Ambarella's (AMBA +2.62%) stock market resurgence has come to an abrupt halt, after Pacific Crest Securities noted that the company could lose business from one of its major customers. Analysts Brad Erickson and Elliot Arnson, believing the camera and video-chip specialist could lose its place in the drones made by Chinese company DJI, downgraded the stock to "sector weight" from "overweight."
But can Ambarella bounce back from this downgrade and the potential customer loss? Here's what investors need to know.
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Ambarella's problems are getting bigger
Ambarella doesn't single out the amount of revenue it gets from DJI, but 68% of its top line comes from its 10 largest customers. The company is already facing problems at its largest original-equipment-manufacturer customer, GoPro, which accounts for almost a quarter of its total revenue. So a potential loss at DJI will only compound the pain.
In January, news emerged that GoPro could turn to Qualcomm for chipsets in a bid to reduce its dependence on its biggest supplier, triggering a potential exodus among other Ambarella customers who might decide to try out Qualcomm chips. Pacific Crest's latest report lends more support to that concern, as the firm's conversations with DJI's customer-service reps indicate that the drone maker is using video-processing chips from a new company.
In fact, Pacific Crest believes Ambarella has already lost the video-processing spot in the recently launched Spark drone that's priced at $499. If so, that could hurt Ambarella by cannibalizing sales of the entry-level drone that's priced identically, which Ambarella has a steak in.
Moreover, Ambarella investors' problems could get bigger. Management had accepted last year that Qualcomm is talking to some of its key customers, setting the stage for potential revenue losses in 2017. For instance, Stifel Nicolaus analyst Kevin Cassidy predicts that the chipmaker's dwindling orders from GoPro could reduce the action-camera maker's contribution to its top line to just 5% in 2017.
Therefore, Ambarella will find it difficult to arrest the revenue erosion if more customers switch to competing chipsets.
AMBA Revenue (Quarterly) data by YCharts
Should investors expect a comeback?
With these headwinds, Ambarella stock will have a hard time rallying. The company's revenue growth has stalled, and its earnings could dip 25% this year, according to Wall Street estimates.
Ambarella, then, just doesn't look like good value at its current price-to-earnings ratio of just under 30, which is higher than the industry average of 24. Moreover, the stock's rally in recent months wasn't driven by any notable catalyst, but by Intel's acquisition of Mobileye, a move that opened the possibility that a larger company could acquire Ambarella, since it's one of the few pure-play camera and video-chip suppliers whose products can be deployed in the automotive space.
But Pacific Crest notes that the automotive premium is already priced into Ambarella shares, and the company won't start recognizing material revenue from this market for the next three to four years. What's more, the company currently doesn't have the required artillery to compete against the might of Intel and Mobileye in this space.
Ambarella didn't have an automotive system-on-a-chip in January this year, and CEO Fermi Wang didn't throw any light on the company's possible automotive-chip introductions going forward. His silence on the matter reduces the possibility that any big company will take over Ambarella, given its slow time to market in this space.
For instance, Mobileye launched its automotive system-on-a-chip in 2007, after eight years of research, and it has relationships with 27 original equipment manufacturers in this space. Intel, therefore, had a nice incentive to acquire Mobileye, given the progress it had already made in the automotive market. That's something Ambarella lacks.
The Foolish takeaway
It seems Ambarella's struggles are just beginning. The company's growth has taken a hit of late, and the trend could continue if it loses its core customers to bigger rivals such as Qualcomm, paving the way for more downside.
