Description

Audience, Inc. (Nasdaq: ADNC), the clear market and IP leader in advanced voice and audio processing for mobile devices, is a severely broken May 2012 IPO that has been left for dead by investors after the company announced on September 6^th that its technology would not be incorporated in the iPhone 5.  As a result, Audience, which priced its IPO at $17.00 on May 11th and traded as high as $23.41 on June 15th, fell to the mid-single digits on the AAPL news.  As a result, ADNC shares are now a value investor’s delight, as it is dirt cheap, despised and left for dead, yet the company is running on all cylinders with strong momentum (really! despite AAPL!).  With a market cap of $192mm using 23.6mm fully diluted shares, after subtracting $120mm of cash & marketable securities ($5.08/share or 63% of the share price is net cash), the TEV is only $72mm and TBV is $5.91/share, providing great downside support at this depressed level.  The street is currently modeling $150-160mm of sales, $80mm of gross profit and $12mm of EBITDA for 2013 (implying <0.5x TEV/Sales, <1.0x TEV/GP and 6.0x TEV/EBITDA) – and I expect these operating estimates too prove far too low given the enormous success of Samsung’s flagship products (Galaxy S III, Galaxy Note II, Google Nexus 10 tablet), big new design wins and new product categories that will be revenue generative in 2013.   Based on the faster than expected uptake into new OEMs and channels (PCs, Automobiles, TV), I believe that 2013 EBITDA meets or exceeds 2012 results, implying a TEV/2013 EBITDA of a remarkably low 3.6-4.0x with strong out-year growth and leading strategic patent assets.  Watch here to understand the Audience technology and how it works: http://www.audience.com/experience

I expect that within 12 months ADNC will trade for at least 2-3x its current price, and I believe there is a very high probability that the company is acquired by Intel, Google or QUALCOMM due to its mission-critical IP and the fact that 3 venture funds own 60% of the stock and will need to exit.  Further adding to our confidence is the fact that the company’s head of engineering bought nearly $800,000 worth of stock (100,000 shares) in the open market at prices ranging from $7.21-8.48 from November 2-16.  ADNC is presenting at the Credit Suisse conference at 12:30 ET this Wednesday, which should bring additional positive attention to the story in the near-term (live webcast here: http://investor.audience.com/).  There are multiple potential catalysts for near-term (next 3 months) value realization here, as described herein.  

Keys to the story are as follows:

