Is Nuance Communications Dead Money?

Nuance Communications (NUAN) just can't catch a break.

After running up in anticipation that Carl Icahn's investment stake will improve the company's prospects, shares made an about-face following its fiscal second quarter earnings results. To make matters worse, the speech recognition company lowered guidance for the upcoming quarter, pushing shares below pre-Icahn levels. Naturally, these developments haven't eased investor concerns that there could be structural issues with Nuance's business model.

Breaking down the disappointment
For the quarter, Nuance reported non-GAAP revenue of $484 million, which represented an increase of 15.9% year over year, but was sharply below expectations. Analysts were expecting Nuance's revenue would come in around $516 million. Here's how Nuance's business breaks down:

Source: Nuance FQ2 Results. Dollars are in millions. YOY = year-over-year. QOQ = quarter-over-quarter.

Nuance blamed poor sales execution and the challenging macro environment in Europe for why the company didn't meet expectations. Still, it wasn't enough to deter the company from announcing a $500 million share repurchase program, which, as the CEO put it, "underscores our confidence in the business and our focus on shareholder value as we expect growth to accelerate in fiscal 2014."

Between all of its business segments, Nuance estimates its total addressable market to be somewhere in the neighborhood of $48 billion. Surprisingly, Nuance's enterprise segment remains its biggest long-term opportunity, which it pegs as a $26 billion opportunity.

Something's not adding up
For a company that's only expected to tap only about 4% of its $48 billion addressable market this year, there seems to be a disconnect between reality and potential. Investors could argue that the company is only getting started and market share will increase in the coming years. This is entirely possible, but some of the numbers to support this belief suggest otherwise.

In the first quarter, which was the same time frame as Nuance's fiscal second quarter, IDC reported a 42% increase in worldwide smartphone shipments year over year. However, Nuance's mobile and consumer business segment, largely driven by smartphone and automotive adoption, only realized a 1% increase in revenue. Nuance CEO Paul Ricci even highlighted that automotive performed quite well. What gives?

Although Nuance has admitted that Apple (AAPL -1.07%) is a customer, it won't talk specifics about the nature of their agreement. However, it's widely believed that Nuance helps power Siri, Apple's voice-activated personal assistant. During the quarter, Apple sold 37.4 million iPhones, the majority of which support Apple Siri. Samsung, which is also pegged as a Nuance customer, experienced a 61% growth in shipments and shipped over 70 million smartphones. Combined, over 100 million devices were sold during the quarter -- and yet Nuance didn't materially benefit.

The million-dollar answer
During the conference call, Nuance acknowledged that the company is continuing to experience a negative shift in the way that it's compensated. Customers are changing their billing agreements toward usage-based terms, pressuring revenue across the board, indicating that its products are not in as high demand as once believed. The company claims this revenue shift will ultimately build stronger, more predicable revenue streams over the long term, but I beg to differ.

This new approach assumes that end users will want to increase their usage of speech recognition technology. The fact that Nuance could only squeeze out 1% growth on 42% smartphone growth isn't convincing me that this will be the case. After all, taking a horse to water is one thing, but getting it to drink is entirely different. In hindsight, I probably shouldn't have purchased Nuance in the first place.