3 Reasons Ambarella Inc Stock Could Fall

Ambarella (NASDAQ: AMBA) is trailing the market this year, and the stock recently dipped below $50 per share to mark a dramatic slide from its all-time high of over $120 in mid-2015.

The slump could set the camera tech specialist up for nice rebound if things play out as management hopes. On the other hand, returns could also get worse for investors.

Let's look at a few of the surprises that might add to Ambarella's brutal stock slump.

Diversification stumbles

Ambarella is moving away from its intense reliance on just a few customers that fuel most of its sales growth. A deep link-up with GoPro (NASDAQ: GPRO), for example, might have looked good to executives back in 2015 when its devices were flying off retailers' shelves. But GoPro's collapsing sales and profit margins last year played the biggest role in pushing Ambarella's own revenue pace into negative territory.

GoPro was responsible for about 25% of Ambarella's business last year and executives see that number falling over time as they expand deeper into other market niches like security cameras. Yet for now the action camera giant remains a key customer, and so surprisingly weak holiday sales or a losing GoPro entirely as a customer could halt the tech specialist's modest growth pace.

New markets don't pan out

Ambarella's low-power, high-definition camera technology seems well suited to a range of industries that could be set for stunning growth in the coming decades. These include exciting fields like virtual reality, automotive, drones, and police cameras, just to name a few.

There's no guarantee that the company will succeed in building and maintaining a leadership position in any of these emerging markets, though. And even if it does, Ambarella still has to continuously raise the bar on the features its technology enables -- or else risk losing pricing power. Today's drone market is a good example of these risks in action. Recent product introductions include flashy features like 4K video and advanced image stabilization that take full advantage of Ambarella's integrated SoC solution. Ambarella's hardware, however, didn't make it into the popular Spark drone product by DJI, calling into question the strength of its position in the industry.

Sinking margins

The company's competitive advantage is founded on its deep portfolio of intellectual property consisting of semiconductor and software design tech. When these features are in high demand, and when Ambarella is leading the market in delivering exactly what hardware manufacturers want, the company enjoys booming sales and can also raise its average selling prices and boost profitability in the process.

Any degradation in that leadership position threatens the business and promises to send profit margins down. That's why Ambarella dedicates a huge portion of its annual spending toward research and development. Three-quarters of its employees, after all, are engineers engaged in the crucial task of advancing the industry in areas like image capturing and compression, power usage, and semiconductor design.

The first hint that Ambarella is losing its grip on innovation in these fields will likely be declining gross profit margins. That metric has ranged from as high as 68% of sales to a low 63% set in early 2014. After a nice climb higher, profitability took a slight step back last quarter because its product mix moved toward less profitable areas like home monitoring. That dip isn't something that should worry investors -- unless it continues into a long-term trend.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ambarella and GoPro. The Motley Fool has the following options: short January 2019 $12 calls on GoPro and long January 2019 $12 puts on GoPro. The Motley Fool has a disclosure policy.