While the broader market has begun to stabilize after macro concerns pushed down stocks the past two weeks, there are still several tech companies that have yet to rebound, thanks to some idiosyncratic concerns. Are these companies bargains for a reason, or do they belong on your watch list?
A full transcript follows the video.
Sean O'Reilly: We're going bargain hunting on this tech edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly, recording from Fool headquarters in Alexandria, Va. Joining me today is the inspirational Dylan Lewis. How's it going today, Dylan?
Dylan Lewis: I love "inspirational." That's a good one.
O'Reilly: You inspire creativity in others. I looked it up in the dictionary.
Lewis: That is fantastic. What an intro.
O'Reilly: Markets had a bit of a pullback; tech names have been beaten up -- what are we talking about specifically today?
Lewis: Today I think we're going to do a little bargain-hunting.
O'Reilly: Going shopping?
Lewis: The market has been hit by some macro concerns lately, and I think while some names have begun to stabilize -- I think the broader market's begun to stabilize -- we're seeing a couple of companies that have been dinged. Possibly for their own reasons. These two compounded might provide investors with a nice buying opportunity.
O'Reilly: For sure. Without further ado, the first company that I really want to talk about is Netflix, everybody's favorite streaming media service. There are two reasons it's been beaten up. The first is, of course, what we already talked about, which is this market craziness. The first rule about market craziness is ..
Lewis: Don't talk about it.
O'Reilly: You just can't. It's like Fight Club.
Lewis: That will be the last mention right there.
O'Reilly: The other thing is, there's been some concern, as this is not the first time we've seen it with Netflix, but the other reason is concerns about competition. In particular it's the un-inked deal with Epix, the cable network.
Lewis: That deal expired and was not renewed.
O'Reilly: Right. Long story short -- we talked about this a bit on Tuesday, our listeners will remember -- Epix is co-owned by the big three: Viacom (NASDAQ: VIA) (VIAB), MGM, and Lionsgate (LGF-A -3.73%). It's the newest of the major cable channels. It's part of the premium package. It's not a basic-cable thing. The sad part is, you're basically not going to see movies like Hunger Games and World War Z on Netflix anymore.
That's no knockout by any stretch, but that's a hit.
Lewis: Those are big names.
O'Reilly: They are. The company didn't re-sign its agreement, which essentially means they're not going to get these names. Netflix's own chief content officer, Ted Sorandos, actually had to come out on the company's blog and say why. I'm not going to regurgitate what he said, but the important key here was, he pointed out that studios are not adapting to the streaming world as quickly as Netflix would like.
I'm sure we've all noticed. If a movie is "good," or "popular," it's going to be over a year before you get it on a streaming service. You're going to have to pay $5 to even stream it six months later.
Lewis: That's a decision on the studio's part to try to juice cinema profits and DVD profits.
O'Reilly: Right. Whenever I see a movie that recently came out on Netflix and it was just in theaters three months ago, I think it's probably not a winner. The key point that the chief content officer made in his blog was:
"While many of these movies are popular, they are also widely available on cable and other subscription platforms at the same time as they are on Netflix, and subject to the same drawn-out licensing periods. Through our original films and some innovative licensing agreements with the movie studios we're aiming to build a better movie experience for you. Here's what's coming in the next few months ..."
Then he talks about Sofia Coppola teaming up with Bill Murray. It's actually going to be really funny, I bet. Murray Christmas. They're going to do a Crouching Tiger, Hidden Dragon: Green Legend movie. They're going more in the original-content route. They've had success with House of Cards because people want new content that's fun and interesting and entertaining, and the studios aren't playing ball with it.
Lewis: The idea here is, you can get these movies like Hunger Games, World War Z ...
O'Reilly: They can get it anywhere else. It is a competitive decision, and Netflix is making the decision to not have what everybody else has, but to have their own, original stuff.
Lewis: That's really interesting.
O'Reilly: The other thing that's been hitting Netflix today is a tweet.
Lewis: A tweet?
O'Reilly: A tweet! The other key factor that's dragging down Netflix as of late is a short case put out by Andrew Left of Citron Research. Dylan, any idea who Andrew Left is?
Lewis: No. I haven't heard the name before.
O'Reilly: He's a famous short-seller. His actual claim to fame is in 2012, where he posted a short case -- you may remember this -- that Nu Skin Enterprises (NUS 0.04%), the skin-care company, he was the one who spearheaded the short case about their operations in China. This caused the Chinese government to investigate them; stock fell 50% in three days when he put out the case, and the Chinese government announced the investigation. It hasn't recovered since.
