On Wednesday, I reiterated that GoPro, which makes hugely popular, action-based video cameras, will be the sexiest IPO of 2014.
However, I appreciate that often-volatile IPO investing isn’t for everyone…
That’s why, when I originally covered GoPro in February, I profiled a craftier way to play what I believe will be a successful GoPro IPO.
That investment is Ambarella, Inc. (AMBA).
And with GoPro making its IPO official last Monday, there’s no better time to put Ambarella to the ultimate test – my C.H.A.O.S. Strategy…
No Chips = No Cameras
Founded in 2004, Ambarella is the leading developer of systems-on-a-chip (SoC) for the video camera market.
In fact, Ambarella’s wide range of SoCs are in a number of high-definition (HD) cameras that are used for security, television broadcasting, automobiles and wearable devices – including the entire GoPro Hero lineup.
In other words, without Ambarella’s technology, GoPro’s cameras wouldn’t exist in their current successful form.
The reason why Ambarella’s SoC technology is a “go to” for GoPro and other video camera manufacturers is simple…
By integrating HD video-, image- and audio-processing capabilities onto one single chip, Ambarella allows users to capture high-quality content at extremely power-efficient levels.
But what about the company’s investment worth?
Ambarella’s Q4 FY 2014 results were outstanding…
Compared to Q4 2013, revenue jumped by 26.8%, to $40 million.
For the full year, Ambarella notched sales of $157.6 million – up 30.2% over fiscal 2013.
This was no fluke. It extended a strong performance in recent years…
Best of all… Ambarella has been profitable since 2010 (the farthest back its public documentation goes).
Over that time, the company has grown its earnings before interest, taxes and amortization (EBITA) from $14.2 million to $29 million, increased its bottom line from $13 million to $26 million, and beaten its earnings estimates every time.
Of course, it’s impossible for a company to generate such results without a strong management team. And Ambarella has one.
It’s presided over a 263% surge in free cash flow since 2011. In turn, that’s led to a cash return on capital invested (CROCI) of 20.9%. In short, this means that for every dollar invested, Ambarella generates $0.20 in free cash flow. That’s impressive, especially given that it was losing $0.80 only four years ago.
I also ran Ambarella through a discounted cash flow (DCF) model. DCF basically values a company based on future cash flow estimates against the current share price to see how much value you’re getting for your investment.
Ambarella shares have an intrinsic value of $37.25 – 48% higher than the current price.
C.H.A.O.S. Meter: 19/20
Given the applications for Ambarella’s (SoC) technology, it’s no surprise that it boasts a very high impact.
Ambarella embeds its proprietary algorithms and software onto one single chip, enabling the low-power, high-definition videos and images that are now standard in today’s video cameras.
And because Ambarella gives equipment manufacturers a variety of different SoC platforms to choose from, its reach has broadened across multiple markets. For example…
- Security Cameras: Ambarella’s SoC technology has helped redefine the security camera market. Today, security cameras are digital instead of analog, and are able to encode and transmit video over a network.
- Broadcasting: Ambarella’s digital signal processor (DSP) architecture and encoding abilities allow broadcasters to compress and transmit videos over satellite, cable and IP infrastructures.
- HD Automotive Cameras: Whether dashboard-mounted, or embedded in a car’s infotainment system or rearview mirror, onboard cameras have become increasingly prevalent in cars – and popular with consumers. And because these cameras require an intricate combination of size and efficient image processing, they wouldn’t exist without Ambarella’s SoC, which consolidates the power of many parts onto one chip.
- Wearable Sports Cameras: Ambarella’s SoC design enables durable, lightweight, high-quality, low-power cameras to wirelessly connect to the internet and social media platforms. It’s the reason why cameras are becoming smaller and wearable.
The downside here is that Ambarella could do a better job of securing its high-impact technology. Despite its wide-ranging international presence, it has just 25 U.S. patents, three patents in China and one patent in Japan.
It does have 35 pending and provisional U.S. patent applications, though, and all the patents are secure through 2024-2031.
C.H.A.O.S. Meter: 17/20
Since its technology is inside every GoPro Hero camera, the biggest accelerant for Ambarella will be GoPro’s IPO.
Don’t believe me?
Since GoPro made its IPO official on Monday, Ambarella is up 7.4%.
And because it boasts peer-dominating financials, analysts and investors are starting to pay more attention.
