Ambarella Inc (AMBA): An IPO on Course for a Price Treble

A year has yet to pass, but for some stocks enough time has passed to double their share price, and continue to set up for a three bagger. Ambarella Inc (NASDAQ:AMBA) made its debut on the markets in October 2012 in what was a disappointing start for the stock; the $9-11 expectations turned into a $6 stock. But since November, investors have taken notice, bidding the stock into the teens before easing back around $14 a share.

The company designs chips which support Ultra High Definition (UHD) resolution and has finished with a positive net income in the $9.9-18.2 million range for four of the last five years. However, it has grown revenue threefold over the same five year period, with a 25% jump for 2013. March earnings gave the stock a foothold which has enabled its current advance.

The major contributor to fiscal 2013 growth was its IP security camera business, with China an important customer in this field. In the Chinese market there was a general migration/upgrade from analog to digital cameras, including good demand for cameras supporting its UHD resolution.

In terms of new products, the company is feeding into the rapid growth of sport cameras (replacing traditional camcorders), including wearable cameras. The company released its new A9 Ultra HD 4K system-on-chip at CES in January, to generally positive feedback. But this was another key sector driving earnings, and is expected to continue into 2013.

Camera revenue accounted for 83% of Q4 results, compared to 70% the year before. The percentage increase related to a drop in “infrastructure” revenue – skewing the relative performance of the camera segment. This disparity is likely to increase as a key customer was bought out, introducing uncertainty into future sales to this company. Ambarella Inc (NASDAQ:AMBA) has two key customers: WT Microelectronics is its major logistics partner for sales and distribution and accounted for over half of revenue, while Chicony accounted for 16% of annual revenue and 30% of last quarter’s revenue. WT and Chicony were the company’s only “10% customers,” but in reality are the only customers for Ambarella. This introduces some uncertainty, and leaves it vulnerable if it’s unable to maximize sales through its existing distribution channels. Although by directly dealing with Chicony, Ambarella Inc (NASDAQ:AMBA) have reduced some of the commission payments made to WT Microelectronics (who Chicony previously bought from).

Not surprisingly, camera sales are expected to be 84-88% of Q1 revenues, up from 67% in the prior quarter. Infrastructure is expected to again suffer in Q1. However, with gross margins in the 60% range it operates with plenty of wiggle room. Better still, it’s the high end scale where sales are most robust – although the company is in the early manufacturing stage for a new chip directed at the low end of the market which should offer good profit margins. It also expects costs to fall for some of its pricier sports cameras, which will shift the margin dynamic through to 2014.

Competition

There are a number of private manufacturers, mostly located in Asia, building security cameras. Broadening the picture to include semiconductors, brings in public companies Fujitsu LimitedIntel Corporation (NASDAQ:INTC), and Texas Instruments Incorporated (NASDAQ:TXN).

Ambarella business is niche compared to these major corporations, so direct comparisons are somewhat tenuous. For example, Fujitsu was impacted by Thai floods which drove down production of its digital camera offerings (which is more consumer orientated than security focused Ambarella), but this is only a small component of its overall revenue – so the net effect is negligible. However, such impacts are avenues from which Ambarella Inc (NASDAQ:AMBA) may benefit as Fujitsu customers look elsewhere.

Even so, as chip producers, each of the aforementioned companies experienced a year-on-year loss in revenue quarterly revenue growth: from 3% for Fujitsu Limited and Intel, to a 13% loss for Texas Instruments Incorporated (NASDAQ:TXN). Ambarella trumped these by turning a 28% quarterly growth. So while the broader chip segment is experiencing a continued drop in demand from a weak economy, certain specialist chips are in hot demand.

For a small company, Ambarella boasts a very healthy Gross Margin. Fujitsu gets by on a 27% trailing-twelve-month Gross Margin, while Intel Corporation (NASDAQ:INTC) operates at 62%. Ambarella Inc (NASDAQ:AMBA)’s comparable Gross Margin is 500 basis points higher than Intels’. Because of the economies of scale, it does lose out a little on Operating Margins, but at 16% ttm it’s well above Fujitsu’s 2%, and just shy of Texas Instruments Incorporated (NASDAQ:TXN) 21%.

With a P/E of 22.1 and projected P/E of 12.3, it’s already a step ahead of net losing Fujitsu, with hard hit Texas Instruments offered a projected P/E of 17.8. Intel Corporation (NASDAQ:INTC) has a trailing and forward P/E which is about the same at 10.3, so Ambarella could comfortably trade with a P/E in the high teens; so even if it missed on growth projections (which looks unlikely), it’s likely still trading at a price under par.

Summary

The key takeaway is while its larger brethren are feeling the pain from broader chip weakness and falling demand, Ambarella Inc (NASDAQ:AMBA) is trading at a valuation tarred by the underperformers. However, it’s posting figures which suggests it should be treated differently. The company operates within a sector generating strong growth, even if vulnerable because of a (naturally) smaller customer base. China looks key to driving the rapid growth, but its new UHD chip, combined with new low-priced consumer options, could open new avenues to diversify the revenue stream.

Declan Fallon owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel.