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Nuance (NASDAQ:NUAN) is not a patent troll. It is a patent dragon, having sued and bought out most of its competitors in voice recognition. Voice recognition is emerging as the next definitive interface, like the keyboard, mouse, and touchscreen were. If Nuance can continue to dominate the category, today's forward P/E of 13 will look downright insane in hindsight.

Like patent trolls, Nuance would be hurt by stricter interpretation of software patents. Patents are coming under increasing scrutiny. Many economists are saying they should disappear altogether. The legal monopoly Nuance has built up through years of lawsuits and acquisitions could fade. This would leave it to compete entirely on technological merit and business relationships.

The technology competition problem for Nuance is Google (NASDAQ:GOOG). A lot of money was made by shareholders in Google's IPO, but since the IPO more money has been made by shorting Google's victims, like Microsoft (NASDAQ:MSFT). Google enters an established industry with a cheaper, more efficient product, and often destroys more earnings than it creates. Good for consumers, bad for competitors - the latter group desperately turns to the FTC for protection.

I salute Nuance shareholders for visualizing the revolutionary impact which voice recognition will have on user experiences. Here is a typical description of Nuance:

An increasingly valuable player in the ongoing technological revolution. We have followed the progress of its Dragon voice-recognition software since 1995. The journey was far longer than we could have imagined, but cloud computing has finally brought this innovation to the tipping point. We can envision speech recognition being combined with language translation (offered by our first Seeking Alpha article/triple, Lionbridge LIOX) to create the world's first universal translator, ala Star Trek. It's going to happen. It's just a matter of when.

It's just a matter of when...

The key to success so far for Nuance investors has been patience. Ten years of investment have produced a triple. So I cannot knock bulls for saying it's just a matter of time. I cannot knock bulls for finding a smarter way to profit from Siri. But we have to consider what Google is good at. Google is good at emulating the human brain, and Google works to get better at it every day.

Google already participates in cloud computing, voice recognition and translation, so Google already competes with Nuance in theory. But practically speaking, Google is just beginning to polish its product in this area. We're talking about the company that makes Priuses drive themselves, well enough to be allowed on public roads. We're talking about the search engine that was built on strict automation principles: Google's code takes the long route and is more robust for it. We're talking about the global leader in AI.

Due to the strictly automated way Google's code in AI is built, a product might take some time to get off the ground, but once it does, it can gain momentum quite quickly.

Google's learning software is based on simulating groups of connected brain cells that communicate and influence one another. When such a neural network, as it's called, is exposed to data, the relationships between different neurons can change. That causes the network to develop the ability to react in certain ways to incoming data of a particular kind-and the network is said to have learned something.

Basically, the human brain is too big to be reproduced by a computer, but some functions of the human brain, like voice recognition, could conceivably be reproduced by a really big computer.

In order for voice recognition to replace text input, it has to allow almost perfect accuracy. Google's neural network approach shows potential here.

"We got between 20 and 25 percent improvement in terms of words that are wrong," says Vincent Vanhoucke, a leader of Google's speech-recognition efforts. "That means that many more people will have a perfect experience without errors."

It's all about engineering momentum. Google seems to be gaining momentum. Ironically, the momentum is in fixing 20% of the problems in an 80/20 situation.

To Google, voice recognition is part of its broader ecosystem. For example: Project Glass, the next iPhone, includes voice recognition. This ecosystem strategy means Google will put a lot of resources into voice recognition, but can still offer it for free. Such "spillover" has famously diluted the pricing power of competitors like Microsoft. This situation would be similarly devastating for Nuance, especially without software patents to fall back on.

Nuance is not Apple (NASDAQ:AAPL). Nuance cannot beat Google by being more cute. Voice recognition is a utility, not a fashion accessory like smartphones.

Nuance has a demographic of smart investors. Normally this is a good thing. But remember that smart investors are quicker to sell when things go wrong.

Conclusion: NUAN, despite a very reasonable forward multiple, appears to be an "avoid" until certainty arises in software patents and Google's voice recognition capabilities.

Source: A Nuanced Case Against Nuance