no longer be using the company’s GPU (Graphics Processing Units) in their devices. This led to a calamitous collapse in the price of Imagination’s shares of almost 70%.

This led many traders to ask the question, can imagination technologies recover? Are they now a takeover target? What will they do about all of their intellectual property that is in the hands of Apple?

We will take a deep dive into the IMG / APPL debacle and analysis whether the shares deserves to fall by such an extensive amount.

What Happened?

Imagination Technologies relied on about 50% of its revenues from Apple. It earned this on the royalties that Apple paid the chipmaker on the sales that were generated. This was £60.7m last year and is widely expected to be about £65m in the year to the end of April.

On the 3rd of April, Apple notified Imagination of the changes that they were making internally that would see the iPhone maker developing their own chips in house.

Apart from the immediate crash in the price of the stock, this raised a number of questions relating to the ongoing intellectual property rights that Apple may have of Imagination.

This also was not the best time for imagination to receive the news. They had been struggling of late and had released a number of profit warnings as recently as September last year. They had been slashing a number of jobs as well as selling some businesses.

All of this contributed to Imagination’s worst full year loss in its history in the 2016 financial year. Although it has managed to slightly recover on the back of favourable currency movements, this will all be undone.

Upon the news the announcement by Apple, Imaginations shares fell from 268p to 100p almost immediately. This should have provided a strong trading signal that Imagination’s shares could indeed keep falling. Indeed, the shares even touched the 76p level.

Where to From Here?

Many intellectual property experts have said that Imagination does indeed have a case and would be worthy of a settlement from Apple. This still leaves Imagination without its biggest customer.

Indeed, the loss of this pivotal customer has led to many analysts downgrading their view to “Sell”. The loss of Apple’s contract will no doubt drive the firm into losses.

There is talk, however, of a possible takeover of the firm by Apple itself. This is not so farfetched as the Tech giant already holds about 8% of the shares in imagination.

Indeed, there are a number of people who are postulating that this could be the underlying reason behind the move by Apple.

Imagination is also currently discussing the decision with Apple. There is the possibility that Apple could use the contract that they have with imagination as a way to obtain lower fees from the firm.

Long or Short Imagination?

Before you consider entering a any trades on Imagination’s stock, make sure that you have a broker that allows you to trade shares and options on the London Stock Exchange such as LBoption or comparable UK based brokers.

From a fundamental standpoint, none of the above scenarios will lead to an outcome for Imagination technologies that will leave it in the same place that it was prior to the announcement.

There are some contrarian investors who could say that the collapse in the price of the shares are a chance to buy the shares at a heavily discounted price.

However, there is still more downside risk. If Imagination is unable to reach a settlement with Apple then it could continue to rack up substantial losses.

The company also has high levels of debt from previous capital raising exercises. This could indeed lead to a situation where Imagination technologies may not be able to recover at all.

Conclusion

Given the number of downside risks to Imagination’s share price, a short position in the shares can be a profitable trade. Enter the trade if the stock gets above 110p per share.

It would be wise to have hard stops in place at least 10p above the current entry price at 120p. Keep an eye on any company announcements that may hit the wire as well as potential rumblings from the Apple community on the supply changes.