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Voice recognition hits critical mass:
And we’ve got the best company and the best way to play it
by Briton Ryle
New or emerging technologies go through two stages. Promise. And delivery.
The promise is the stuff speculative bubbles are made of. It captures people’s imagination. Inflates their expectations. Loosens their wallets... and turns tightwads into Tulip maniacs.
Promise was king over the last couple of years. Fiber optics, wireless, B2B — you name it. Investors responded with a bubble-building, stock buying frenzy.
Of course, reality always sets in. You now have wireless access via your mobile phone. And you realize that it’s no fun at all to "stumble upon" immoral websites peppered with huge binary files if your monitor is the size of a matchbox.
At that point, all those fiber optic and wireless companies have to prove that the technology has legs. Sustainable business models come in handy, too. This is the delivery stage.
I would argue that the Internet itself has passed the delivery stage. But many of the companies associated with it have not. That means you’ve got to look for the sustainable businesses.
No big secret there.
But I think I’ve found some pretty nifty technology that’s just entered the delivery stage. And it looks like the company is going to make a lot of money for investors over the next couple years.
The Heinlein Maneuver
Anybody who’s ever read a science fiction story or immersed himself in sci-fi movies or TV shows within the last fifty years knows that, one day, people will converse freely with computers.
Voice recognition technology has been in the promise stage for at least 15 years, with as many fits and starts as a cat hacking up a furball.
Until recently, talking to computers was pure fiction and very little science. Sure, we’ve had voice recognition software companies, like Lernout & Hauspie. Even IBM holds some pretty important patents in the field. But, with the exception of automated call centers, the market for voice recognition technology was mostly promise.
I’m seeing signs the situation is changing. Voice recognition is maturing. It’s ready to...
...stand and deliver
A number of factors are behind the maturation of voice recognition technology. The Internet and wireless are obvious. Not so obvious drivers are improvements in search engine technology, an emphasis on cost-savings through automation, increased computer processing power, and the backlash against people using cell phones while driving.
Still, wireless is the most important. If you’ve ever used a web-enabled phone, you know exactly what I mean. Because of small screens and smaller keyboards, navigating the Internet from a phone stretches the limits of patience. Wireless needs voice recognition capabilities.
And with thousands of high-school punks and purchasing managers sporting gadget-studded belts that would make Batman groan, there’s a strong future for a company like Nuance Communications.
Margins for success
Nuance (NUAN:NASDAQ) has all the elements of a successful tech company. It’s been around since 1994, with industry-leading technology and a blue-chip customer list. And, judging by the recent explosion in revenues, voice recognition technology is just getting up a head of steam.
Nuance is a software company. Years ago they made the decision to focus on creating a voice interface platform and let others create applications for it. In my opinion, this was an important decision because it streamlines the R&D process.
Successful software companies boast obscene profit margins, and Nuance is no exception. Gross margins typically run in the 70% range (70-80% of Nuance’s sales comes from licensing, and the remainder is from services, which include training and implementation of the platform).
Customers come in all shapes and sizes, from voice portals on the Internet, like BeVocal and Tellme, to business software companies like Siebel Systems (SEBL:NASDAQ), to mainstream tech companies like Intel (INTC:NADSAQ) and Cisco (CSCO:NASDAQ), to old economy stalwarts like General Motors (GM:NYSE) and General Electric (GE:NYSE). Charles Schwab (SCH:NYSE) even offers voice interface for asset management.
(The voice portals are simply web sites that have a voice interface. You can call them and ask for everything from sports scores to restaurant reviews. BeVocal and Tellme license the software from Nuance and then create their own applications with it.)
Even though the wireless web has been slow to gain acceptance in the U.S., the voice portals are doing better than you might think. BeVocal has deals with Sprint PCS (PCS:NYSE) and Qwest (Q:NYSE). Tellme has teamed up with AT&T (T:NYSE).
The market
The biggest market for wireless web applications is currently in Europe and Asia. And Nuance has signed up Deutsche Telekom, British Telecom, Greece’s Cosmote, Sweden’s Telia and NTT in Japan, just to name a few. In all, Nuance’s voice interface speaks 22 languages.
But Nuance’s relationship with GM is most significant, because I think it’s representative of what we’ll see in the future. If nothing else, signing on the car manufacturer is a major validation of voice interface technology.
GM wants to add voice interface capability to its OnStar service. OnStar is a subscription service with around 800,000 members. As it now stands, OnStar is a wireless connection between driver and a live operator. Drivers can ask for directions, get breakdown help on the highway, have emergency services sent to wherever they are, and so on. Subscribers can access web data like e-mail, traffic and weather updates, and certain entertainment services. (That’s going to drive Taipan publisher J. Christoph Amberger nuts: not a day goes by that he doesn’t fire off impassioned tirades against people talking on their car phones. Wait till he sees people trying to surf the web while driving!)
This expanded service, called Virtual Advisor, is projected to be available by the end of the first quarter 2001, which is very soon.
Around the same time, OnStar is also slated to offer Personal Calling, a voice-activated wireless telephony service using Verizon’s CDMA network. GM will also license OnStar to other auto manufacturers like Toyota, Honda and Lexus, with models rolling out over the next year or so.
Terms of the GM/Nuance deal should be pretty interesting to would-be investors. GM accepted 100,000 warrants for Nuance stock at US$138.50 a share. That’s nearly a 300% premium over current market value.
Dollar signs
I think it’s pretty clear that Nuance is delivering on the promise. But a bunch of high-profile customers means nothing if they’re not dropping high-profile dollars in Nuance’s account.
Since its IPO last April, Nuance has posted a minimum of 20% sequential revenue growth, peaking at US$17.4 million in the fourth quarter of 2000, which ended December 31. Fiscal year 2000 revenues were up 165% over 1999, to US$51.8 million.
Like most tech companies, it seems, Nuance operates at a loss. But it has over US$200 million in the bank and claims it can run for at least two years on its cash reserves. Chances are this claim won’t be put to the test, as Nuance is expected to turn profitable in 2002, with US$17 a share in earnings. But Nuance has a history of beating estimates, so profitability may come sooner than expected.
Pay to play
The only concern I have with Nuance is its current valuation. At nearly 20x revenues, it’s not cheap. The high valuation in my opinion reflects its market-leading status, and the fact that voice interface technology has reached critical mass.
On the plus side, after hitting highs of more than US$180 a share, Nuance is trading roughly in line with its IPO price. And if you know anything about Chris DeHaemer’s "Flying V" trading system, you know to watch out for the expiration of locked-up shares from an IPO. For Nuance, this event has passed, and it took the stock down from just over US$100 to around US$35.
Entry strategy
We’re at a very interesting time in the stock market. What we’re seeing right now could easily go down as one of the greatest buying opportunities of all time. Upside potential is tremendous... if you’re accustomed to looking back at last year’s highs. But current economic conditions could worsen, despite Greenspan’s efforts to jump-start the economy.
Just in case the stock (and the NASDAQ) hasn’t bottomed yet, I recommend a "scaling-in" strategy for taking a position in Nuance at levels between US$35-40. Scaling-in means taking a position in steps, rather than investing all you plan to invest at once.
Scaling-in means more transaction fees and the potential for missing some upside action, but it will help protect your investment if Nuance and the market haven’t bottomed yet. If there’s more downside to Nuance, scaling-in will give you more shares at a lower dollar cost per share.
For more information, contact Nuance Communications, 1005 Hamilton Court, Menlo Park, CA 94025, tel. (650) 847-0000, website: www.nuance.com.
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