Shares of Nuance Communications (NUAN) recently slipped on news that Alphabet's (GOOG -0.08%) (GOOGL -0.15%) Google had opened up its cloud-based speech recognition API to software developers. Nuance, best known for creating Siri's speech recognition engine for Apple (AAPL 0.49%), sells similar software to a wide variety of healthcare, enterprise, mobile, and imaging customers.
Since Google owns the most popular search engine, mobile operating system, and mobile web browser in the world, the widespread availability of its Cloud Speech API could disrupt Nuance's long-term plans for growth. To make matters worse, Google is initially offering the API for free, although it plans to eventually introduce pricing plans. Google's platform also covers 80 languages and connects to its cloud storage and "neural network," which powers Google's voice search and typing capabilities.
Should Nuance investors be worried about Google's aggressive expansion into its backyard? Let's take a closer look at Google's battle plan to decide.
Google isn't just aiming at Nuance
Nuance could clearly suffer if some of its developers use Google's Cloud Speech API, but Apple and Amazon (AMZN -0.16%) should also pay attention.
By opening up its API to developers, Google has launched a pre-emptive strike against Apple, which hasn't done the same for Siri. This means iOS developers could tether their apps to Google's neural network instead of Apple's, enabling the search giant to mine even more data for its mobile users. That data can help Google craft better targeted ads and give it more ways to generate ad revenues from Apple devices. It might also help Google offset lost revenues from mobile ad blockers on Safari, along with the $1 billion it pays Apple annually for keeping its search box on iPhones.
Google's decision can also be considered a direct response to Amazon, which recently let developers integrate its virtual assistant Alexa into their own apps. That move could pull more apps into Amazon's ecosystem, feed more data to Alexa, and undermine Google's usefulness as a voice search application. Furthermore, Google is trying to catch up to Amazon in the cloud platform market. By tethering more apps to its speech API, Google could encourage more developers to use its infrastructure and platform services. Therefore, Nuance might not actually be Google's primary target -- it's just getting hit by the collateral damage in an ongoing ecosystem war.
Should Nuance investors worry?
While Google and Amazon's escalating battle could certainly hurt Nuance, Deutsche Bank analysts Nandan Amladi and Sameer Kalucha recently called the risk "fairly limited." Amladi and Kalucha argue that Nuance's industry-standard speech engine, its focus on applications, and its "well-developed" neutral API should keep it protected from Google and Amazon's recent moves. The analysts also call Nuance's API the "Switzerland of speech engines," making it the ideal choice for developers who don't want to feed their data to Google or Amazon.
Despite that optimism, Nuance's non-GAAP sales rose just 1.2% annually to $494.9 million last quarter. Healthcare revenues, which accounted for half that total, fell 1%. Mobile revenues stayed flat, enterprise revenue slipped 2%, and imaging revenue improved 3%. Its non-GAAP net income rose 38% to $113 million, but it remains unprofitable on a GAAP basis. Analysts currently expect Nuance's sales and earnings to respectively rise 1.4% and 17.3% this year. These numbers suggest a prolonged battle against Google or Amazon could cause its sales growth to peak and reverse course.
However, the battle between Apple, Amazon, and Google could also make Nuance a compelling buyout target. Nuance's enterprise value of $7.1 billion is easily affordable for all three companies, while its forward P/E of 11 and 5-year PEG ratio of 0.6 suggest that its stock is undervalued compared to its earnings growth potential.
The key takeaway
Google and Amazon often absorb or steamroll over smaller companies in their efforts to establish prisoner-taking digital ecosystems. While it's uncertain if Nuance will become a casualty in that war, the risks of owning Nuance stock have certainly risen. Nuance's industry-leading speech engine will likely keep powering connected devices across multiple sectors, but it's unclear if developers can resist the urge to tether themselves to Google and Amazon's larger ecosystems.