Ambarella (AMBA) seems to be caught up in a yet another difficult spot. US regulators are reportedly moving to blacklist China’s video surveillance companies - Hikvision and Dahua. Shares of Ambarella, which supplies chips to both these firms, dropped by about 15% right after this news broke out. I believe risk-averse investors would be best served if they avoided this value trap and invested their capital elsewhere. Let’s take a closer look at it all.
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Risk Exposure Is Quite High
Let me start by saying that Ambarella hasn’t disclosed its revenue exposure to Hikvision or Dahua. The company provided investors with a revenue split of its customers in its latest 10-K filing, but it doesn't provide us with any clarity in this situation. Ambarella has listed Chicony and Wintech as its largest customers which are resellers by nature and aren’t end-buyers themselves.
Wintech and Chicony, in turn, sell chips to a number of OEMs, so Ambarella’s exact revenue exposure to its Chinese video surveillance customers isn't available in the public domain. The next best alternative to that missing piece of information is analyst estimates. As a matter of fact, Joseph Moore of Morgan Stanley issued a research note earlier this week noting that the two companies collectively represent about 35% of Ambarella’s overall revenues.
Needless to say, blacklisting these two companies can seriously cripple Ambarella’s sales, which, as the chart below highlights, have been languishing over the recent quarters as it is. Wintech and Chicony are unlikely to sidestep this blacklisting – by way of tweaking supply chains or changing bill-to-locations – to prevent a retaliatory ban by US regulators. So, the blacklisting-related news is a legitimate risk factor for Ambarella and its channel partners.
It's A Risky Proposition
The risk factors don’t end just there. Joseph Moore from Morgan Stanley noted in their research note that Hikvision and Dahua collectively account for 35% of Ambarella’s overall revenue. Interestingly, Ambarella had noted in their last earnings call that sales to security camera customers actually accounted for 60% of its overall revenue in fiscal year 2019. Here’s the relevant excerpt from the company’s Q4 earnings call:
"Security camera revenue represented about 60% of total revenue for fiscal 2019."
This brings us to two very important questions.
Scenario 1: If Moore’s estimates regarding Ambarella’s revenue split across Dahua and Hikvision are correct, then Ambarella must be generating about 25% of its revenue from other security camera vendors (60%-35%). Who exactly are these other security camera customers? If these customers are of Chinese origin, then we could see US regulators moving to blacklist them as well over the coming weeks (if trade tensions escalate), basically suggesting that Ambarella shareholders may be in for another shocker.
Scenario 2: What if Moore’s estimates are incorrect? Ambarella may be generating most of its security camera revenue by selling chips to Dahua and Hikvision. In this case, their collective revenue exposure would be about 60% of Ambarella’s overall topline, much higher than the 35% figure that Moore stated in their research note. This would again suggest that Ambarella’s shareholders would be in for a rude awakening once actual figures come out; ~60% of its revenues would be at risk if Dahua and Hikvision are blacklisted.
The best thing that Ambarella investors can hope for is that the remaining portion of the chipmaker's security camera revenue is accounted by customers that are not headquartered in China. That would partly ensure that these customers don’t get caught up in escalating trade-related tensions between the US and China. Or investors can hope that US regulators don't blacklist Dahua and Hikvision at all. But all I would say at this point is that relying on hope isn’t always a winning strategy in capital markets.
Plan Of Action
Well, there isn’t any standardized solution as to how readers and investors should act at this point. There’s no surety on whether or not US regulators will blacklist Hikvision and Dahua. Also, we don’t know if blacklisting them would be a permanent affair or something that can be reversed if they became compliant. We also don’t know what portion of Ambarella’s revenue comes from customers that face the risk of being blacklisted.
My guess is that institutional investors, which collectively own 76.54% shares in Ambarella, would reassess the chipmaker’s evolved risk profile and start dumping its shares in the open market over the coming weeks if US regulators continue to move forward with the blacklisting. This dumping of shares in the open market can easily drag down shares of Ambarella. So, investors should stay vigilant here than being greedy.
But overall, this dearth of information makes Ambarella more of a gamble than a sound contrarian investment opportunity. I believe that risk-averse investors should take a loss and exit the stock altogether. Things could get worse for Ambarella as about 60% of its revenue could be at risk compared to the 35% figure being cited as of now.
At the same time, this whole thing could go away as well if trade-related tensions between the US and China de-escalate going forward. So, investors with a greater risk appetite, who are looking to speculate on this scenario, may want to buy into Ambarella with a short-term time horizon and expose only risk capital to this gamble/speculative trade. Good Luck!
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