Lewis: He's right there.
O'Reilly: He's somewhat effective, yes.
Lewis: What's he saying now?
O'Reilly: He's been pretty effective. He's mostly focused on Chinese companies, but now he's turned his sights on Netflix. I was disappointed when I read the tweet. I pulled it up, you can head to Citron Research's Twitter (TWTR 6.35%) page, if anybody cares. He says: "Citron's stayed away, but finally time to short NFLX. Competition heating up and doesn't have another trick like Apple (AAPL 2.32%), Google (GOOG 2.32%) (GOOGL 1.88%), or [Amazon.com] (AMZN 4.03%). Back to 80."
At the time of this recording, Netflix's stock was at $98, so it dropped to $80. It was at $50 a year ago. This is not "Oh God! The sky is falling." That's why I was disappointed. His concerns about the competition are there. They didn't ink the deal with Epix, and now we hear rumblings about Apple starting its own streaming media service next year. Amazon's rocking it and they've won Emmys.
His point is, Amazon, Google, and all these other companies have things they can pivot to in order to still make money. Netflix is a streaming media service and that's it. I don't know.
Lewis: That's surprising to hear from one of the market darlings. They're a company that's largely revered.
O'Reilly: They've had this halo, and we'll get to their valuation in a minute, but they're being awarded a stratospheric valuation. It's similar to Amazon. They're trading at 300, 400 times this year's GAAP earnings. The reason is, if they're successful in capturing a meaningful percentage of their future market, they'll be enormous, gargantuan, Standard Oil size ...
Lewis: Absolutely ubiquitous.
O'Reilly: It will be huge. That's why they're getting these valuations, but if the tiniest needle comes along and pricks that balloon -- that's kind of what you're seeing right now.
Lewis: With that said, how do you feel about the stock? What are you looking for in Netflix?
O'Reilly: I went over to our friends at S&P Capital IQ. For those that are not aware, they're not free cash flow-positive, so there's that. They keep investing in new content and services and opening in Australia and Japan. They're currently trading for 400 times this year's GAAP earnings, and according to S&P Capital IQ analysts that have been polled, in 2019 -- four or five years from now -- they're going to earn $4 per share.
They're trading at 25 times earnings five years from now. It seems like it's on the line, and the stock would have to fall a good bit more to become interested. That being said, I remember all too well late last year, in 2014, when the stock cratered and it hit $50 and I was concerned about the competition and how they might not make any money. It's double since then. It's still at double since then, right now.
I'm remembering their ability to surmount many hurdles in their life so far.
Lewis: You're sitting on the sidelines now?
O'Reilly: I am.
Lewis: What about for existing shareholders? Is this something to worry about?
O'Reilly: If you're an existing shareholder, I'm assuming that you've bought into the company's story. The story is still there.
Lewis: OK. That's great to hear.
O'Reilly: Be strong, Dylan. Before we move on, I want to make everybody aware of a very special offer for all of Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter, started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.
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If you're just joining us, it's the tech edition of Industry Focus, and I'm sitting here with Dylan Lewis and we're going up and down the aisles of Wall Street looking for some tech-stock bargains. We just finished talking about Netflix. What have you got for us, Dylan?
Lewis: I think it's natural to talk about Ambarella (AMBA 6.71%) and with them, GoPro. I think it's a natural pair. You see them move a lot together in the market. News from one tends to affect the other because of their supplier relationship.
O'Reilly: For our listeners that might not be aware -- and me -- why do they move in tandem? Is one a supplier for the other? What's the deal?
Lewis: Ambarella is a supplier for GoPro. They're a semiconductor company that develops low-power, high-definition, ultra-HD video-compression and image-processing products. That's a bit of mouthful.
O'Reilly: Say that five times fast.
Lewis: Their components are usually used in HD, ultra-HD cameras. Some of the applications are security IP cameras, sports cameras, wearables, flying cameras, and automotive dash-type recorders. Looking at how that breaks out for revenue for them, GoPro is about 25% of that.
O'Reilly: It's a chunk, for sure.
Lewis: A big chunk, yeah.
O'Reilly: As I understand it, they just had a really good quarter.
Lewis: Yeah. They reported earlier this week. Their earnings report was pretty nice. Their revenue was up 79% to $84.2 million. Analysts were expecting $81.7 million. That's a nice beat right there. That's the fifth consecutive quarter where they've had year-over-year growth acceleration. That's another nice thing you love to see.
Their adjusted earnings soared 150% to hit $29.7 million, roughly $0.88 per share on expectations of $0.80 per share.
