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The Little Chipmaker Driving a Growing Video Trend

By David Meier - Dec 14, 2013 at 2:00PM

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Ambarella's video processing chips are changing the way people use high-definition cameras.

Ambarella (AMBA -0.67%) is a classic enabler. It designs video systems-on-a-chip for capturing and processing high-definition video, and its technology is fantastic. If you've seen an adventure video shot on a GoPro camera, you've seen Ambarella in action. I expect Ambarella to continue selling more product to its existing customers like GoPro while finding new customers for its next-generation chips. But before I make the case for Ambarella as an excellent growth investment going forward, let's see how the company is performing today.

Ambarella recently reported excellent third-quarter results. Revenue increased 29% to $46 million, coming in ahead of analysts' estimates. Net income rose 36% from $6.7 million to $9.1 million. It's always nice to see the bottom line growing a little faster than the top line. That gives management additional funds to reinvest into future growth, which is exactly what management is doing as it develops new chips. I expect Ambarella to continue to produce excellent results going forward. So here are the three reasons Ambarella has what it takes to be a market-beating investment.

Putting the band back together
I normally don't start with management when talking about a company. However, management's story, in this case, is an integral part of Ambarella's great start so far and its success down the road.

From my research, there are three main players at Ambarella: CEO Fermi Wang, Chief Technology Officer Les Kohn, and EVP Didier LeGall, the co-founders. These three amigos have worked together in many capacities over their careers. They worked together at C-Cube Microsystems and helped develop the first MPEG codec chip. A codec, short for coder/decoder, is an algorithm and/or chip that "encodes a data stream or signal for transmission, storage, or encryption, or decodes it for playback or editing."

So Wang, Kohn, and LeGall have worked together for more than a decade at various companies. But one thing has not changed, and that's their passion for video. In fact, the trio reunited in 2004 to co-found Ambarella. All three are well schooled and well versed in technology, and Wang is the business leader of the three. Together at Ambarella, they have developed small, low-power chips for HD video, and customers can't get enough of them.

Video is the wave of the future
Creating and sharing memorable content has never been easier than it is today. Smartphones are everywhere, and more people are taking pictures and shooting video to capture moments and experiences in their lives. And just think about all the ways to share the content: YouTube, Facebook, Vine, Instragram, and the list goes on and on.

According to research by Cisco, video will make up 69% of consumer data moving across the Internet in 2017, up from 57% in 2012. That will be the result of more devices capturing and delivering video, more high-definition video being taken, and new uses cases for video being developed as a result of the falling costs of computing power and data storage. Ambarella's leading technology chip systems are enabling that trend to push forward unfettered.

So here is the catalyst. Ambarella will continue to develop chips for all sorts of devices that people will use to capture their experiences. And people will share those videos across many platforms on the Internet. That creates a big opportunity for the company over the next 10 years.

Great markets today; more markets tomorrow
Ambarella's three main markets are all growing quickly: wearable sports cameras, made up mainly of sales to GoPro, at 59% per year; Internet Protocol security cameras, at 58% per year; and automotive cameras, at 77% per year. As a result, analysts expect the company's revenue to grow just under 25% annually. And given its technological superiority, continued reinvestment, and expanding markets, I think that will end up being a little low.

The reason is that the company is spending an incredible amount of money on R&D to develop new, even smaller chips for new markets over time. In particular, management believes that there will be more and more wearable form factors popping up over time, as developers and entrepreneurs look for new ways to help people capture their experiences in video. In its Q2 2014 conference call, the company said it expects "meaningful revenue" in FY2015 from new wearable cameras in new form factors. Management reiterated its position in the most recent conference call, too. So not only does Ambarella serve some great markets today, but it's going to serve many more makers tomorrow.

Lights, camera, action!
Three smart, successful technology guys saw the video trend and used their expertise to develop a technology and a company to take advantage of it. Today, their chip technology is helping companies like GoPro and many others grow very quickly, as they offer all sorts of video cameras to different markets. And as demand for video continues to increase, Ambarella will work with many more customers to help them develop products for new markets over time. As the company continues to rack up sales and profit growth, I expect the market to reward the company with higher and higher valuations over time, giving shareholders 2 to 3 times the return on their investment. That makes Ambarella an exciting opportunity for any portfolio.

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