Ambarella (NASDAQ: AMBA) shareholders have endured intense volatility this year as the stock lurched between gains of 20% and losses of almost 10%. Wall Street is focused on the camera technology specialist's cloudy short-term growth outlook, basically ensuring that shares will swing with every new shift in that trajectory.
Yet the major factors that could doom this investment have more to do with the company's operating structure and its portfolio of intellectual property.
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With that in mind, let's take a closer look at a few of the biggest long-term risks facing Ambarella investors.
Ambarella relies on just a few companies to deliver the majority of its revenue. In fact, in each of the past two years, 56% of sales came from its top five customers alone. This concentration exposes the business to major growth swings like the recent one that came from plunging results at GoPro (NASDAQ: GPRO) beginning last year. Demand from the sports-camera giant slumped as its recent device introductions stumbled in a crowded marketplace, and Ambarella investors shared in the pain.
Ambarella is working hard to diversify its product line to lessen this dependence on just a few niches. It is making progress moving deeper into security products and cameras designed for use in automobiles. However, it will take time to build up these other areas. GoPro accounted for close to a quarter of Ambarella's sales last year, and management believes its struggles will be an important factor in 2018's results.
Innovation is the key
Technology forms the basis for Ambarella's competitive advantage through patents the company owns on a wide range of technology its engineering team has developed over the years. This intellectual property is anchored by a suite of popular semiconductor design solutions that deliver efficient video compression and processing, based on a low-power, integrated system-on-a-chip platform.
These innovations have advanced the high-definition camera industry and won Ambarella significant market share with manufacturers so far. Yet the pace of change in the segment is dramatic, and that volatility is compounded by the fact that the company is pushing into new industries, like automobiles and drones, that have well-funded competitors and come with engineering challenges that don't necessarily sync up well to Ambarella's core software and semiconductor design strengths.
About three quarters of Ambarella's employee base is dedicated to research and development, which shows just how important it is to the company that it keep leading the way forward with video capture, processing, and sharing innovations. Stumbles in this high-stakes arena will likely first show up in declining gross profit margins before slumping sales growth follows.
Risk and reward
Ambarella hasn't posted a net loss in any of the last five years despite the major step back its operations took in fiscal 2017. It has no long-term debt on its books, either, which gives management flexibility as it pushes to expand the company's addressable market.
There's no question that the potential there is large. High-definition camera technology could form a key part of the autonomous automobile market, for example, and the outlook is similarly bright for wearable cameras, drone cameras, and sports cameras.
If Ambarella holds its innovation lead as these industries mature, it could log explosive growth over the next decade. Investors have to balance that optimism against the real possibility that the company loses its design edge over time.
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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.