Ambarella: Looking At The Bigger Picture

Summary

• Ambarella posted a revenue and EPS beat in its Q4 yet again.
• However, its Q1 FY19 guidance is rather dull.
• Expect revenues from its CV chips to start coming in only next year.

Ambarella (NASDAQ:AMBA) just posted its fourth quarter results. The chipmaker managed to beat the Street's EPS and revenue estimates yet again and also reduced its revenue exposure to GoPro (GPRO) on a net percentage basis. Granted that its Q1 guidance was rather dull, but if we weigh its prospects over the long-term time frame, Ambarella might just be on the cusp of an inflection point. Let's take a closer look at both bullish and bearish arguments surrounding the name, to have a better understanding of where its shares could be headed next.

The FUD

Let's begin by discussing Ambarella's Q4 FY18 earnings highlights. Its revenue for the period came in at $70.6 million, which was perfectly within its guidance range of $68 million to $72 million and slightly above the analyst consensus of $70.41 million. Its EPS came in at $0.45 which was noticeably higher than even the most bullish estimates that topped out at $0.4. Needless to say, the company exceeded the Street's estimates in both areas.

Moving onto perhaps the most watched item of all. Management had guided previously in their Q3 conference call that their sales to GoPro and its ODMs during fiscal year 2018 would collectively account for around 14% of its overall revenues. However, I had argued in my last article that the figure would be closer to 12% due to the camera maker's lacklustre sales in Q4. Well, as it turns out, the actual figure came in quite close at 12.5%. Here's an excerpt from my last article:

While using the management's guidance brings us to the 14% figure, I'm of the opinion that the actual figure would be closer to 12%. I say this because GoPro announced a disappointing set of Q4 results earlier this month. Its revenue for the period came in lower than its already lowered forecast. This could directly impact Ambarella's revenue recognition from GoPro quite naturally.

If we look at this data on a granular level, then the chipmaker met its guidance and exceeded the Street's expectations even though its sales to GoPro dropped faster than expected. I believe this was one of the key highlights of its earnings report that probably went unnoticed by many investors. This goes to indicate the robustness in Ambarella's non-GoPro business. The chipmaker has actively tried to diversify its revenue stream by refreshing its product portfolio, expanding into new segments and reaching out to under-penetrated customers over the past year, and it looks like its efforts are starting to bear fruit.

With that said, there was also a key item that particularly stood out in Ambarella's earnings report. Its management guided that their revenues during Q1FY19 would be between $54.5 million and $57.5 million - equating to a mid-point guidance of $56 million. While this figure may not mean much in isolation, it actually represents a 12.6% decline in the chipmaker's revenues from the year-ago quarter. Its management attributed this decline to softer drone sales.

Ambarella's management didn't provide us with an FY19 sales figure, but analysts are pegging its revenue growth for the year to be essentially flat at $296 million. Attaching this figure with the management's Q1 guidance and historical H2 FY(X) trends leads us to the following chart. I plotted the price-to-sales metric on the same chart to discuss the bear argument.

It's evident that Ambarella's P/S metric is largely in the same range as its historical levels, even though the chipmaker's growth rates have dropped quite substantially over the past few quarters.

The bearish argument implies that market participants won't be willing to pay a premium for Ambarella when its growth rates are clearly expected to remain subdued until the next fiscal year at least. It essentially calls for a crash or a major correction in Ambarella's stock price so that its P/S metric shrinks in line with its now-softened growth rates. I must admit that the argument does make sense if we look at the company from a standpoint of trailing financials.

But the problem with this line of thinking is that it doesn't factor in the possibilities that lie ahead of Ambarella:

• For starters, and this is purely from a financial standpoint, Ambarella has gained a reputation of exceeding the Street's estimates time and again. In fact, if we look at this Estimize page, then it's quite evident that the company has beaten the Street's revenue consensus in 7 out of the past 8 quarters. So if past statistics are anything to go by, it's highly likely that Ambarella's FY19 sales figure would also come out to be better than what the Street is currently projecting.

(Source: Estimize)

• Ambarella may have refreshed its product line-up over the last year, but as I noted in my last article, its chips will start to meaningfully enter OEM products in mass volume only this year. This is especially apparent in its security camera division, where the latest HEVC-compression can save as much as 50% of the transmission bandwidth. The savings may not mean much for single camera products, but it really starts to have a compounded effect where there are multi-camera setups on a limited bandwidth. Ambarella hasn't provided us with the granular sales figures of this business division yet, but the pick-up of HEVC-capable camera systems could stabilize Ambarella's overall revenue over the course of FY19 at the very least.
• And lastly, let's not discount the fact that Computer Vision could be a big winner for the chipmaker.

Computer Vision

The key thing to note here is that Ambarella's CV solutions (mass sales haven't begun yet) will be a key enabler of various kinds of intelligent camera systems, which includes Advanced Driving Assistance Systems (ADAS). The chipmaker's management noted that its exhibition of CV-powered Embedded Vehicle Autonomy (EVA) solutions garnered an audience of 40 automotive and Tier 1 companies at the CES last month. It also noted that a few of these automotive and Tier 1 vendors have already begun evaluating their CVflow solutions.

Granted that qualification efforts can take a long time to convert into actual sales. In fact, it would be perfectly reasonable to expect that Ambarella won't generate any sizable sales from its CVflow solutions at least until mid-CY2019. But just because it's going to take time doesn't mean we should discount the prospects of its new technologies altogether. The fact of the matter is that the ADAS market alone is expected to meaningfully grow over the next several years, as highlighted in the chart below.

(Source)

Now there are broadly four ways Ambarella stands to potentially benefit from this developing market dynamic:

1. Since the ADAS industry is expected to grow at a blazing pace over the next several years, there's a good chance that market forces could start baking this future sales contribution into Ambarella's FY19 stock prices well in advance.
2. Ambarella happens to be one of the very few publicly listed pure-play chip manufacturers that operate in the segment, so institutional and retail investors, who want to get some exposure on this booming market, might be encouraged to go long on the chipmaker in large numbers. Naturally, if there's heavy buying into a security over an extended period of time, and the increase in its demand isn't matched by an increase in supply, then the price of the security is bound to go up.
3. Any technology major that wants to buy their way into the ADAS market would consider buying out Ambarella. The chipmaker has an enterprise value of only $1.22 billion which isn't much for larger technology firms like Broadcom (AVGO) that rely largely on buyouts for the bulk of its growth. A buyout at $2.4 billion would be 2x of Ambarella's current enterprise value and only 11x its sales, which is still very far away from Mobileye's (MBLY) buyout - also an ADAS provider - at over 40x sales.
4. Next, management of Ambarella had noted in their Q4 conference call that it garnered an audience of 40 automotive and Tier 1 vendors. If even 5 of these names start purchasing chips from Ambarella, each at a run-rate of $4 million per quarter, it would single-handedly represent a 27% upside over Ambarella's FY18 overall revenue figure. And this is a conservative baseline estimate in my opinion.

Investors Takeaway

I'd like to remind readers that nobody can say with certainty if any of the above-mentioned factors will definitively play out or not. But the point that I've tried to make here is that the upside potential in Ambarella appears to be far greater than its downside potential. The chipmaker is entering a new industry that's poised for sustained rapid growth, and I really don't think it would be prudent of us to value Ambarella based on its past financials, from a period when it didn't even have ADAS enabling solutions on the market.

Author's Note: I'll be covering Ambarella's Computer Vision chips in more depth in my next article. Make sure to click that "Follow" button at the top of this page to get a notification as soon as the report goes live. Thanks!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.