Shares of Ambarella (AMBA 0.58%) have stumbled nearly 20% this year, woefully underperforming the Philadelphia Semiconductor Index's 5% gain. The image processing SoC (system on chip) maker's decline can be attributed to the loss of top customers, rising competition from bigger chipmakers, and its lofty P/E of 46 -- which is much higher than the industry average of 25 for semiconductor equipment makers.

Nonetheless, bottom fishing investors might still consider Ambarella to be a potential turnaround play in the frothy semiconductor market. However, I wouldn't touch Ambarella for one simple reason: the competitive headwinds are too fierce to counter.

An Ambarella chip floating in orbit.

Image source: Ambarella.

Why is Ambarella losing ground to its competitors?

Several years ago, Ambarella established itself as the "best in breed" maker of image processing SoCs. Larger chipmakers weren't focused on this niche market, so Ambarella became the preferred supplier for companies like GoPro (GPRO 1.83%), DJI Innovations, and Hikvision -- which are respectively the top makers of action cameras, drones, and security cameras in the world.

Unfortunately, larger chipmakers eventually noticed Ambarella's growth. Qualcomm (QCOM 0.10%), the top mobile chipmaker in the world, launched new variants of its Snapdragon SoC -- which included its integrated Spectra image processor and 4G baseband modem -- for action cameras, drones, and other devices.

Ambarella's SoCs don't have built-in modems, so an OEM would need to buy a baseband modem separately (likely from Qualcomm) to add stand-alone 4G connectivity.

DJI's Spark drone.

DJI's Spark drone. Image source: DJI.

Intel (INTC 0.02%) also took aim at Ambarella with its acquisition of computer vision chipmaker Movidius in late 2016. DJI already uses Movidius' Myriad 2 in its portable Spark drone (which doesn't use an Ambarella SoC), and is expected to use the newer Myriad X chip in newer drones.

DJI's flagship Phantom 4 drones previously used the Myriad 2 alongside an Ambarella SoC, but its newer portable drones cut Ambarella out of the loop by using the Myriad 2 for both computer vision and image processing tasks. Hikvision also uses the Myriad 2 in its newer AI-powered cameras, and Alphabet's Google uses the chipset in its new wearable Clips camera.

A slow response to obvious threats

Ambarella's response to the Myriad and similar all-in-one computer vision chips has been painfully slow. Its first computer vision chips -- the CV1 and CV22 -- have been in development for over four years, and were only recently revealed at CES in January.

Ambarella plans to target the ADAS (advanced driver assistance systems) market with its first CV chips, but here's the problem: Intel also owns Mobileye, which already provides ADAS solutions to about 90% of the world's top automakers.

Therefore, Intel can bundle together Movidius' computer vision chips with Mobileye's ADAS solutions to establish a firm foothold in the automotive market, and Ambarella will struggle to match that scale.

A woman sits in a connected car.

Image source: Getty Images.

Qualcomm is also focused on the automotive market. It previously launched custom Snapdragon SoCs for connected cars, and plans to acquire NXP Semiconductors (NXPI -0.27%), the biggest automotive chipmaker in the world.

NXP also owns BlueBox, an onboard computer that turns regular vehicles into driverless ones. The combination of those technologies, along with its newer depth-sensing Spectra modules, could turn Qualcomm into a major threat to both Ambarella and Intel in the near future.

But Intel and Qualcomm aren't the only threats to Ambarella. Last year, GoPro cut Ambarella out of the loop and hired Japanese chipmaker Socionext to create the custom GP1 SoC for its Hero 6 cameras. GoPro, like DJI, realized that it would be more cost-efficient to use a chipset with an integrated image processor instead of buying Ambarella's stand-alone SoCs.

Where does that leave Ambarella?

Analysts expect these headwinds to cause Ambarella's revenue and earnings to respectively drop 5% and 32% this year. Looking ahead, the best case scenario for Ambarella is a buyout, but the stock's lofty valuation should keep potential suitors at bay. Therefore, investors should avoid Ambarella unless it can form a meaningful moat against its much larger competitors.