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Last week, I overheard my twelve-year-old daughter asking her iPad, "Siri, could you do the dishes for me?" Since Apple (AAPL) introduced Siri on the iPhone 4s, intelligent voice technology has finally made it to the consumer market. Most high-end smartphones now have the voice "personal assistant" built into them. Luxury cars are also equipped with the same technology. The technology has evolved from pure voice recognition to artificial intelligence (AI), which can understand human language, analyze the content, and respond accordingly. It is reasonable to expect that in five years, all smartphones, TVs, PCs, tablets, GPSs, and game consoles will come with the "voice assistant". A fair percentage of cars, high-end appliances, and toys will also have this technology built in. The market potential is enormous. All the new gadgets expected to come out in the next couple of years, whether it is an iWatch, iTV, or Google (GOOG) glasses, will have voice interaction as one of the primary interfaces. One company that stands out in this field is Nuance (NUAN). The following are several reasons why it is currently an opportune time to buy Nuance.

1. Leader in the industry

Nuance is by far the leader in the voice technology industry. Currently, it faces little competition. The list of its mobile customers will help you see the point. Key mobile customers for Nuance are Amazon (AMZN), Apple, Audi, BMW, Comcast (NASDAQ:CMCSA), Chrysler, Dell (DELL), DoCoMo, Ford (F), Volkswagen, GM, HTC, Huawei, Kyocera, LG, Oi, Nokia (NOK), Intel (INTC), IBM, Panasonic (PC), Pantech, Prosodie, BlackBerry (BBRY), Samsung (OTC:SSNLF), Sony (SNE), Telefonica, Telstra, T-Mobile (OTCPK:DTEGF), and ZTE. Major automobile manufacturers and almost all smartphone players are on the list. The gross margin, which has remained around 70% for six years, is also an excellent indication of weak competition.

In today's market, the most prominent example of the mobile device interface is Siri, the voice assistant that is in the latest iPhone and iPad. It is widely suspected that Siri uses Nuance Technology. Siri's co-founder, Norman Winarsky, admitted, "Nuance has far and away the most IP in speech synthesis technologies in the industry." Nuance has also developed its own voice personal assistant "Nina," which is well received by the market. For Nuance, the only potential serious competitor is Google. Google has been developing its own voice technology for the past few years. Given the history of Google and its talented R&D team, it is quite possible that in a year or two, Google will be very competitive in this area. However, Nuance has a very substantial head start. Unless Google's product is vastly superior to Nuance's, companies that are already using Nuance's technology will be unlikely to change their vendor. Because Google is a competitor of most smartphone companies, it will probably be more comfortable for these companies to deal with Nuance.

2. Market potentials

Nuance has four lines of business: Health Care Solutions, Mobile and Consumer Solutions, Enterprise Solutions, and Imaging Solutions. I will focus on the top three.

Health Care Solutions is the largest revenue and profit generator for Nuance. In 2012, the revenue generated was $669 million and profit was $314.9 million. The organic growth for revenue was 11%. The reason for using organic growth is that Nuance has made quite a few acquisitions in the last few years. The demand from the health care industry is fueled by the need to computerize medical records. Voice interface is a much more convenient and time-saving solution than typing on a keyboard. Due to government spending cuts in the health care industry, growth has slowed down a bit. However, the need for computerization of all medical documents is still very strong. Nuance is the number-one provider for the health care industry in voice interface solutions.

Mobile and Consumer Solutions' business has the greatest potential for Nuance. As I mentioned earlier, voice interface is quickly becoming the norm for mobile device users. The advantage of voice interface for automobiles is extremely obvious for safety reasons, and I expect all major car manufacturers will adopt this technology. As AT&T CEO Stephenson put it, "The way we think about the car is that it's just a big smartphone on wheels in the future." All the new wearable gadgets, such as iWatch and Google glasses, will have to be voice activated as well because the surface is too small for a touch screen or keyboard. The revenue in 2012 for Nuance in Mobile and Consumer Solutions was $508 million, with a profit of $228 million. The organic revenue growth was 23%. Given the market potential, the growth will see strong acceleration in the next two to five years.

Enterprise Solutions mainly deals with service-oriented companies. Nuance's customers include the majority of the top 25 global banks, the majority of global Telcos, the majority of global airlines, and most of the Fortune 100 companies. This line of business is more mature and cyclical, and the global economic environment will have an impact on the growth. In 2012, the revenue in Enterprise Solutions was $228 million, with a profit of $91 million. The organic revenue growth rate was 10%.

Overall, Nuance is expected by the market to grow its sales at least 20% in the next year. I won't be surprised if the rate exceeds 20%, given the potential new gadgets and consumers' enthusiasm for the voice interface.

3. Strong fundamentals and low valuation

Nuance traded over $31 shortly after Apple's debut of its iPhone 4s with Siri built in. But the latest earnings report slightly missed the estimates, and the stock took a beating and went down to the low $18s. The miss is mainly due to the slowdown in the health care sector and Europe. Despite the miss, the fundamentals are still very strong. From 2006 to 2012, its revenue grew from around $400 million to over $1.7 billion; the net income grew from $67 million to $556 million (42% annual growth rate); EPS grew from $0.37 to $1.73 (29% annual growth rate); and CFFO (cash flow from operation) grew from $60 million to $470 million (40% annual growth rate). Nuance has maintained its gross margins close to 70% while achieving these impressive growths. The average of next year's EPS estimate from analysts is $2.02, which yields a forward P/E of 9 at current price around $18. Given the expected growth rate around 20%, the valuation is very low. It is an opportune time to buy the stock.

4. Potential takeover target

The low valuation and high growth potential have made Nuance a very attractive takeover target. The relatively small market cap of $5.77 billion should also make it easy for an acquirer. Apple, Samsung, or IBM may consider taking over Nuance. The strategic importance to Apple or Samsung is obvious. All mobile devices need voice technology, and Nuance is the leader. IBM, however, is the best fit among them. Nuance has worked with IBM in Health Care Solutions for a number of years, and health care is an important area for IBM's growth. Voice technology has evolved from voice recognition to voice intelligence that requires intensive R&D on artificial intelligence. IBM has the most advanced AI research among all high tech companies. The combination will advance the voice intelligence technology to a new level.

Conclusion

The prime time for voice technology has arrived. Voice interface will become the norm for mobile devices in five years. Nuance is the clear leader in the industry with few competitors. The growth rate over the last six years has been very impressive. The slight miss of the earnings estimate has created an opportunity to buy the stock at $18.

Here is Siri's response to my daughter's question "Can you please do the dishes for me?"

"I have found six restaurants within one mile radius." Smart, a very smart answer!

Source: The Era Of Intelligent Voice Technology - An Opportune Time To Invest In Nuance