Robert W. Baird downgraded rating of OmniVision Technologies Inc. (OVTI) to 'neutral' from 'outperform' with a price target of $34, based on limited upside potential near-term.

We downgrade OmniVision to 'neutral' based on our belief there is a higher likelihood the iPhone 5 could use two CMOS image sensor suppliers in order to address continued supply constraint concerns. While Omnivision remains well positioned as a leading supplier of CMOS image sensors, risk/reward ratio becomes less attractive under a dual-sourcing scenario, said Tristan Gerra, an analyst at Robert W. Baird.

Gerra believes there is an increasing potential for the iPhone 5 to use two CMOS image sensor suppliers. This would reduce the risk of potential supply constraints, given the sharp year-over-year unit increase Gerra expects for the iPhone this year.

Gerra said he has constructed three earnings scenario for Omnivision this year: 1. retains 100 percent of all iPhones; 2. gets the non-U.S. portion only of the iPhone 5; and 3. does not participate in the iPhone 5 (Gerra believes Omnivision will supply 100 percent of the Verizon-based iPhones as well as the second-generation iPad).

We speculate Scenario No.1 is now less likely, due to continued tight capacity (we believe Taiwan Semiconductor Manufacturing Co. has been raising wafer prices selectively), as well as some initial quality issues for Omnivision’s second-generation BSI 8mp sensor. We continue to believe Scenario No.3 is unlikely, due to capacity constraint risks for Sony, which is also a supplier to Nokia. Scenario No.2 is a close match to our current estimates, said Gerra.

Gerra sees less appreciation potential for OmniVision shares near term due to: continued uncertainty regarding Omnivision’s calendar second half of 2011 outlook (depending on its participation into the iPhone 5); and his expectation for the January quarter, which he expects will be well above seasonal, to mark a near-term EPS peak, followed by two quarters showing weaker seasonality.

Gerra continues to believe Omnivision will be one of only few suppliers of 8mp sensors into smartphones this year, with this resolution expected to become mainstream in smartphones by the second-half of the year. Barriers of entry continue to increase, notably with BSI technology, and Gerra believes Omnivision remains well positioned as a leading supplier of CMOS image sensors long term.

Omnivision stock fell 4.76 percent to $27 in the pre-market trade on the NASDAQ stock market.

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