Better Buy: Ambarella vs. Qualcomm

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Chipmakers Ambarella (NASDAQ: AMBA) and Qualcomm (NASDAQ: QCOM) have a lot of common ground between them. Both companies have been troubled this year due to rising competition, though Qualcomm has arguably had it worse because of its feud with Apple over royalties. Not surprisingly, the business of both chipmakers has taken a hit in recent quarters, and this has weighed heavily on their share price.

QCOM data by YCharts

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However, the similarities between Ambarella and Qualcomm don't end here. Both companies are targeting identical opportunities in the drone and automotive markets to trigger a turnaround, though finding out a clear winner between the two might not be too difficult. Let's see why.

Ambarella's turnaround isn't a sure thing

Ambarella's business is under siege as its key clients have reduced their reliance on the chipmaker. For instance, GoPro decided to make its own custom GP1 image signal processor for the latest Hero 6 Black action camera with the help of a company known as Socionext. The action-camera maker claims that this chip has been in development for the past three years.

And now that it is ready, Ambarella will miss out on some of the terrific growth of the action camera market that's set to clock an annual growth rate of 15% globally for the next four years. This is bad news for Ambarella investors as GoPro commands a substantial share of the digital camera market in the U.S., and its refreshed product line-up could make things even better.

But this isn't the only lucrative opportunity that has slipped through the chipmaker's hands of late. Drone maker DJI Innovations has also moved away from Ambarella as the recently launched Spark drone doesn't use its chip. Furthermore, the Spark's attractive price point of just $499 effectively means that potentially it will cannibalize sales of high-end drones.

This could cut Ambarella at the knees as it is busy developing a chip for high-end drones. So it can't expect much business from DJI over the next year and a half in the budget drone space. This will weigh on Ambarella's business as DJI commands  36% of the $500-$1,000 drone market in North America.

Finally, Ambarella's upcoming computer vision chip -- the CV1 -- might not do much for the company's fortunes either. The chipmaker plans to demonstrate this chip next year, having already spent four years developing it. But such a long development time has pushed Ambarella behind the curve.

The company believes that the computer vision chip will allow it to make a dent in the automotive market, but that is easier said than done. Rival chipmaker Intel is trying to capture as much of the automotive camera vision market after its Mobileye acquisition. Intel's advantage is that it has created an entire ecosystem to make sense of the data captured through computer vision, radars, LiDARs, and other sensors, while Ambarella is just developing a chip right now whose performance is yet to be proven.

Qualcomm could get out of the water

The Apple feud will definitely weigh on Qualcomm's results until and unless a settlement is reached, but the chipmaker has been hedging its bets by reducing its reliance on smartphones. Last year, Qualcomm announced that it will be acquiring NXP Semiconductors to boost its automotive business.

Once complete, the deal will enhance  Qualcomm's addressable market by approximately 40% to $138 billion in 2020 thanks to the stronger presence in automotive and security chips the deal will bring. NXP commands 14.5% of the automotive chip market, this foothold will help Qualcomm take advantage of the potential increase in semiconductor content in cars.

Not surprisingly, Qualcomm is going all out to make sure that it can close this deal as soon as possible. The company has reportedly agreed to exclude some of NXP's patents from the deal to gain antitrust approval in the EU, where the deal has been stalled twice already. Therefore, the chances of the deal getting closed in 2017 had seemed unlikely but they could get a shot in the arm after the chipmaker's latest maneuver. The deal would make Qualcomm the largest supplier of automotive chips.

Qualcomm doesn't want to miss out on the potentially fertile drone market either. The company is looking to democratize drone development with its Snapdragon Flight Drone  Platform. It is selling its drone development kit for $675 to developers and OEMs (original equipment manufacturers), who can use Qualcomm's hardware and software package to design their own drones.

The drone development kit is currently sold out. Earlier this year, the company showcased that its drones can fly autonomously without the need for global positioning system (GPS). Based on this early success Qualcomm looks capable of making a dent in the fast-growing drone market, eventually boosting chip shipments in the long run.

The verdict

The bottom line is that Ambarella is losing clients while Qualcomm can win more of them thanks to the pending NXP acquisition and drone development. In addition, investors will be on the more safe ground while choosing Qualcomm over Ambarella given the former's cheap valuation.

QCOM PE Ratio (TTM) data by YCharts

Clearly, investors won't have to pay through their nose for Qualcomm as its price-to-earnings (PE) ratio is lower than the industry average of 25. Arguably Qualcomm is slightly undervalued when compared to Ambarella. Investors, therefore, will be better served by Qualcomm as a cheaper valuation and better turnaround chances make it a better bet than Ambarella.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ambarella, Apple, and GoPro. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Intel and NXP Semiconductors. The Motley Fool has a disclosure policy.