Ambarella Inc (NASDAQ:AMBA) shares are plunging in the wake of a disappointing first-quarter earnings report. In fact, AMBA stock is off by more than 10% so far in Wednesday’s trade.
Our Luke Lango, in his preview of the quarter, acknowledged the risk but called the stock a good long-term play because of the promise its chips — which first powered the GoPro Inc (NASDAQ:GPRO) camera — could be a key ingredient in the next decade’s autonomous transportation revolution.
They think the chips will go into self-driving cars.
Everyone in tech is betting on autonomy. Apple Inc. (NASDAQ:AAPL) is said to be doing it. Alphabet Inc (NASDAQ:GOOGL) already has. Tesla Inc (NASDAQ:TSLA) has gotten rich on it. Uber stands accused of stealing it.
Ambarella could be the next boom’s arms merchant. The argument is that you buy the dip on the hype, wait until either the field takes off, and profit!
This veteran tech reporter has a different story to tell about AMBA stock. Come with me, then, into the cave of riches known as Moore’s Law.
The Cave of Moore’s Law
Moore’s Law — the idea that the chip density can double (and prices can halve) every year or two — has been the driving force of technology for 50 years.
It may be the only thing the 2017 stock market believes in, given that the five most-valuable companies in the world — Apple, Google, Amazon.com Inc. (NASDAQ:AMZN), Facebook Inc. (NASDAQ:FB) and Microsoft Corporation (NASDAQ:MSFT) — all use it to power their clouds.
But Moore’s Law isn’t just a story of wealth. It’s also a story of wealth’s destruction.
Because chips get better every year, PCs rot like fruit on a warehouse floor. Their value declines rapidly with time. Companies that make chips, even mighty Intel Corporation (NASDAQ:INTC), have to race ever-faster just to keep up. Then there is Moore’s “Second Law”: As chips become more complex, their production becomes more capital-intensive. Only three of the hundreds of companies that emerged from the PC revolution are still with us — Apple and Microsoft are the other two.
Most of the diamonds in Moore’s cave are glass. Interesting in that they’re made of the same thing — silicon.
Hardware Becomes Software
Ambarella chips “see.” They process incoming light or other waves into digital information, then translate that information into inputs a drone can use to avoid obstacles, or a car can use to drive itself.
They are a vital ingredient in self-driving cars, which must process all kinds of incoming data, on all kinds of frequencies, to replicate what you do every day when you decide to make that left turn into incoming traffic.
The idea is that these systems can be packaged, put into vehicles as they’re manufactured and deliver most of the value those vehicles have in the form of services — the service of getting.
What’s Next for AMBA Stock?
Tech goes through hype cycles like this all the time. I have been following them for 40 years.
First comes a solution. That’s where we are now. Then the solution goes into production, at which point the hype cycle reaches a peak. But here’s what happens next. As it goes into full production the solution becomes a commodity. The system becomes a box, the box becomes a board or collection of chips, the board becomes a chip, and finally the hardware becomes software. All along the line the price of the solution, and its contribution to the value of the car, will go down.
What does this mean for AMBA stock, which already went through this cycle with GoPro?
It means it’s near the peak of a second cycle, with its recent quarter delivering revenues of $64.1 million, and net income of $2.6 million, 7 cents per share. Adjusted earnings of 39 cents per share were better than 26 cents per share, but guidance — for revenues of $69 million to $72 million, as well as a dip in gross margin — was awful.
It means it’s time for Ambarella to sell itself.
Sell now, when the hype is reaching a peak, and a buyer is going to reach to get it, as Intel itself did in buying Mobileye NV (NYSE:MBLY) for $15.3 billion.
Shares are trading at more than 4 times its expected 2018 revenues, even with a 10% drop in early June 7 trade. A turnaround isn’t coming. A sale is the only way investors long AMBA today will eventually profit.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AMZN, INTC, FB and MSFT.