Thursday, January 8, 2015

Ambarella, Inc. A Solid Growth Story

     Before reading further: this article is my opinion.  I'm not asking you to buy or sell this security.  Do you own research to figure out if this company makes sense for you.  Heck, you might actually learn something in the process.

     AMBA came up on one of my FINVIZ growth screens a few months ago.  I've being watching the chart and slowing combing through the fundamentals and have concluded this is a good company for a long position.

Technical Position

The stock hit a low of 21.6 in early May.  Since then, it has been in a solid uptrend, printing a nice series of higher lows and higher highs.  Since the end of November, prices have consolidated in a triangle consolidation pattern.  Yesterday, prices printed a solid bar on very strong volume that closed above previous highs.

Fundamental Analysis

AMBA is involved in the high definition video market.  From their 10-K:

We are a leading developer of semiconductor processing solutions for video that enable high-definition, or HD, video capture, sharing and display. We combine our processor design capabilities with our expertise in video and image processing, algorithms and software to provide a technology platform that is designed to be easily scalable across multiple applications and enable rapid and efficient product development. Our system-on-a-chip, or SoC, designs fully integrate HD video processing, image processing, audio processing and system functions onto a single chip, delivering exceptional video and image quality, differentiated functionality and low power consumption.

No one is an almost ran in their own company report, so take their "leaking developer" language with a large grain of salt.  However, this is a market that is growing due to the increased proliferation of devices that can record this type of video, the overall increased acceptance of this technology and the growing ability to store the data associated with making these films. 

    At this point, I have to admit that I don't have the technical capability to understand their technology.  Frankly, all I use my phone for is calls, email and web surfing.  This means I can't properly evaluate their technology.  However, the increasing revenue figures posted by the company indicate the market feels this technology is very good.

     The company has a very important drawback, due to the following two points also from the 10-K: 

Our sales cycles typically require a significant investment of time and a substantial expenditure of resources before we can realize revenue from the sale of our solutions, if any. Our typical sales cycle consists of a multi-month sales and development process involving our customers’ system designers and management and our sales personnel and software engineers. If successful, this process culminates in a customer’s decision to use our solutions in its system, which we refer to as a design win. ..... Volume production may begin within six to 18 months after a design win, depending on the complexity of our customer’s product and other factors upon which we may have little or no influence. Once our solutions have been incorporated into a customer’s design, they are likely to be used for the life cycle of the customer’s product. Conversely, a design loss to a competitor will likely preclude any opportunity for future revenue from such customer’s product.


We derive a significant portion of our revenue from a limited number of ODMs who build products on behalf of a limited number of OEMs and from a limited number of OEMs to whom we ship directly. .... In fiscal year 2014, sales directly and through our logistics providers to our five largest customers collectively accounted for approximately 55% of our total revenue, and sales to our 10 largest customers collectively accounted for approximately 67% of our total revenue. In fiscal year 2014, sales to our largest ODM customer was approximately 29% of our total revenue.

     So, the sales cycle is long, complex and expensive.  And once a sale is make, the company still has to wait 6-18 months for "volume production."  Assuming a 6 month sales cycle (which, given the complexity of the product is a fairly aggressive assessment), it will take the company at least 12 months for volume production to begin, making the true payoff from a new product a very long time in coming.  In addition, there are obviously only a limited number of companies who can not only benefit from the technology in a financially meaningful way, but also provide the platform for AMBA's products.  This means that if a newer and better technology come along, AMBA could lose revenue very quickly.

     Their annual report admits as much with this very important warning:

Achieving design wins is subject to lengthy competitive selection processes that require us to incur significant costs. Even if we begin a product design, a customer may decide to cancel or change its product plans, resulting in no revenue from such expenditures.

     In addition, they rely extensively on a single company for their Asian operations:

We sell most of our solutions through a single logistics provider, Wintech Microelectronics Co., Ltd., or Wintech, which serves as our non-exclusive sales representative in all of Asia other than Japan. Approximately 56%, 63% and 80% of our revenue was derived from sales through Wintech for the fiscal years ended January 31, 2014, 2013 and 2012, respectively. ... Our current agreement with Wintech is effective until September 2015, unless it is terminated earlier by either party for any or no reason with 90 days written notice or by failure of the breaching party to cure a material breach within 30 days following written notice of such material breach by the non-breaching party. Our agreement with Wintech will automatically renew for additional successive 12-month terms unless at least 60 days before the end of the then-current term either party provides written notice to the other party that it elects not to renew the agreement.

     The report contains numerous other warnings, all of which can be summed up by noting this is a n early stage growth company.  Right now, it's products are hot.  But, they are only one 13-year old tech genius away from obsolescence.

Balance Sheet

     Over the last five years, AMBA has been building up their cash position, which has risen from $26.5 million in 2010 to $143 million in 2014.   Unfortunately, over the last few years, their cash conversion cycle has increased from 40 to 60 days.   The large increase in the cash position helps to alleviate concerns with this increase and the growth nature of the company allows a certain amount of latitude with internal management.  And investors can breath a bit easier with both the cash and quick ratio over 5.  However, this number is a bit concerning, though hardly fatal.

     Also, their AR more than doubled between 2012 and 2013, although it decreased about 10% from 2013-2014.

     But the most impressive balance sheet statistic is their remarkable increase in overall book value, which has increased form a -$17 million in 2010 to $156 million in 2014.  This is very solid growth of overall company value.

Income Statement

     This is what originally attracted me to this company.  Their overall YOY revenue growth rate has been very strong:  for the years 2011-2014, these rates have been 32.46%, 2.66%, 24.48%, 30.18  respectively.  And their operating and an net margins have also been increasing, with the former rising from 11% to 17% and the latter rising from 10% to 16% (both of these increases are for the years 2012-2014).  And SGA expenses have dropped a bit as well.  Overall, this is great revenue growth with a wonderful combination of controlled expenses.

Cash Flow

     Usually growth companies obtain their cash position from the issuance of additional equity or debt.  This is not the case with AMBA.  Over the last five years, their free cash flow has fluctuated between $8.9 and $32 million -- which goes a long way towards explaining the company's strong balance sheet.  Their most expensive capital expenditures year was 2013 when they spent $1.7 million.  But that was easily dwarfed by their cash from operations.


     The top line growth numbers of this company are excellent.  And, they are keeping expenses in check.  Their cash flow is more than adequate to fund current operations.  And their balance sheet is rock solid.

     There are some serious drawbacks.  First, their product development cycle is long.  And, should they fail at closing a deal, they don't have many other potential suitors for their technology.  There is also the over-reliance on a single sales agent for Asia.

     But, as of now, this is a good growth play with upside potential.