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Two Chip Plays for a Brave New World

By Igor Greenwald on February 1, 2013

The following science fiction scenarios might become reality soon.

When that jerk tailgates your car, passes on the right and then cuts you off, you’ll press a button and the video of the entire episode will wend its way to the nearest highway patrol dispatch.

When your phone rings to report a home intrusion alarm, you’ll scan the associated footage remotely to discover that it was only Fluffy using a window crack to sneak outside.

And when you make that 30-foot wave your own, video of the ride will arrive to friends back home before you’ve had a chance to fish your board out of the surf.

The age of smartphones and smart cameras is upon us, and with it the ability to record a high-definition video with a tiny camera, parse the imagery and instantly transmit the footage and associated telemetry around the world.

Of course, the phones and cameras are only as smart as the miniature silicon brains controlling them. Which is why you’d be smart to consider two chip designers whose wares have brought this brave new world to our doorstep.

Ambarella (NasdaqGS: AMBA) is a developer of low-power, high-definition video compression and image processing semiconductors. Its products are used in security, wearable sports cameras and, increasingly, in video recording systems mounted on automobile dashboards.

Ambarella has been around since 2004 and has stable, experienced management. But its initial public offering in October was coolly received, pricing below expectations.

The stock closed that first day near $6, but soon enough went on a tear that took it up all the way to $13 on Jan. 10. Since then, it has retreated to $10 in recent trading.

This values the company at less than 13 times forward earnings, 8.5 times trailing cash flow and 2.2 times trailing sales. Which is very cheap for a rapid grower that increased revenue 24 percent in its most recent quarter, is forecasting growth of 16 percent to 24 percent in the current period and enjoys gross margins above 60 percent.

After backing out the $95 million in cash on Ambarella’s debt-free balance sheet, its forward price/earnings ratio drops to just 8, which suggests that this month’s high-water mark above 13 may be revisited sooner rather than later.

Silicon Motion Technology Corp (NasdaqGS: SIMO) is another chip designer whose shares are well off their highs. Silicon Motion designs controllers for use in flash products from cards to USB and solid-state drives; these accounted for just over two-thirds of recent sales.

Silicon Motion also develops LTE transceivers used in smartphones and tablets; Samsung Electronics (OTC: SSNLF) is a big customer for these and sales to the South Korean electronics giant account for a third of the company’s business. Silicon Motion’s chips also enable mobile TV tuning; all in all mobile accounts for up to 75 percent of revenue.

A year ago, the stock was a highflier with all the momentum in the world. Then sales growth slowed and shares plunged on fears that Samsung may increasingly replace Silicon Motion’s chips with integrated solutions from Qualcomm (NasdaqGS: QCOM). The stock has spent the last nine months building a base, only recently poking its head above the declining 200-day moving average.

Revenue growth for the quarter due to be reported early Monday is expected to be down to as little as 3 percent, though still up at least 25 percent for the year. The key for the growth trajectory in 2013 will be Samsung’s decision on deploying Silicon Motion’s transceiver in its flagship Galaxy IV smartphone. The Galaxy III used it in Korean handsets but not in those sold in the US.

At the moment, analysts are counting on sales growth of 13 percent, not bad for a stock selling at 8 times forward earnings. Cash on the debt-free balance sheet has more than doubled in a year and now accounts for more than a quarter of the market cap. Excluding cash, the forward earnings multiple is 5.5.

Silicon Motion, which was founded in San Jose, CA but is now based in Taiwan, recently authorized a $40 million buyback and a 15-cent quarterly dividend that promises an annual yield of nearly 4 percent at the current share price.

The company’s destiny hangs on decisions made in far-off Seoul by Samsung and other large customers like Hynix. But its technology sits in the industry’s sweet spot and offers Samsung an alternative to growing dependence on Qualcomm.

Igor Greenwald is an investment analyst with The Energy Strategist.

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