Ambarella (AMBA 2.39%) is best known as GoPro's supplier of image processing system-on-chips (SoCs). Yet orders from GoPro actually only generate about a third of the company's revenue, while the remainder comes from sales of SoCs for other action cams, security cams, in-dash cams, and drones.
However, a new heavyweight competitor now has its sights set on this sector. Qualcomm (QCOM 0.89%), the largest mobile chipmaker in the world, recently started selling SoCs for action cameras and drones as well. Could that move throttle Ambarella's growth in both markets?
How dangerous is Qualcomm?
Qualcomm licenses its mobile chip designs from ARM Holdings, but so do lower-priced rivals like MediaTek and Rockchip. In the high-end market, Samsung, one of Qualcomm's top customers, replaced Qualcomm's chips with its own silicon in its flagship S6 devices. The competitive pressure from both ends of the market is forcing Qualcomm to diversify into new devices like action cameras and drones.
Morgan Stanley analysts recently stated that Ambarella's SoCs are more cost effective than Qualcomm's without cellular integration. But with cellular integration factored in, Qualcomm's SoCs could be the better bargain. That's probably why Ambarella recently lost a bid to Qualcomm to supply SoCs for 4GEE's new 4G action camera. Another 4G action cam, BenQ's QC1, is also powered by a Qualcomm SoC.
As for drones, Qualcomm has several advantages over Ambarella. In February, it acquired KMel Robotics, a startup which develops multi-rotor drones which can coordinate with one another in "swarms". Neither Ambarella nor Intel (which has drone ambitions of its own) owns this type of technology, which could prove useful for military, industrial, or commercial applications. Yuneec Electric Aviation, a major Chinese drone maker, recently signed on with Qualcomm as the first major customer to use its Snapdragon Flight platform for drones. That all-in-one chip reference design, which Qualcomm claims will cut drone development costs, contains a single quad-core Snapdragon 801 chip which handles all flight control, recording, and wireless communications.
Yuneec's biggest rival is DJI Innovations, the largest drone maker in the world and one of Ambarella's main customers. If Yuneec starts producing cheaper drones, DJI could be pressured to switch to Qualcomm as well. If that happens, it's possible that even GoPro could consider using Qualcomm's SoCs for its upcoming drones and connected action cams.
Don't dismiss Ambarella just yet
Concerns about Qualcomm and a muted sales outlook for the second half of the fiscal year have caused Ambarella's stock to plunge nearly 40% over the past three months. However, investors shouldn't write the company off just yet.
Last month, Canaccord Genuity's Matthew Ramsay defended Ambarella, stating that its strong portfolio of "application-specific video encode, compression, and analytics processors" would keep generating strong sales and earnings growth as "HD and UltraHD video capture and compression become increasingly important across several consumer and enterprise markets." Ramsay admitted that "integrated or general purpose solutions may penetrate mid and low tiers of Ambarella's target markets" but that its strength in the higher tiers would offset those weaknesses.
Ambarella's established strength and its relatively small market cap of just over $2 billion also make it a tempting takeover target for Qualcomm or Intel. It might be smart for either company to buy Ambarella to keep it out of the other's hands, and it might be cheaper to buy its established business instead of competing against it.
The key takeaways
Ambarella investors should remember that the company's future isn't completely defined by GoPro or connected drones. GoPro might eventually lose ground to rival action camera makers, but Ambarella can still sell SoCs to those competitors. Qualcomm might gain a price advantage in 4G action cameras or drones, but a market should still exist for ones that don't require SIM cards.
Despite those uncertainties, Ambarella is still growing rapidly. Its revenue soared 79% annually last quarter, up from 73.5% in the first quarter and 25% growth in the prior year quarter. Therefore, investors should recognize the threat that Qualcomm poses to Ambarella, but they shouldn't overreact and sell their shares before those rivals make any meaningful progress.