Cerence: Strong Growth Tailwinds With Potential Upside (NASDAQ:CRNC)

Description

I modeled Cerence (NASDAQ:CRNC) to have 24% upside.

The rate of vehicle connectivity adoption is expected to rise rapidly, as consumers view vehicles as mobile devices and OEMs value connectivity for warranty repairs and advanced ADAS and autonomy. I also expect the market for automotive voice assistants to grow as more people adopt and become accustomed to using them. Furthermore, CRNC has a strong relationship with OEMs, due to its track record of successfully collaborating with them and gaining a thorough knowledge of their requirements, development roadmaps, and global GTM model. More importantly, CRNC’s white-label business strategy allows OEMs to create individualized and distinctive user experiences while maintaining control over their own data and system architecture. The company also announced a strategy shift in 3Q22, where it will stop offering fixed contracts and cap annual fixed contract deals at $40 million, which may slow revenue growth in the short term but help to even things out in the long run.

Company overview

CRNC is a global provider of virtual assistance solutions for the automotive industry, supplying AI-powered assistants for connected and autonomous vehicles and enabling touchless interactions between vehicles, drivers and passengers, and the wider digital world.

The world gets more connected

Given the clear benefits to be gained by all parties involved, I anticipate the rate of vehicle connectivity adoption to continue to rise rapidly.

• The importance of the automobile as a mobile device is growing in the eyes of consumers, and this trend has surpassed the traditional focus on vehicle performance.
• In my opinion, the decreased cost of warranty repairs and the central role vehicle connectivity plays in the implementation of advanced ADAS and autonomy are two reasons why OEM value increased connectivity.
• Connectivity expands the content-per-vehicle for vendors and allows them to unbundle software and hardware, giving their clients more options.

Considering that 63% of car shoppers consider voice assistants when making a purchase decision, I anticipate that voice activation will play an increasingly important role in the in-vehicle experience for passengers. In addition to this, voice assistants improve security in other ways. Distracted driving has led to an increase in the frequency of accidents in the near future, despite a decrease in the collision rate over the long term. When fully implemented, voice assistant technology has the potential to significantly reduce distracted driving. One key differentiator for CRNC is its capacity for cognitive arbitration, which enables it to work with third-party systems. That’s because, in my opinion, automakers want to provide customers with a variety of options in the hopes of mimicking the smartphone experience within the vehicle and reducing the frequency with which passengers need to use their own devices (while driving).

As such, I anticipate the market for automotive voice assistants to grow as more and more people adopt and become accustomed to using them. This will likely occur at an increasing pace as we grow more accustomed to it.

Strong relationship with OEMs is a strong barrier to entry

Designing and developing the vehicle’s head unit is a complex process that requires careful coordination of all the software and hardware components that interact with the vehicle. I am confident in CRNC’s ability to innovate technologies to meet an OEM’s specifications because of the company’s track record of successfully collaborating with OEMs and gaining a thorough knowledge of their requirements, development roadmaps, and global GTM model. Furthermore, CRNC’s partnerships with OEMs give it a competitive edge in marketing and selling solutions on a global scale and at a local level, depending on the needs of each individual OEM.

For background, for over 20 years, CRNC has supplied speech recognition systems to OEMS and suppliers, working closely with customers. The result is CRNC being able to integrated its solutions into OEM respective brands. As a result of the geographical reach and industry expertise of CRNC’s professional services teams, the company now collaborates with all of the world’s major OEMs. In my opinion, the most crucial point to remember is that CRNC’s global presence and extensive background in the automotive industry lend credence to the company in its pursuit of new business with OEMs. There is no doubt in my mind that CRNC’s global servicing and deployment expertise will be highly valued by OEMs with a global sales presence.

Another reason I can think of is OEMs are open to collaborating with CRNC in part because of the company’s white-label business strategy. Now more than ever, the way people interact with their vehicles while they’re on the move depends on what they find inside the vehicle. OEMs are realizing the value of providing branded, distinguishable cognitive assistance for vehicles. Because of its status as an impartial, independent, and white-label software platform provider, CRNC allows its clients to create individualized and distinctive user experiences while maintaining control over their own data and system architecture. With CRNC’s cognitive arbitration capabilities, users can open the door to third-party virtual assistants without giving up full authority over the user’s experience with cognitive assistance.

Competition

Even though companies like Apple (AAPL), Google (GOOG) (GOOGL), and Amazon (AMZN) may be competitors, they are not necessarily direct threats and may even cooperate with CRNC on occasion. Unlike their large tech rivals, CRNC allows OEMs to own and profit from customer data, allowing for greater brand differentiation and customization. CRNC’s cognitive arbitration solution is also meant to give end users and OEMs some leeway in choosing the best voice assistant on the market. That’s why I think that, in the long run, CRNC and the voice assistant solutions offered by Big Tech can and will coexist peacefully.

A strategy shift announced in 3Q22

Due to rising discount and concession demands from customers and the fact that its consumption has low visibility, management took the strategic decision to stop offering fixed contracts in the 3Q22 earnings. Notably, CRNC will not record any deals in the fourth quarter, and beginning in FY23, it will cap annual fixed contract deals at $40 million. To me, customer friction is a potential risk that could slow revenue growth in the short term but help to even things out in the long run. I see CRNC’s strategic plan as a high-risk, potentially lucrative shift, given the increasing popularity of voice AI software in automobiles and the increasingly concentrated nature of OEM customer base. As a company with a large established market share, a white label software strategy, and a global presence, CRNC has the resources to successfully renegotiate contracts.

Valuation

After a major beatdown in share price over the past 2 years, the stock price has finally gained some recovery momentum. Based on my model, my price target is around $30, which is about 24% more upside. My model is based on FY22 guidance from management and a historical growth rate after a weak FY23 due to a reset in contract terms. I believe there is a path for valuation to go back to 5.5x forward revenue (historical average) when management is able to give a better outlook into FY24.

Key risks

Emerging competition

Regulatory requirements, innovative technology, short product life cycles, price consciousness, and the presence of substitute products all contribute to the intense competition in the automotive virtual assistance market. My main worry is that sales and profits at CRNC may be threatened by new technological rivals.

Exposure to automotive cycle

The automotive industry is CRNC’s only end market exposure, and it is subject to strong cyclicality and dependent on macroeconomic conditions. I think it’s important to point out that there will be cyclical periods even though the secular trend is strong.

Summary

Consumers’ increasing inclination to treat their cars as mobile devices, as well as the importance to automakers of connectivity for warranty repairs and cutting-edge ADAS and autonomy, point to a bright future for the connected car. As more people try out and eventually come to rely on these systems, I think the market for voice assistants in automobiles will expand.