3 Reasons Ambarella Inc. Stock Could Fall

By Markets Fool.com

Image source: Ambarella Inc.

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Though Ambarella (NASDAQ: AMBA) stock has climbed more than 30% year to date as of this writing, longtime shareholders of the video processing chip specialist know it hasn't been a smooth ride.

Ambarella stock kicked off 2016 with a precipitous decline, promptly falling 40% from the beginning of the year before hitting a fresh 52-week low in February. For that, it could thank a combination of the broader market's historically painful start to 2016, as well as ongoing weakness in the wearable camera market. And even after accounting for its incredible rebound since then, shares are still down more than 40% from their all-time high set in July 2015.

Of course, Ambarella has momentum on its side having exceeded expectations with each of its last two quarterly reports. But even the most bullish investors would be wise to take note of the risks Ambarella faces. Here are three reasons Ambarella stock could fall going forward.

1. Hiccups in the wearables rebound

First, last month I singled out the wearable camera market as Ambarella's worst business segment so far in 2016.

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Ambarella is a key supplier to GoPro (NASDAQ: GPRO), which dominates this market and previously represented as much of 30% of Ambarella's total revenue.But as GoPro's camera lineup began to age -- its high-end HERO4 Black and Silver models were launched almost exactly two years ago, and GoPro badly fumbled last year's introduction of the HERO4 Session by pricing it too high -- sales of those cameras also plunged. As a result, Ambarella management confirmed early this year that demand from GoPro had declined to the low-single-digit range as a percentage of overall sales.

However, Ambarella management has also suggested the wearable market is gradually recovering into the key holiday season, leaving investors optimistic that this formerly core segment will once again represent a valuable contributor to overall results rather than holding them back. That's fair enough considering GoPro only just introduced the massively improved HERO5 Black and HERO5 Session cameras last month, and itself has told investors to expect the "vast majority" of GoPro's revenue to be collected in the second half of the year.

If GoPro delivers as promised, Ambarella should have no reason to worry. But if GoPro's new cameras fail to spur the growth in wearables that investors have come to expect in the second half of 2016, Ambarella stock could suffer the fallout.

2. Supply disruption headwinds

Next, Ambarella has been forthright about the effects on its business of the April earthquake in Kumamoto, Japan -- namely, that this earthquake damaged the primary factory that produces Sony (NYSE: SNE) image sensors used in non-cell phone video capture devices. Between 40% and 48% of Ambarella's revenue depends on customers' ability to secure adequate inventory of those Sony sensors.

To be fair, Ambarella managed to beat expectations last quarter despite incurring lost or delayed revenue estimated in the range of $2 million to $4 million from this shortage. And last month, Ambarella CEO Fermi Wang told investors "most supply issues" should be resolved by the end of the current quarter. That's encouraging considering two quarters ago, Wang warned this issue could persist for "several quarters." But if he's wrong and Sony endures some unforeseen headwinds getting back on track, Ambarella stock could fall as investors assess the near-term impactof extending the duration of image sensor supply shortages.

3. Competitive losses

Finally, I've argued before that competition is the single greatest threat to Ambarella's long-term story. Thankfully, management is well aware of this threat, and even makes a habit of updating investors with regard to the competitive state of its key markets each quarter.

In March, for example, Wang admitted that Ambarella knows chip giant Qualcomm (NASDAQ: QCOM) is talking to its customers. But he also insisted competitors' solutions were "quite behind in video quality, compression efficiency, power consumption, video features and performance," leaving Ambarella's platforms as the clearly superior option as consumers increasingly demand high-quality video in even lower- and mid-tier devices.

Then last quarter, Wang focused his competitive comments on the fast-growing drone industry, noting each of its A12, A9SE, and H2 System-on-Chip platforms simultaneously runs 4K video, high-quality photos, HDR processing, and electronic image stabilization. Add to that superior power consumption and total solutions cost, and Wang insists this provides Ambarella "sustainable competitive advantages versus the competition."

But in today's fast-changing world of technology, Ambarella also knows all too well that it needs to continuously innovate to remain ahead of the competition. So, while Ambarella might be the gold standard right now in terms of cost-effective, high-quality video processing chip solutions, long-term investors would do well to listen closely for any negative changes in the competitive state of Ambarella's markets.

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Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ambarella, GoPro, and Qualcomm. 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.