Name That Trade – $AMBA Sauce

by Dan March 3, 2015 12:39 pm • Commentary

Event: Ambarella Inc (AMBA), the supplier of chips to mobile cameras like GoPro (GPRO), reports their fiscal Q4 results today after the close.  The options market is implying about an 8% one day move which is well above the 4 qtr average of 3.3% and the 4.7% average over the 9 quarters since going public in Q3 2012.

Valuation: Unlike one of its largest customers, GPRO (almost 10% of their sales) AMBA trades at almost palatable multiples, 30x expected fiscal 2016 earnings, and 7x expected fiscal 2016  sales of $320 million, expected to grow 22% year over year.  

Take Over Candidate? The NXPI/ Freescale merger agreed to the other day (read here) could serve as an impetus for semiconductor companies that are looking for growth outside of PCs and Smartphones to look farther afield into potential faster growth areas that would use embedded cameras in consumer electronics like GPRO devices, connected home devices, autos or other industrial uses.  AMBA’s $1.8 billion market cap makes the company an easy take-over target for a large semi-conductor company like Intel (INTC), Qualcomm (QCOM), or Texas Instruments (TXN).

Sentiment:  Wall Street analysts remain fairly mixed on the stock with 8 Buy ratings, 3 Holds and 3 Sells with a 12 month price target of $60.45, just below where the stock is trading. Investors seem a bit more convicted with short interest at 37% of the float!

Price Action / Technicals:  The stock has been in a massive uptrend since its 52 week lows, gaining nearly 200%, and up 20% this year alone:

[caption id="attachment_51552" align="aligncenter" width="600"]AMBA 1yr chart from Bloomberg AMBA 1yr chart from Bloomberg[/caption]

Options Open Interest:  Total open interest sits at 83,000 contracts, amazingly evenly split between 41,600 calls and 41,000 puts with the largest single strikes of open interest 3500 March 60 calls, 32000 Jan 25 puts, 3,000 Aug 50 calls, 2,000 Aug 49 puts, and 32500 March 60 puts

Implied Volatility Snapshot:  30 day at the money implied vol has been ticking up as the stock has made its steady advance which in a lot of ways appears to be a similar slope of the advance of the stock since its 52 weeks lows in late spring:

[caption id="attachment_51551" align="aligncenter" width="600"]AMBA 1yr chart of 30 day at the money IV from Bloomberg AMBA 1yr chart of 30 day at the money IV from Bloomberg[/caption]

My View:  The stock is not cheap, and its future for the time being is very much attached to one company (GPRO) who is about to face a whole lot of competition from lower priced providers like Xiaomi who may have much better success in their home country of China. That being said, some analysts think that a lower end Xiaiomi wearable camera could benefit AMBA by dramatically increases the size of its addressable market.

The stock, while not priced to perfection the way GPRO and MBLY were recently prior to their six month IPO lockups, faces similar skepticism on valuation, despite having a much smaller market cap and a more palatable price to sales multiple.

I see no reason to step in front of this stock prior to tonight’s report, but if the stock were to be hit hard after a disappointing report the stock could be a scoop, or a defined risk view with options could be a way to play if you believe the stock could be a take-over candidate. I obviously have no knowledge of this, but yesterday’s deal in the semi space, and then HPQ’s purchase of Aruba (ARUN) for $2.7 billion suggest that the predators are prowling for growth.  AMBA’s market cap below $2 billion makes it an easy target while MBLY’s $7 billion and GPRO’s $5.3 billion make it much harder when factoring in potential premiums.

Potential Trade: Take advantage of elevated IV and the potential for the stock to consolidate recent gains (stock is up $10 in the last 2 weeks) but finance the purchase of longer dated calls in the event the company gains customers like Xiaomi or is thrown into the ring as a takeout candidate:

AMBA ($61) Buy March 6th (weekly) / May 65 (regular) call spread for $2.60

This structure tales advantage of elevated front month implied volatility (selling march weekly calls at 100 vol) while buying May vol at 54 which is very close to historical (albeit a short history) lows. The ideal scenario for this structure is if the stock is up slightly on earnings or even flat. Large moves lower or a huge gap higher and the premium is at risk.

Disclaimer: This is a VERY bull market trade and that’s probably the reason why we’re not doing it ourselves. However, these are the sorts of companies that get scooped up in this stage of the market. We’re not predicting that in any way but it wouldn’t take much for rumors to start. So this structure fades a huge breakout this week on earnings for the possibility of one over the next few months with defined risk.