O'Reilly: They're doing all this, and they're profitable right now. That's awesome.
Lewis: This is the sixth consecutive quarter that Ambarella has beat income estimates by a double-digit percentage margin.
O'Reilly: Wall Street doesn't seem to be happy.
Lewis: Wall Street always wants it all. They want incredible earnings and they want to see really awesome guidance as well. This is another case where, looking back, things look great. Looking forward, there are some adjustments that people need to make. I think the reality is, people should have seen this coming.
Guidance didn't look great. Basically what happened was, they're reliant on new product launches and feeding the components to these larger products. They experience a lot of their end customers launching products in Q2. GoPro, some of the dash cams I mentioned, and most notably GoPro debuted its latest HERO model, the HERO4 Session. Xiaomi, the Chinese manufacturer, also began ramping up some of their wearables.
From the conference call, Q3 guidance is showing that the wearable market is going down sequentially, also year over year because of product ramping up slightly different from last year. Even with that down, our Q3 growth is still over 40% year over year.
O'Reilly: It was a shift.
Lewis: What happened was, instead of all these product launches coming in Q3 -- which has happened historically, and most notably for GoPro -- we're seeing it in Q2 instead.
O'Reilly: As if that would throw off all the buy-side analysts' Excel spreadsheet models. I did have a question. What competitors to GoPro is Ambarella in? As the market itself grows -- that's the bear case against GoPro; they'll get competed away and their margins will get destroyed -- is Ambarella in any of the competitors? How do they look there?
Lewis: They mentioned Xiaomi in their conference calls. I have to assume that they're working with them. A GoPro is one of the staples of their supply chain. They're the ones to watch. I think that's why you start to see them move on the same news.
O'Reilly: What do you make of all this? If I'm a shareholder, where are we?
Lewis: I think the important thing to realize here is that they guided for this last quarter. I have that in all caps in my notes here. I think it's so important to notice. This is what they said in their guidance for the previous report: "The unusually high number of new product launches we are experiencing in Q2 have historically occurred in our third fiscal quarter. Therefore, we anticipate that our second half quarterly growth profile will more closely follow our historical seasonal trends, and year-over-year growth will moderate."
Basically, they're saying they'll see smoothing if you average it out, but you're going to see some of it front-loaded in this quarter.
O'Reilly: The fact that it arrived earlier should actually be bullish, because every model that everybody ever used would discount the future to the present, and the discount factor went down a little bit.
Lewis: Another thing you have to consider is Barrington Research cut their rating on the stock to a "perform" from an "outperform." That's another thing that might have slightly moved the needle of this company. I think the reality here is, if you liked Ambarella before their earnings, you should still like them now. If you didn't have them on your radar, maybe keep an eye on them.
O'Reilly: OK. What's going on with GoPro, before we head out?
Lewis: GoPro, same story. They're affected by the same news. Given Ambarella's exposure, they're naturally going to move with them. This is basically all derivative concern. The important thing to note here is there hasn't been anything from GoPro directly saying ...
O'Reilly: It's just sympathy sell-off. There's no ...
Lewis: Yeah. GoPro hasn't said they're expecting lower volumes. You can read into their product release and say there might be more front-loading this quarter, but their guidance for the upcoming quarter was still solid. You look at what happened with Ambarella, and it wasn't just GoPro that one of their end customers had released new products.
They had flying camera models from JI, dash cams, and IP security customers all release new products. This impressive revenue beat, and income beat, is also tied to that. It's not just tied to GoPro and the new HERO release. From Ambarella's perspective, it sounds like all their segments are firing on all cylinders. What it comes down to is, the market is over-reading into some of the possible issues.
Again, I think it's more of a smoothing thing.
O'Reilly: Got it. Before we head out, what do you think of their valuations?
Lewis: I think GoPro looks pretty attractive right now. It's a company that I've always thought is very expensive. I think the same thing as Ambarella; if you liked them before this news, you should still like them, probably really like them. If you haven't really had them on your radar, I think this is a company to watch, especially if it stays at this current valuation. GoPro has a trailing P/E of 35 and a forward P/E of around 20.
O'Reilly: I've seen worse.
Lewis: Yeah. I've seen worse, and it's a really high-growth company right now. It's a pretty attractive valuation for a company with their growth prospects.
O'Reilly: Cool. Thanks for your thoughts, Dylan.
Lewis: Always a pleasure, Sean.
O'Reilly: We'll see you next week. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at firstname.lastname@example.org. Again, that's email@example.com.
As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening, and Fool on!