The voice recognition marketplace is projected to grow at a compound annual growth rate (CAGR) of 8.8% between 2010 and 2015. Meanwhile, the subsection of this market for voice recognition software solutions is expected to grow at a CAGR of 9.8%. At these rates, the overall size of the market is expected to reach 58.4 billion by 2015. And make no mistake about it: these growth rates are occurring at a time when the economy is stagnating. Imagine the growth of this sector in a robust economic recovery!
At the very center of this thriving and potential $60 billion marketplace? Nuance (NUAN), a company based in Burlington, Massachusetts that focuses on speech technologies. It has come to dominate the market for voice solutions through research, growth, and an aggressive acquisition strategy. Most recently it purchased Ditech Networks to continue improving its mobile voice offerings.
Central to my investing thesis in this company is the barrier to entry, which is centered around NUAN's intellectual property (IP). Voice recognition technology is not easily developed. And, NUAN has not been shy about protecting its IP. Its voice-technology related patent stable is formidable. It holds 274 granted voice patents and 104 pending. Interestingly, four are specifically related to SIRI and some to "voice activated" search commands, more on which below.
In a professional capacity, I have been using speech-to-text software for seven years. The software translates my speech at a fast conversational rate to document text, including punctuation. It also controls my computer in opening or closing programs. I even "tell" my microphone (which is perched on top of my center monitor) to "go to sleep" or "wake up" so that it does not record or respond to extraneous noise when I am on the phone. I have used PowerScribe and a host of Dragon products (both from NUAN) as well as a number of non-NUAN speech products. I can promise you that after you "train" the computer to your voice, the NUAN products are first-rate. I dictate with a 98% accuracy rate. But such accuracy does not come cheap: my latest NUAN program cost approximately $1600.
I like to think about the price of some of these advanced programs and the occasional complaints from users (i.e. consumer complaints about SIRI) as paralleling the early days of the PC market. Everyone thought early PCs were neat and corporations were early adopters. But, it took significant technological advancements and a couple decades for the PC to really penetrate the average family's home and add value. I think the voice recognition market of today is analogous to the PC market in the early-mid 1980s.
When we reflect on the consumer segment of this business, it is only recently that this voice activated technology has begun to make inroads into the consumer experience. SIRI on the Apple iPhone (AAPL) was perhaps the most high profile case, but when you look around you see a plethora of products coming to market with basic voice activated features (from cars, to phones, to tablets, to navigation systems). I imagine that in 10-15 years, voice activation technology will have penetrated into a much larger number of consumer electronics.
"We're at a transition point" says Vlad Sejnoha, chief technology officer of Nuance, "I think speech recognition is really going to upend the current [computer] interface."
Let's review. We have a core voice recognition market growing at nearly 10% per year. We are in the early stages of mass consumer penetration for this technology, which could increase that growth rate well beyond expectations. And (lucky for us!) we have a dominant company in that market with NUAN. Not to be discounted is also the high barrier to entry of the voice patents and speech kernels that NUAN has been developing and honing for more than a decade.
You would think that such a company would trade at a sky-high valuation, right? Perhaps something like Amazon's 300+ P/E multiple? Nope! Wrong! Here are the stats for NUAN:
- 7.7 billion market cap.
- Stock price of $25.16 (9/23/2012)
- Analyst estimates range from $1.74-$2.00 for FY 2013
- Forward P/E of 12.6 to 14.5 (using the range above).
- Growth rate of 20% for the past 5 years.
- Anticipated growth rate of 16% for the coming 5 years.
- Debt of 1.4 billion (reflecting its aggressive acquisitions).
I don't like to buy companies solely based on buy-out potential. However, I will say that NUAN seems like a perfect takeover target for any large technology company that wants to continue expanding its consumer voice offerings. In particular, I feel that AAPL will continue to refine SIRI and move voice solutions to its tablet and computers. At a $12 billion acquisition price, NUAN would be worth $38/share (more than 50% upside). An acquiring business could spin off the corporate services and healthcare businesses into a subsidiary and take advantage of the voice technology in consumer and mobile applications.
So, what could go wrong? Well, voice technology could have slower than anticipated penetration into consumer products. Like SIRI has shown us, for many people voice technology is still a novelty. It's not quite reliable enough to gain widespread use. We need continued improvement in the technology for voice technology to jump from a niche field to a ubiquitous product. For others, NUAN acquisition-induced debt is an issue. However, I think this has been money well spent, and its debt-to-equity ratio is still conservative. The final point critics have against NUAN is that it is expensive. However, I have to disagree. When you take into account the expected and potential growth, I think it trades at a very reasonable risk-reward multiple.
For all these reasons, I expect NUAN to outperform the market over the next decade. With reasonable assumptions in the growth of Voice technology, I think it can grow its stock price 15% per year annually over the next decade (assuming it remains independent). And, if it gets acquired, even better for us!