3 Reasons Ambarella, Inc. Stock Could Rise

I've recently expressed my disappointment in Ambarella (NASDAQ: AMBA), which sells image application processors for action cameras, drones, security cameras, dash cams, and other devices. Its sales are plunging, margins are contracting, and it's too dependent on the saturated action camera market. It also faces tough competition from cheaper Chinese rivals and mobile chipmaker Qualcomm (NASDAQ: QCOM), which integrates 4G modems into its smartphone-based image processors.

Image source: Ambarella.

All those concerns have caused Ambarella to lose about a quarter of its market value over the past 12 months. However, here are three potential catalysts that might cause Ambarella to rally in the near future.

1. GoPro might post a blowout holiday quarter

Ambarella's biggest customer is GoPro (NASDAQ: GPRO), the largest action camera maker in the world. Pacific Crest estimates thatorders from GoPro will account for about 25% of Ambarella's top line this year. GoPro's sales are expected to fall 15% thisyear, compared to 16% growth in 2015 and 41% growth in 2014.

That slowdown has occurred because GoPro hasn't launched any new flagship Hero cameras to succeed its popular Hero 4 Silver and Black devices from late 2014. Instead, it sold low to mid-range cameras last year in a weak attempt to reach more mainstream consumers, then launched the ice-cube sized Hero 4 Session as its "premium" device. The $400 Session was poorly received, and its price had to be reduced to $200 before it attracted buyers.

But looking ahead, GoPro will launch the new Hero 5 camera and the Karma drone during the holiday quarter. If sales for both devices are strong, Ambarella could get a nice year-end sales boost. CFO George LaPlante seems to believe that will happen, declaringduring last quarter's conference call that the action camera market would likely recover in the second half of the year.

Image source: GoPro.

2. Qualcomm might miss the mark

On paper, Qualcomm looks like a fearsome rival. The company has deeper pockets and is widely considered the "best in breed" maker of mobile SoCs and baseband modems.

If the market for action cameras and drones with stand-alone 4G connection grows, Qualcomm could gain a huge edge over Ambarella by offering more cost-effective SoCs with integrated image processors and modems. Customers using Ambarella SoCs, by comparison, would need to buy separate baseband modems to add stand-alone connectivity.

But despite that pressure, Ambarella has retained key customers like GoPro and drone king DJI Innovations, despite its own admission that Qualcomm was"talking" to its top customers. That's likely because Ambarella is still considered the "best in breed" SoC maker, and most action cameras and drones don't necessarily need stand-alone 4G connections yet.

Moreover, first-gen 4G cameras like the Qualcomm-powered 4GEE Action Cam weren't well-received. TechRadar noted that thecamera's video quality wasn't consistent, and that it was built more for "families and YouTube funsters than hardcore adventure filmmakers." This means that GoPro, DJI, and other premium device makers probably won't switch to Qualcomm's SoCs anytime soon.

3. Sales of drones could take off

Sales of SoCs for drones only account for about 10% of Ambarella's revenue, but that market could grow considerably over the next few years. DJI doubled itsannual revenue to $1 billion last year, and that figure could keep rising as companies, hobbyists, and mainstream consumers buy more drones.

Image source: DJI.

Apple (NASDAQ: AAPL) notably gave DJI a big boost earlier this year by placing large "feature bay" displays for its Phantom 4 drones at more than 400 of its brick-and-mortar stores. DJI employees also visited the stores to provide flying demos and lessons.

PWC estimates thatthe global drone market could grow from $2 billion today to $127 billion by 2020. If Ambarella retains its "best in breed" position in image application processors, its drone revenue could surge through the end of the decade.

The bottom line

These catalysts could all boost Ambarella's stock price, but a lot of things could also go wrong. GoPro might be optimistic about its holiday quarter, but the action camera and drone markets have become very crowded over the past two years.

Qualcomm might still be behind in terms of image processing, but its integrated modems will likely become more important as companies buy more automated drones that can fly over long distances. If that happens, Ambarella could gradually cede the drone market to Qualcomm. Therefore, investors should carefully weigh these risks against the potential catalysts before buying shares of Ambarella.

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Leo Sun owns shares of QCOM. The Motley Fool owns shares of and recommends AMBA, AAPL, GPRO, and QCOM. The Motley Fool has the following options: long January 2018 $90 calls on AAPL and short January 2018 $95 calls on AAPL. 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.