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Market cap- $3.01 B
Cerence Inc., (CRNC $72.52) is the market leading provider of embedded voice-powered assistance and artificial intelligence (AI) software for automotive manufacturers worldwide. CRNC enables drivers to use their voice to control internal features in the car such as using the cars navigation system, infotainment systems, and connect to the outside internet via cloud providers such as Google, Amazon, Apple and Microsoft bringing the ability to use third party external services such as sending a text, making a phone call, making a reservation through Open Table or getting a weather update. This is all through voice activated artificial intelligence capability provided by CRNC. Car OEMs around the world can use CRNC's platform for both voice activated control of internal systems in the automobile and connecting to outside third party service providers via the cloud. Enabling a true connected car to be realized. CRNC has around 53% market share of the cars with voice activated internal control systems and around 13-15% market share of cars with connected capabilities.
We feel the street's reaction to CRNC's results and outlook were overly negative and this is a case of a good company with a lower than expected outlook getting taken out to the woodshed and beaten. The stock dropped over 20% the day the company reported September quarter results and has continued to drop in the week since the report and is down around 33% since reporting Q4FY2021 results on November 22nd. However, we believe this is an opportunity to Buy the stock at a much lower price point with a move back to the $125 level over the next few quarters as automotive production increases as the supply chain of semiconductors or integrated circuits (ICs) improves. We believe automotive production is bottoming as we speak and will start to get better in 1-2 quarters. And as this happens we believe CRNC's stock will start to move higher over the next few months and we would be adding to positions at current valuations for a move back up above $125.
CRNC gets paid several different ways from automotive OEMs with the biggest being licensing revenue for the embedded voice activated software shipped with each new car produced which controls the cars internal systems such as stereo, navigation and control systems of the car. The company typically gets a one-time up front licensing fee for each car shipped with CRNC's embedded software installed that totals on average $4.00-$5.00 per car (more for premium models and less for entry level cars). This revenue is recognized in a lump sum when the car ships with CRNC's embedded software installed. CRNC has around 53-58% market share of cars that ship with some form of embedded control systems (73% of cars have voice activated software and CRNC has 80% share of the 73%). with competition coming from I-Fly Technology in China and a US company called Soundhound.
The company also offers voice activated connectivity solutions allowing CRNC to offer drivers to access outside services via the cloud such as checking the weather, making dinner reservations, searching for a gas station or making a phone call all activated by voice hands free. CRNC generates revenue when cars are produced using the company's voice activated connectivity solutions versus if the user or driver of the car actually uses the connectivity solutions. This revenue stream equates to around $1.00-$1.50 per car per year for the length of the contract. Revenue is received up front for the life of the contract and is amortized over the period of the contract in equal amounts each year generating a large deferred revenue balance and great quarterly predictability as over 80% of revenue each quarter comes from recurring revenue streams. The competition in this segment is mainly internally produced solutions from the automotive OEMs so we feel more OEMs will outsource this capability in the future to people focused on this market with a broader product line such as CRNC.
In addition, CRNC has around a $2 billion backlog of design wins with key automotive OEMs worldwide for cars that have yet to come into production creating an even more predictable future revenue stream if the cars move into production with the company's embedded voice activated software or its connectivity software solutions. We would expect this total backlog to take another huge jump higher over the next couple of quarters as one of CRNC's European automotive customers is expected to use CRNC's embedded solutions in a wider swath of its cars and brands generating another order that could be worth more than $100 million. CRNC had two orders in FY2020 that added up to over $230 million worth of orders and backlog from the same European automotive customer and total orders in FY2020 added up to over $835 million again suggesting the company's huge backlog of orders should provide strong revenue visibility and predictable results once automotive production normalizes.
CRNC collects up front licensing revenue when a car is produced using its connectivity solutions versus the user actually using the services. This is one of the key issues on the September quarter conference call that caused investors to be nervous and the stock to drop over 20% as when this revenue source dropped sequentially many investors took this as a sign CRNC was seeing less usage per car of its connected services which is not the case. CRNC gets paid if the car is produced using CRNC's connectivity solutions, and not how much each driver actually uses the services, so this revenue source dropped sequentially because of lower auto production levels caused by chip shortages and some one-time spikes in this revenue line item in the June quarter making the sequential comparisons difficult.
Another reason the stock got smacked down after the conference call is investors are now more skeptical with the company's FY2024 revenue target of $600 million given the slow growth environment CRNC is currently facing driven by anemic level of current automotive production. If growth is projected to be in the 9-16% range for FY2022 to $400-$425 million (which was below the street's initial estimate of $440) this suggests growth must accelerate to 30%+ in FY2023 and FY2024 to hit the longer-term target of $600 million in FY2024.
We believe growth will accelerate for CRNC as overall automotive production improves as IC chip shortages slowly subside during 2022 and into 2023. Increased levels of total production, increasing market share with key auto OEMs for its core voice activated embedded control software, further penetration into connected services with multiple new and current customers, new connected service offerings and new product introductions for new markets such as ATVs, trucks, and elevators should drive the growth required to hit the $600 million revenue target by FY2024. Having around a $2 billion backlog and a large deferred revenue balance and 81% of total revenue coming from recurring revenue sources helps with the predictability and visibility into future revenue and EPS growth giving us confidence revenue growth will accelerate. We are convinced auto production is or has bottomed recently and will grind slowly higher over the next few quarters. As investors see the increase in overall auto production CRNC's stock will start to move higher and when overall production gets back to normalized levels the stock should move back above $125.
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