Recent Swype Purchase A Game-Changer For Nuance Communications

| About: Nuance Communications, (NUAN)

One of the first items taught in business school is that railroads failed to to understand that they were in the transportation business, not the railroad business, and that this shortsightedness is caused their demise. Nuance Communications (NASDAQ:NUAN) CEO Paul Ricci must have taken copious notes in class because his company's recent purchase of Swype has catapulted it from a voice recognition company to an input organization. I think this is a big move for the company because it expands what it, as an entity, does.

Donna Howell, in a recent Investor's Business Daily article, explains:

To "swype," a person traces across keyboard letters in a continuous motion to comprise a word. Swype says its input method lets people do more than 40 words a minute, and says the application is meant to work across not just phones and tablets, but also game consoles, kiosks, televisions and other screens.

The posting goes on to interview FBR & Company analyst Danial Ives and he reports:

Swype is licensed by a number of Android-based device makers, and that Swype has signed with 15 manufacturer partners and is on 50 million devices shipped in the last 18 months.

That's a lot of smartphones, and let's not forget that Apple (NASDAQ:AAPL) is a player in that arena, too. In fact, it recently released its much ballyhooed iPhone 4S with the usual media circus in tow. The technology and investing press have written extensively about the device, and the big selling point of the communicator is its voice-recognition wizardry, more commonly known as Siri. Nothing has been confirmed, but Nuance Communications purportedly has the technical know-how that is the backbone of this game changer.

An October 5th, TechCrunch posting by MG Siegler reports:

Siri does not work without Nuance. Though they initially tried Vlingo, Nuance was found to be the better technology. In fact, Siri was still using Nuance right up until Apple pulled the old standalone app from the App Store yesterday.

Apple stands for ease of use and quality, and my take is that if it did indeed partner with Nuance, it made the right choice. This is because, according to SmartMoney,

Dragon (the Nuance voice engine) happens to be almost universally regarded as the best voice recognition software.

With the cognoscenti on board, Nuance appears to have the leading position in providing all forms of input as we know it. A Vulcan mind meld or telepathic texting could be next with the exotic software it produces, especially at the rapid pace technology is evolving. To insure its position, the inner sanctum of the company has reached its tentacles into the acquisition space the last few years and, as a result, is buying smaller firms. Companies like Equitrac, SVOX, Webmedx and Loquendo were obtained not only for their software, but for their patents. In the Q2 conference call, Mr. Ricci explains that the company has about 4,000 patents and patent families, and this was before absorbing the above-mentioned companies.

As we've moved from predictive text to voice activated mobile computers, one thing is apparent - not one company can do it all alone. These wireless communication devices are a symphonic whole of many efforts. "The nature of the Mobile business is changed to one where our engagements with a number of important partners has become more extensive in co-development.


I think that's a trend that will continue.

The CEO doesn't specifically cite any one partner and, in fact, seems to keep his cards close to his vest. My guess is that he is talking about Apple, but that's just conjecture.

In my last article on Nuance, I gave a lot of detail on its business model and in order not to be redundant, I will opt not to give a breakdown of its overall operation. A 10-K comes out once a year and I really can't add anything to the conversation that I didn't say in the last posting. However, I would like to emphasize that the company is a major player in electronic medical record transcription products and services and may be a big benefactor of the HITECH Act. The HITECH Act is part of the government's Stimulus Plan where thirty billion dollars has been slotted to modernize medical records through 2020.

Besides discussing the move from touch-tone transmissions to audio sensitive devices in the last post, I also talked about the valuation of Nuance. My belief was that it was expensive on a price/cash flow basis and since it hadn't been profitable in ten years, I was going to sit on the sidelines. Well, I'm happy to report that after a decade of being in the red, it has finally moved into the black and it looks like this trend will continue. In addition, in the seven months since the article was written, the stock has gained 33%, rising from $18 to it's current price of just about $24. Heavy-duty profits in a market that has gone nowhere in 2011.

Even with the impressive gains, Nuance seems to be running on the cool side as we take its temperature. Some of this can be attributed to the lackluster market. Consensus earnings estimates on Yahoo Finance give it $1.35/share for 2011 and $1.57/share for 2012. That gives us a current P/E ratio of 18 and, going forward, a P/E ratio of 15 - very reasonable valuations for a stock that has a growth rate of 16% for next year and a five year CAGR (compound annual growth rate) of 13%. We're talking about PEG ratios at about one, which is a fire-sale price for a growth company.

Analysts seem to like the stock as much as I do. Out of the 19 companies that cover Nuance, 15 have a buy or strong buy, three say to hold the stock and only one says to sell. What Nuance probably needs to kick it into high gear is a "Qualcomm (NASDAQ:QCOM) moment". You may remember back in the dot com bubble when a PaineWebber analyst put a $1,000 price target on the stock. Retail investors would be all over it. As is, Main Street isn't aware of Nuance because its products and services are ubiquitous. If Siri on the new iPhone 4S turns out to be a success, then that would be a marketing and public relations bonanza for the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short the market with inverse ETFs