Is Nuance Communications a Buy?

Nuance has seen good growth in bookings as a result of its innovations and strategic partnerships, but Apple could be a concern in the future.

Mar 31, 2014 at 10:00AM

Speech-recognition technology provider Nuance Communications (NASDAQ:NUAN) has begun the year on the right foot. Nuance shares have appreciated more than 12% this year as the company continues to benefit from its partnership with Apple (NASDAQ:AAPL), recording solid growth in earnings per share.

A big number of positives
In the recently released first-quarter results, Nuance's bookings grew 26%, year over year. In addition, Nuance issued a robust outlook for the future, as it is seeing solid growth across different areas. Nuance's health-care and automotive businesses are doing quite well; these were the primary drivers behind the growth in bookings. The outlook for Nuance's health-care business looks strong, with new products and strategies in the pipeline.

The company's partnership with Hyland Software has proven to be a good move, as Nuance's new product, eCopy ShareScan, is based on Hyland's technology and should help it tap into the channel of Hyland customers. The product, which scans and captures data from patients' documents, has been well-accepted in the market.

Nuance is expecting its automotive business to get better. Its decision to acquire Tweddle Connect has proven to be profitable, as the combination of Nuance's acclaimed Dragon Drive, an in-car infotainment system, and Tweddle's Connect provides a personal-assistant experience for a safer, smarter connected car. Dragon Drive's growing popularity has attracted many well-known brands such as Audi, BMW, Chrysler, Ford, General Motors, Hyundai, Toyota, and many other automakers. Looking ahead, Nuance is expecting its new and innovative solutions to attract adjacent growth markets.

The company is making significant investments in innovation, as well. Nuance plans to invest in scalable cloud-based platforms and is also focusing on leadership in natural language understanding, reasoning, virtual-assistant technologies, and on delivering sophisticated implementations of these technologies.

Recently, Nuance launched a simpler version of its voice biometric technology for law enforcement, which delivers accurate and unique identifying characteristics akin to DNA and fingerprint evidence. This updated software is designed to confirm or deny the identity of individuals based on audio files that are used during investigations.

Some concerns
Investors should remember that Nuance is currently in a transition phase. The company is changing its license-based revenue system to a subscription-based system, and this strategy will prove to be profitable in the long run. Changing from the license model to the subscription model means that Nuance's customers will not have to pay the whole amount for a product up front, but it will be distributed in small installments paid over an extended period of time.

Though this will result in a short-term decline in sales and earnings, it will ensure sustained profitability in the long run. This strategy will also lead to an increase in demand and will further boost Nuance's margins.

Apple's big threat
Nuance can face a big threat from Apple over the long run. Apple is reportedly preparing its own speech technology for use in Siri, so it could move away from Nuance's solution. Apple has reportedly set up a team of top speech scientists in Boston in an effort to cut out its dependence on Nuance. So far, Nuance has been powering Siri across Apple's ecosystem, but there is a danger that it might lose its Apple account in the future.

In fact, Apple has been poaching talent from Nuance, as at least two Nuance speech scientists left their jobs last year to join Apple. Since Apple has a history of breaking away from third-party suppliers in order to reduce external dependence, Nuance could be in the crosshairs.

Nuance is very cheap, selling at just 13 times forward earnings. Potential investors should definitely take a look at the company, since it is making a lot of positive moves. However, investors shouldn't forget the fact that an Apple breakup could be a big negative in the future. We have already seen the likes of Cirrus Logic suffer due to reduced business from Apple, and the same could happen in the future with Nuance if Apple decides to go its own way with Siri.

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Mukesh Baghel has no position in any stocks mentioned. The Motley Fool recommends Apple and Nuance Communications. The Motley Fool owns shares of Apple and Nuance Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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