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Shares of Ambarella (NASDAQ:AMBA) continue to gain ground after a disappointing public offering last year. The developer of low power, HD video compression and image processing semiconductors released its first quarter results for its fiscal 2013 on Tuesday after the close.

While shares have nearly tripled since their public offering in the autumn of 2012, I think there continues to be some upside potential. The valuation is still relatively modest, especially considering that the company continues to grow at a rapid pace.

First Quarter Results

Ambarella generated first quarter revenues of $33.9 million, which is up 30.9% on the year before. Revenues came in ahead of consensus estimates of $31.9 million.

The company reported GAAP earnings of $4.7 million or $0.16 per share. This compares to last year's earnings of $2.6 million or $0.07 per diluted share.

Non-GAAP earnings came in at $6.2 million, or $0.21 per share, up from $0.11 last year. The discrepancy between GAAP and non-GAAP earnings is entirely explained by $1.5 million in stock-based compensation expenses. On average, analysts were looking for earnings of $0.15 per share.

Looking Into The Results

While revenue growth was impressive, Ambarella suffered from some margin pressure. Gross margins came in at 63.9% of total revenues, down 710 basis points on the year before.

Positive was that the company managed to boost earnings on the back of very strict cost control. Total operating expenses were up by just 6.3% to $16.5 million. On a relative basis, operating expenses fell to just 48.5% of total revenues, down an incredible 1,170 basis points compared to last year.

As a result, net income rose by 82% to $4.7 million. Net earnings came in at 14.0% of total revenues, up 400 basis points on the year. Note that effective tax rates of 9% are quite low and are most likely not sustainable in the future.

Valuation

Ambarella ended its first quarter with $104.3 million in cash and equivalents. The company does not have any debt outstanding for a solid net cash portion.

The company generated annual revenues of $121.1 million for 2012, up 24.5% on the year before. Net income rose by 86% to $18.2 million in the meantime.

Factoring in a modest 3% jump following the release of the earnings report, shares are exchanging hands around $17 per share. This values Ambarella at $450 million. Excluding the net cash position, operating assets are valued at $345 million, thereby valuing the firm at 2.8 times annual revenues and 19 times last year's earnings.

Ambarella does not pay a dividend at the moment.

Some Historical Perspective

Ambarella went public as recently as October of 2012. The offering was a huge disappointment as shares were placed at $6 per share. Initially the firm and its bankers were trying to place the shares in a $9-$11 price range.

From that point in time shares have almost tripled, currently exchanging hands at $17 per share. After being scared off following the disastrous public offering, investors have started to appreciate the growth potential of the firm.

Between 2009 and 2012, Ambarella has increased its revenues by a cumulative 70% to $121 million. Net earnings rose by "merely" 37% to $18.2 million in the meantime.

Investment Thesis

I am extremely disappointed with myself for not keeping a closer eye on the company. Just after the offering, I wrote an article about the public offering of Ambarella. I concluded that I was puzzled on the reasons behind the failed offering, and was contemplating taking a long position depending upon further research.

I never ended up doing the additional research, something I greatly regret in hindsight.

But enough about the past. The relevant question for investors is whether today's levels represent an opportunity to pick up some shares.

For starters, the outlook looks solid. Second quarter revenues are expected to come in between $34.5 and $37.5 million, surpassing consensus estimates of $34.8 million. At the midpoint of the guidance revenues are expected to increase by almost 13% on the quarter and 28% on the year before.

At this pace the company is on track to generate annual revenues of around $150 million on which it could earn around $20 million for 2014. This would bring valuation multiples down to a more acceptable 2.3 times annual revenues and 17 times annual earnings.

Adding to that, the market prospects remain good given the increased usage of video content on portable devices. Even video and surveillance cameras require high definition images in today's world.

Another positive development is the decreased reliance upon its distribution partner WT Microelectronics. WT distributed 40% of sales over the past quarter, compared to 75% the year before. Chicony Electronics became the company's most important distributor over the past quarter, distributing some 42% of total sales.

Even after the tremendous rally I believe a long position offers the best risk-reward in the medium to long term.

I think current levels still look attractive but obviously not as attractive as participating in the public offering at $6 per share. Ambarella has a solid track record of consistently growing its business in recent years, and a 17 times earnings multiple does not look excessive for such a business.

Source: Ambarella: After Shares Have Nearly Tripled, Upside Potential Remains