The Nuance of Voice Recognition

Lamont is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Any investor’s quest for technology’s next big thing will turn up speech recognition. And it may be the next big thing, but the problem is finding a pure play—a firm whose financial success is wedded to the success of speech recognition technology.

Why speech recognition? Most people use a keyboard to input text, but without training they are unlikely to type faster than 40 words per minute. But speech recognition lets you dictate the text by speaking it aloud: you decide what to say, you say it, and it appears on the screen. You can input 120 words per minute, with no danger of carpel tunnel syndrome. This is the big leagues compared to telling your smartphone who to call (although similar technology is involved) and it used to demand high-end desktop computers. Today, thanks to Moore’s Law, anything bought new will do a good job.

Pure play: Nuance

The closest thing to a pure play in speech recognition would be Nuance Communications (NASDAQ: NUAN), whose Dragon NaturallySpeaking desktop speech recognition software (which lets you give dictation to your computer, as well as control it with spoken commands) has been widely advertised. There are versions for both the PC and Macintosh.

Nuance, headquartered in Burlington, Massachusetts, is a 20-year-old, 12,000-employee company that has shown healthy revenue growth for the last three years, from $1.12 billion in fiscal 2010 to $1.3 billion in 2011 to $1.65 billion in 2012. Net income has shifted from a $20,000 loss in fiscal 2010 to a $38,000 profit in 2011 to a $207,135 profit in 2012. Besides its retail offerings for the desktop, it also licenses its technology for various transcription and mobile messaging services and third-party products. Nuance technology is reportedly behind the Siri interface of the Apple iPhone. Nuance has also diversified into optical character recognition and imaging (for paper input), which amounts to about 12% of its revenue, and has licensed that technology to office printer vendors.

In its two decades in speech recognition Nuance has bought up or merged with most competitors (especially the Belgian firm Lernout & Hauspie in 2001), or acquired the rights to competing products (especially IBM’s ViaVoice dictation software for the PC, in 2003.) It has also gone through three name changes, most recently in 2005.

What’s not to like? Well, the stock behaves like it’s over-hyped, and lately it’s been in play. Good as its growth figures looked when the latest quarterly results came out in February, they fell short of expectations and the stock price fell 18.5% to $20. It rose only pennies until it came out (on April 1) that Carl Icahn had acquired 9.3% of its shares. Then it jumped more than a dollar—and soon began sagging downward. In the spring of 2012 the price was flirting with $27. Also, the P/E ratio is 38.6.

Microsoft gives it away

And then there is the troubling fact that when it comes to desktop speech recognition, Nuance’s best-established competition is a product that is given away free, by no less than Microsoft (NASDAQ: MSFT). Microsoft founder Bill Gates was a great believer in speech recognition, and it’s a little-known fact that Microsoft Windows has a perfectly good built-in speech recognition system. (Windows is not really given away free, of course, but since it comes bundled with a PC its price is not apparent.)

If you’re sitting at a Windows PC, click Start and then Control Panel and then Speech Recognition. Have fun dictating. The Microsoft speech recognition system does not have all the features available in Nuance’s Dragon NaturallySpeaking software, but is perfectly adequate for composing text. (First, however, you’ll need to supply your own headset microphone. Nuance supplies a very good one with Dragon NaturallySpeaking, and this amounts to another competitive advantage).

So, yes, Nuance is competing with $73.7 billion Microsoft. Microsoft’s stock is less volatile and has been drifting upward for the last quarter, being recently between $28 and $29. But it too has seen better days, as it was above $32 last year. Its P/E ratio is a less daunting 15.5.

But Microsoft is well short of being a pure play when it comes to speech recognition: the Speech Recognition applet is just one feature in Windows, and Windows (contributing about $13.8 billion) makes up a little less than 20% of Microsoft’s revenue. By comparison, Microsoft’s revenue from server software was $18.7 billion, almost $24 billion came from business software (like Office), and $9.6 billion came from entertainment systems like the Xbox.

Basically, if Windows really were given away free, Microsoft could still limp on. As for the Speech Recognition applet, there is no evidence of people rushing out to buy Windows purely for its dictation facilities. So the future of Microsoft (unlike Nuance) is not exactly wedded to the future of speech recognition.

Looking ahead

As for the future of speech recognition, there are problems that it has to overcome. Dictation may be easier to learn than typing, but you do have to learn it, and dictation can feel strange and alien if you already know how to type. These can be serious impediments for casual typists, but trivial considerations for those facing carpal tunnel syndrome. Either way there is a significant number of people who could profit from speech recognition, and the market is a long way from saturation.

As for Nuance as an investment, apparently Icahn liked it. The one-year estimate shown by Yahoo! is 27.08, indicating that no contributing analyst saw any serious reason to dislike the stock. I don’t know if I’m that bullish on it, but its products offer real benefits and so its market—and therefore its revenue and stock price—is likely to continue to grow.

Lamont Wood has no position in any stocks mentioned. The Motley Fool recommends Nuance Communications. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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