Recently, analysts have either initiated covered with “Buy” ratings or raised their price targets. In fact, the only negative came from Zacks, which downgraded the stock to “Neutral,” but maintained its $37 price target.
All told, the average price target is $35.
With the GoPro IPO set to grab headlines, it should provide a healthy boost for Ambarella.
Using a wearable recording device, Helpouts is essentially an online personal assistant that links people who want to learn about a topic with relevant experts. Google takes a 20% cut from each video session. For companies, it’s a chance to market to would-be customers who want advice.
As I said last time, “According to Cisco (CSCO), mobile video is set to grow at a 90% annual rate, reaching 71% of total mobile data traffic by 2016. Clearly, Ambarella is going to want a piece of the action.”
And with more big-league companies trying to break into wearables, future deals would ignite Ambarella shares.
On a negative note, Ambarella has suffered from the recent broader Nasdaq selloff. And while it’s clearly oversold and undervalued, the market only seems to be noting that it trades at a premium to 97% of its peers.
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C.H.A.O.S. Meter: 15/20
Ambarella sells its solutions to original design manufacturers (ODMs) and original equipment manufacturers (OEMs) around the world.
The company classifies designers as “direct customers,” and manufacturers as “end customers.”
These companies then source Ambarella’s solutions to OEM end customers like: Ericsson (ERIC), Harmonic, Inc. (HLIT), Avigilon Corporation (AIOCF), Wintech Microelectronics (Taiwan: 3036), Axis Communications and Dropcam.
And, of course, GoPro!
Business is flourishing, too, driven by large increases in demand for Ambarella’s security camera SoCs and wearable camera SoCs.
All told, 88% of total revenue comes from SoC sales in the camera market – up from 75% in fiscal 2012. However, the firm did take small hits to its infrastructure and automotive SoC orders, the latter of which was primarily due to a delay of its new A7LA SoC.
But that’s not really the problem…
The bigger issue is that the company is too dependent on certain areas.
For one, most of Ambarella’s ODMs and OEMs are in Asia. That makes it vulnerable to foreign economic turmoil and currency fluctuations.
Plus, roughly 85% of Ambarella’s revenue came from Chicony Electronics and Wintech Microelectronics. Frankly, that’s a perilous situation.
However, I’m optimistic that Ambarella’s relationships with GoPro and Google will help balance the load and boost the company’s presence in the U.S. market.
C.H.A.O.S. Meter: 14/20
Here’s how Ambarella can grow in the years ahead…
Growth Within Existing Markets: As tech trends evolve, Ambarella needs to increase the number of devices where its technology appears, diversify its ODM and OEM relationships, and expand its presence in developed markets.
Wearable Technology: Thanks to GoPro, Ambarella is strongly positioned in the wearables market. From here, it needs to provide SoCs that continue to shrink the size of cameras, while maintaining power, durability and functionality. At that point, Ambarella should score significant revenue from a multi-billion-dollar market.
Internet of Everything: The “always-on” movement means anyone can connect to anything at any time. In this area, Ambarella can do more than just connect people with people. It can leverage the “streaming video cloud” to boost home security. Through IP cameras and the cloud infrastructure, Ambarella can allow families to detect unwanted activity in their home while they’re away, or help parents monitor their baby from another room.
There’s compelling potential for Ambarella going forward, but keep in mind that its markets are fiercely competitive.
For example, in the wearable sports and security camera markets, it’s up against huge multinational firms like Canon (CAJ), Panasonic (PCRFY), Sony (SNE), Texas Instruments (TXN) and Fujitsu Limited (FJTSY).
This is a huge challenge, as these firms all boast greater distribution, broader product offerings, bigger war chests and significantly better brand recognition.
C.H.A.O.S. Meter: 13/20
Final Verdict: Ambarella is an excellent company, with:
- Solid financials…
- High-impact technology in popular markets…
- Near- and long-term catalysts…
- Increasing orders from some of technology’s biggest names…
- Multi-billion-dollar industries to expand into…
The only factors holding Ambarella under the 85-point mark are its dependency on one ODM and one OEM for the bulk of its revenue, as well as an ultra-competitive landscape.
But with the GoPro IPO in the pipeline, it should feed off the positive buzz. Wait for some weakness before buying in.
Your eyes in the Pipeline,