This Stock is Loaded with Potential
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Richard Branson, Henry Ford, Ray Kroc. Successes or failures? All of them built great business empires. But all of them at one point were looked at as failures. Each one dropped out before completing high school. Yet they each possessed incredible potential. And they ultimately fulfilled that potential.
I thought about these men as I researched my short list of companies that I consider to be candidates to “graduate” to the S&P 500 Index. There is one company on my short list that, numerically speaking, probably shouldn't be a candidate for the index. This company’s revenues last year were barely over $1.3 billion. Not standard S&P 500 material.
For that matter, this company - again, based on the numbers alone - might not be a stock that investors should even consider. Its trailing P/E is 150. The profit margin from 2011 is a scant 3.23%. Return on equity was worse - 1.92%. There are plenty of people who don't expect much from this stock, evidenced by a short percent of float at 9.5%. This one doesn’t sound very appealing, does it?
I’ll admit - the numbers cited above aren‘t great. But just like the young Branson, Ford and Kroc, the same company with those underwhelming numbers has a great potential that exceeds that of most stocks. Who is this company? Nuance Communications (NASDAQ: NUAN). There are three significant areas for potential that investors should consider:
- Consumer products
The healthcare market accounts for over 38% of Nuance’s revenues. Healthcare non-GAAP revenue for 2012 Q2 was up 23.9% compared to last year. Over 3,000 hospitals use Nuance technology. More than 150,000 doctors and caregivers use the company’s Dragon Medical products.
The potential for Nuance in healthcare lies in leveraging this large customer base on two fronts. First, even though federal incentives have resulted in significant numbers of hospitals and physicians implementing EHR technology, there still are holdouts. Furthermore, a recent survey confirmed that there is widespread resistance to actually using the systems even after they are implemented because of workflow concerns. This is where Nuance’s speech recognition technology could be a game changer by enabling medical professionals to maintain a natural workflow without having to key information when they're with patients.
The second healthcare front with great potential for Nuance is in the migration to ICD-10, the diagnosis classification system mandated by the federal government. Due to backlash from the medical community, the government delayed the deadline for transitioning to ICD-10 until 2014. The transition will be a major headache for providers, especially with training staff. ICD-10 includes 140,000 diagnosis codes compared with around 18,000 in the currently used ICD-9 code set. Nuance’s opportunity is in helping make this transition easier using speech recognition.
Nuance’s primary competitor in the healthcare space is M*Modal (NASDAQ: MODL), formerly known as MedQuist. M*Modal is smaller than Nuance, with 2011 revenues of just under $444 million. The potential market appears large enough to support strong growth for both companies.
A poorly kept secret represents one of the potential catalysts for Nuance in the consumer products market. Although not officially acknowledged, it is widely believed that Nuance powers the Siri technology used in the iPhone. Many analysts expect Apple (NASDAQ: AAPL) to deploy Siri and related technologies from Nuance to iPads and even iMacs in the near future.
Another tremendous area of potential for Nuance is in the smart TV market. Samsung teamed up with Nuance for its 2012 line of Smart TVs. Rumors abound that Apple will launch its own smart TV soon, potentially using Nuance voice recognition technology as well. It’s too soon to know for sure, but this could be a significant revenue driver for Nuance in the coming years.
Speaking of drivers, over 70 million cars on the roads today use Nuance technology. Nuance’s customers include the 10 largest automakers. Voice activated technology is quickly becoming a de facto standard for new autos. That’s another potential growth area for Nuance.
Companies threatening Nuance in the consumer segment include AT&T, Google (NASDAQ: GOOG) and Microsoft (NASDAQ: MSFT). All three giants have products or development under way that could compete with Nuance.
That leads us to the third big potential for investors in Nuance - possible acquisition. Possible suitors include Apple, Google, IBM (NYSE: IBM) and Microsoft. Take a look at the cash available for each of these compared to Nuance’s market cap.
Buying a company the size of Nuance would be easily doable for Apple, Google or Microsoft. IBM has less available cash than the others. However, there is at least one area of synergy between IBM and Nuance -- the companies are working closely to integrate Nuance's speech recognition with IBM’s Watson technology.
There are pros and cons for each of these companies when it comes to possibly buying Nuance. But while Nuance’s trailing P/E is sky high, its forward P/E is only slightly over 12. It wouldn’t be a surprise if a major player saw the potential in bringing Nuance under its wing.
Most Likely To Succeed
Yes, some of Nuance’s numbers might be bothersome to investors. I’m not usually enamored with stocks having very low ROEs and whopper trailing P/E ratios. And while it’s on my short list of prospective S&P 500 Index candidates, I’m really not looking for it to make the index in the foreseeable future.
What Nuance has, though, is enormous potential. It will continue to be a major force in healthcare technology. Great opportunities lie ahead in the consumer market. At least a few executives with larger companies have surely entertained the idea of acquiring Nuance. This stock looks like it could be among the most likely to succeed for investors in the coming years.
Keith Speights owns shares of Apple. The Motley Fool owns shares of Apple, International Business Machines, and Microsoft. Motley Fool newsletter services recommend Apple, Microsoft, and Nuance Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.