PortalPlayer acquisition to yield wireless iPods?

In a research note released to clients this week, Citigroup analyst Glen Yeung raised his price target on PortalPlayer — maker's of audio controller chips for Apple's video and nano iPods — to $36 from $29, saying the company could see customer growth rise in the second half of 2006, driven by the popularity of iPods, which he believes accounted for 90 percent of PortalPlayer's revenue in the third quarter of 2005.

"We have raised our estimates for PortalPlayer based on an increased shipment assumption for iPods, and the expectation for a lower than normal seasonal decline in the first half of 2006," Yeung wrote.

Yeung also added that PortalPlayer is looking to acquire a small private company specializing in wireless technology. He believes such an acquisition to cost between $1 million and $30 million. And because PortalPlayer has said it is dedicating 2006 to building out wireless capabilities, the analyst believes Apple is considering building wireless capabilities into its iPod.

Reading into PortalPlayer's future product plans has proven to be a good indicator of what to expect in future versions of the iPod. In December of 2003, PortalPlayer announced that it would soon release a "Photo Edition" of its controller chip with photo handling code. Less than a year later, Apple announced the iPod photo.

Hints that PortalPlayer was working on further additions to its portfolio began last month when it withdrew a proposed offering of 4,500,000 shares of common stock, saying management and the Board of Directors believed the stock price did not reflect the company's market opportunity and future growth.

"Our relationships with our leading customers remain strong, as evidenced by the announcement of two dynamic market expanding products that have just begun to roll out to the market," said Gary Johnson, president and chief executive officer of PortalPlayer. "We believe we are well positioned for the year ahead with these customers."

"Our organic growth and diversification strategy is on track, and we expect an additional major market segment for our products to be introduced in the first quarter of 2006," Johnson added.

Apple, which has also been experimenting with wireless iPods in its R&D labs, is PortalPlayer's largest customer.

Third parties also foresee iPods benefiting from wireless technologies and have recently come knocking on Apple's door, eager to get a piece of the lucrative digital music player market. In September, Cambridge Silicon Radio approached Apple with the idea of installing its Bluetooth wireless microchips into future generations of the iPod music player, which would pave the way for iPods with wireless headsets.

Along with the price target increase, Citigroup raised its rating on PortalPlayer to "Buy" from "Hold." For the quarter, the firm expects the company to earn 48 cents per share on $74.8 million in revenue.