Ambarella (NASDAQ:AMBA) got a boost after its largest customer, GoPro (NASDAQ:GPRO), reported strong quarterly results, further extending its recovery after a negative report. Some investors have been getting nervous about Ambarella's lofty valuation though, especially as the GoPro action-camera market may be getting saturated or undercut by cheaper competitors.
But as we'll see, Ambarella has demonstrated an ability to adapt and find new areas of growth. This is exactly what it appears to be doing today, as the company could be setting up to take advantage of exploding markets in IP security cameras, wearable cameras, and perhaps even commercial and consumer drones. This is Ambarella's greatest strength and could be a huge source of growth for the foreseeable future.
Ambarella has been here before
Ambarella's latest 10-Q revealed that one of its risks is its reliance on a relatively small number of customers. This situation is largely due to its relationship with GoPro, which analysts estimate make up over 30% of the company's revenue. That is indeed a risk and not to be taken lightly. But it's also the unfortunate consequence of hitting an absolute home run, giving Ambarella its incredible performance in the first place.
The company also had this to say, in the same paragraph of the 10-Q:
In fiscal year 2010, the majority of our revenue came from the pocket video, camcorder and infrastructure markets. Over the last five years, we have continued to provide solutions for the camcorder and infrastructure markets, but also have expanded our focus to include the wearable sports, IP security, and automotive aftermarket camera markets. We believe our entry into these markets will continue to facilitate revenue growth and customer diversification.
In other words, Ambarella has been a one-trick pony before, largely relying on chips for video infrastructure, an industry that slowed, or hand-held cameras, which were quickly replaced by cell phones.
That Ambarella found ways to pivot toward higher-growth areas is impressive, and it appears the company is doing it again. While GoPro gets all of the attention, an even larger portion of revenue comes from IP security cameras, previously estimated by analysts at approximately 45% of revenue. . The video surveillance market is expected to reach almost $43 billion by 2019, a compound annual growth rate of over 19%. Further, the IP-based video surveillance market is expected to grow at an ever faster rate of 24% per year during this time, which is what Ambarella specializes in.
Ambarella should be one of the main beneficiaries, as security camera systems continue to switch over to digital. Further, many of these systems either stream the video feed over a network or back them up to the cloud, making video compression a top priority for these products, something Ambarella's algorithms excel at.
Wearable-camera growth isn't done
The wearable-camera market is expected to increase shipments by a compound annual growth rate of 33% through the year 2020, according to a recent market research report. While there may be an upper limit to how many extreme-sports enthusiasts will strap cameras to their helmets, the wearable-camera market has many other uses.
As the report noted, wearable cameras are beginning to proliferate more widely in the public safety and enterprise sectors. Body cameras are being used by more police forces and hospitals, and other businesses are also experimenting with them. As the cost continues to come down for these devices, it will make sense for businesses to adopt them for safety, training, data gathering, and quality control.
There are also a few wild cards that could provide a boost to growth, such as Ambarella's acquisition of VisLab. The adoption of car cameras could also add a bit to the bottom line, especially as backup cameras will be mandatory on all new cars in the U.S. by 2018. Finally, GoPro has been talking up its own line of drones for a while now and may even be breaking into virtual reality.
Ambarella's "one-hit-wonder" with GoPro is somewhat of a worry, and rightly so. But it doesn't mean the company's growth is done. Instead, it appears to be doing exactly what you would want a small growth company to be doing -- expanding into adjacent areas where it can leverage its expertise. With a current P/E near 60, and even a forward P/E around 40, the market is expecting a lot from Ambarella based on its valuation, but so far all lights look like they're green for this growth stock.
Chris Kuiper has no position in any stocks mentioned. The Motley Fool recommends Ambarella and GoPro. The Motley Fool owns shares of Ambarella and GoPro. 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.