Ambarella Inc. (AMBA 2.51%) has been incorporated since 2004. It is primarily a semiconductor and software design company focused on making systems on a chip (SOCs) for the camera industry. Most recognize that its corporate headquarters are in the heart of Silicon Valley -- but a deeper look reveals information that can better help an investor understand Ambarella and fully appreciate its value on a forward basis.
Ambarella's major tax advantage
Over the past three years, Ambarella has had an effective tax rate far below what a U.S. company might normally pay, which could be as high as 35%. Below is a chart with the details by year for Ambarella.
| Metric | Fiscal Year 2017 | Fiscal Year 2016 | Fiscal Year 2015 |
|---|---|---|---|
| Effective tax rate | 5% | 10% | 3% |
Data source: Ambarella. Chart by author.
The lower effective tax rate is due to the fact that the company is incorporated in the Cayman Islands. A few years ago, tax inversions were all the rage -- U.S. companies were teaming up with foreign entities by merging and then taking on the tax domicile of the foreign company. The end goal was lowering the effective tax rate of the former U.S. company. In the case of Ambarella there was no need to go this route as it was originally incorporated outside the U.S.
Image source: Getty Images.
Manufacturing is outsourced
Ambarella is hands off when it comes to manufacturing its SOCs. It outsources all aspects of the process including packaging and tests of the semiconductor devices to Global UniChip Corporation, located in Taiwan, and Signetics Corporation. The semiconductor SOC wafers are fabricated by Samsung Electronics Company, Ltd. and by Taiwan Semiconductor Manufacturing Company Limited. The company reserves its expertise for hardware and software design, and sales and marketing to its worldwide customer base.
The result is an asset-light company that has small expenses in the way of capital equipment, property, and plants.
The majority of employees are located outside the U.S.
The asset-light structure of the company allows it to deploy employees to the most cost-efficient areas of the globe, as they are not tied to a specific factory with a fixed location. It also allows Ambarella to hire the expertise it needs from a diverse pool of engineers located around the world.
The company has design centers in Taiwan, China, and Italy, along with its headquarters in Santa Clara, California. As of the end of last year, the company had 669 employees; 73% were in R&D. The employees' location by region is shown in the chart below.
| Metric | Asia | United States | Europe |
|---|---|---|---|
| Employees by geography | 482 | 146 | 40 |
Data source: Ambarella. Chart by author.
The company also lists its sales offices as being in Santa Clara and Hong Kong and business development offices in China, Japan, South Korea, Sweden, and Taiwan.
Ambarella's primary source of revenue is Asia
The bulk of Ambarella's revenue comes from Asia. All those GoPro Inc. cameras that contained Ambarella chips are made by various original design manufacturers (ODMs) in Asia. In addition, in the fiscal year 2017 Ambarella shipped 60% of its revenue to its Asian logistics partner Wintech.
Why is this so important?
All of this adds up to a legitimate business that has its products manufactured outside the U.S., has most of its employees outside the U.S., and most of its customers and revenue produced outside the U.S. -- and as a result is able to incorporate outside the U.S. and pay a much lower tax rate than U.S. companies. One could argue that Ambarella's cash is much more valuable than offshore cash held by U.S. companies due to the 35% repatriation tax rate that those companies are burdened with. Ambarella does not have that issue to contend with.
When valuing Ambarella, in addition to the $12.50 per share in cash and zero debt that was on its balance sheet at the end of the first quarter, investors should also consider that future earnings have a much higher after-tax value due to the low tax burden on the company's profits. This drives up the after-tax earning's capabilities for the company.
The company has been quite successful in generating cash quarter after quarter by selling its differentiated product offerings at premium prices. Now you know that shareholders retain a much higher percentage of that cash through its international status.