• Audience has emerged as the clear leader in the intelligent voice technology field, and is beginning to benefit in a large way from the adoption of speech recognition and voice-based applications.
• Major industry trends provide a huge tailwind for ADNC:
  • Accelerated usage of speech recognition in mobile devices, both for keyboard replacement and personal assistant capabilities (e.g. Google Voice Search).
  • Increasing attention to the dependability of speech recognition services in a noisy environment.
  • Audience’s market leadership is driving rapid adoption in tablets and other new markets (PCs, Ultrabooks, Automobiles, TV).
  • Major carriers showing sharply increased focus on speech recognition technology, e.g. AT&T & China Mobile in particular, the latter of which invested $215mm for a 15% stake in iFlytek, the leading Chinese speech recognition company (http://asia.cnet.com/china-mobile-to-take-stake-in-voice-recognition-firm-iflytek-62218428.htm).
• Audience has developed a very strong partnership with Google/Samsung.  Its audio processing chips, considered the world’s best technology in this regard, have been incorporated in flagship products including the Samsung Galaxy S III, the Samsung Galaxy Note II, the Google Nexus 10 tablet (manufactured by Samsung), the Xiaomi Phone 2 (Xiaomi is the “Apple of China” according to JP Morgan) among many others detailed below.
• 8 of the top 10 mobile OEMs are now customers or ramping up as customers, and customers now include Samsung, Motorola, ZTE, LG, Huawei, Xiaomi, Acer, HTC, Sharp, Xolo, and it is rumored that Audience is in talks with Microsoft regarding a partnership.  Here are some of the products which feature Audience technology: http://www.audience.com/find - make sure to note that there are 3 tabs for Americas, APAC, and EMEA regions (discussed at minute 35:00 of Q3 conference call)
• Audience has industry-leading IP surrounding its “earSmart” technology, including 7 issued U.S. patents, 87 pending U.S. patent applications and 37 pending foreign patent applications.
  • On the Q3 conference call, the JP Morgan analyst questioned whether Apple may be infringing on ADNC patents, and the CEO refused to comment.
  • The technology Apple chose for its iPhone 5 has been criticized by users as poor (https://discussions.apple.com/message/19740160#19740160), while the call quality has been praised heavily for the latest Audience products (http://www.audience.com/audience-news/in-the-news) and was praised for the iPhone 4, which also used Audience technology (http://www.engadget.com/2011/05/18/curtain-lifts-audience-exposed-as-iphone-4s-noise-cancelling-w/).
  • Audience solidified its position in the fast-growing China market with its recent win with Xiaomi’s high-end smartphone Mi-2 or “Xiaomi Phone 2”.  The first version of the phone sold >5.3mm units and the new version is expected to be a huge hit (http://www.engadget.com/2012/11/14/xiaomi-phone-2-mi-two-review/).  Xiaomi chose Audience over Qualcomm’s inferior voice processing solution “Fluence.”
  • Audience technology is now in high demand for PCs and Ultrabooks – this is mission critical to Intel.  Read here how Intel says “Voice recognition and touch are just the beginning” http://blogs.intel.com/technology/2012/09/the-future-will-come-alive-at-idf-san-francisco/
    • When asked about Intel on the Q3 call (“Is your noise enhancement going to be part of Intel’s solution?”), the Audience CEO sounds a bit uncomfortable, laughs and says “It goes without saying that there is interaction with Intel (laughs) and speech recognition services on the PC platform.  I can't go farther than that in terms of specifics with those players… But we are very far along in exploiting the demonstrations we can do on the PC and notebook platforms.”
• Audience technology is now in high demand for automobile applications.  On the Q3 call (minute 29:50), the CEO said “New market opportunities are emerging at a rapid rate” and that during Q3, ADNC booked its first notebook computer and automotive design wins, which will generate revenue in 1H of 2013.
• TV is another huge potential end market.  The CEO commented that they are “Tracking a number of TV opportunities in our pipeline.”  The Samsung SmartTV product line and other similar products would seem to be a natural fit as Voice Control becomes a standard feature.

While it’s unclear why AAPL chose to go with its own beam-forming technology for the iPhone 5, Audience technology has consistently beaten it in the marketplace as Apple’s technology has exhibited the following problems (again, discussed on the Q3 conf call):

• Poor noise suppression
• Inadequate positional robustness
• Directional sensitivity
• High latency

A critical question is how strong Audience’s relationship with Samsung is, given that Sammy represented 55% of ADNC’s Q3 sales (this should decline significantly due to ramp with new customers and product channels in late 2012 and 2013).  Audience CEO clearly stated on the Q3 call that the Samsung relationship was very strong, and he listed three structural reasons why Sammy would not leave Audience, aside from the best-in-class tech that Audience offers:

1. Samsung is different from AAPL in how they source and go to market, they have lots of products and suppliers, a low tendency to insource and their internal semiconductor group is a ‘merchant group’ in a separate division.
2. Samsung has been very nimble in bringing the best technology to market as soon as possible, ultra-responsive to users and carriers, and ADNC’s success in raising voice specs with carriers is important.
3. He said he had spent significant time in Korea, and he sees no decrease at all, only opportunity with Samsung going forward.

Risks:

• Unexpected loss of business with Samsung/Google
• Better technology developed by a competitor, that does not infringe on ADNC patents

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Note 1:  Interestingly, the transcript for the company's Q3 call is not readily available.  I would highly recommend listening to the call itself, as we believe the CEO's tone in certain comments is quite telling.  The link is here: http://investor.audience.com/eventdetail.cfm?eventid=119596

Note 2:  It was released today in the proxy that there is a proposal to exchange 1.9mm options with an average exercise price of $12.07 for 1.8mm new options struck at the closing price as of the date of the exchange offer while resetting the vesting schedule.  While option repricing is never ideal, it is probably reasonable in order to retain key employees and maintain morale given the company's strong momentum and share price movement due to AAPL.  The 23.6mm fully diluted sharecount used above is the company's estimate for Q4.

Note 3:  Having recently upgraded from a Samsung Galaxy S II to the Galaxy Note II (an Audience product), the difference is incredible even to an untrained ear.  The example in the video on the company's website is accurate in my assessment. 

Catalyst