This article, originally titled “‘Universal Voice Control’ and ‘The End of Google as We Know it,'” was published on May 11. The ads have recently been coming in hot and heavy for this service, with the new ads headlined “Want to Invest like Jeff Bezos” and “Jeff Bezos’ Next Big Bet”, so we’re re-running this piece to answer some of those questions.
The stock has not changed markedly over the past three months, but it did have a (relatively disappointing) earnings release, and the stock has come off its recent highs… I’ll add a little updated note to the bottom, but the text that follows is otherwise largely unchanged. The ad itself is a bit different now, but the gist is the same… and the company being teased is unchanged.
We looked at a Jason Stutman pitch for the “death of the iPhone” well over a year ago, and that was one of the most aggressively distributed teaser ads for a long time — we even updated our analysis back in January because the questions continued to pile up at our front door… but now, it appears, his Technology and Opportunity publisher has finally moved on to a new ad, with a new “secret” stock to tease.
So let’s figure it out, shall we?
This is the intro that has Gumshoe readers all revved up:
“20 years ago, Google ushered in the dawn of artificial intelligence.
“Now the technology is leaping forward and will shake up the entire tech world in 2017. Here’s the full story and why it’s…
“The End of Google as We Know It
“Google, Apple, Intel, Amazon, Microsoft, and Virtually EVERY Tech Powerhouse is Racing to Reach this Breakthrough — and It’s Set to Deliver a Major Windfall to One Small, Illinois-Based Company.”
The basic spiel is that artificial intelligence has been an important part of a lot of tech products for a long time, and that it’s getting more and more embedded… and that the next phase of growth will make “early AI,” like what’s represented by Google Search and other prediction and suggestion algorithms, look antiquated and primitive.
“The same way companies like Dell, HP, and Logitech once made Google’s dreams possible, this company will allow the next stage of AI to become a reality.
“More specifically, it produces a special kind of technology vital for AI to take the next step.
“And for investors, that could mean yet another historic run, as demand for this company’s technology skyrockets.
“In fact, using historic stock returns as a base line, this firm is setting up some of its early participants for as much as a million-dollar payday.”
That “special kind of technology” is microphones, with the pitch being that personal digital assistants (Siri, Alexa, etc.) are the next wave of “always on, always around” artificial intelligence… and that Stutman has a favorite microphone technology company that he thinks will be the big winner as more and more technology becomes voice-driven.
And he puts a lot of emphasis on the profit potential of buying those “enablers” …
“When it comes to truly monster returns, it’s the enablers hiding behind the curtain that stand to benefit the most.
“And this is why I’ve spent hours researching this technology, in search of smaller companies to find you the one that will deliver tremendous gains.
“Remember, it was the firms that provided the hardware — the mice, keyboards, computers, and microprocessors — that profited big off the back of Google Search.”
That allows him to throw in some really impressive-looking charts, but it’s always wise to try to step back and get a little perspective — his argument is that Google was incorporated in September, 1998, and that the big winners were the hardware manufacturers who enabled and benefitted from this explosion in “search,” companies that had huge runs over the next 18 months like Dell, Logitech, HP and Intel — he says that if you put $2,500 each into those companies in the Fall of 1998, you became a millionaire 18 months later in March of 2000.
But that “March 2000” should ring a pretty loud bell for you — that was right around the peak of the ludicrous dot-com bubble, and the bubble did not, of course, inflate just because of Google (there were lots of search engines then — even at the peak of the bubble, Google was still an almost brand new upstart, tiny compared to Yahoo, with maybe 10% of the search market versus Yahoo’s near-40%). Just about every technology stock surged as the Internet started to grow up (and even giant Intel, for example, fell by about 75% over the next couple years as that bubble burst).
So whatever you think of this stock that Stutman’s touting, or the potential of AI and voice command and personal digital assistants, don’t go into an investment assuming that there will be another goofy and unsustainable bubble that brings you your profit — sure, we’d all love to sell at the top of the next bubble… but we’d better not plan on it.
And that means it’s time to get to the actual specifics. What is this microphone stock being pitched? Here are a few clues:
“One Small Company Owns the Hardware Needed to Take Personal Digital Assistants Mainstream
“It should almost go without saying why microphones will be crucial to the emergence of conversational AI.
“Effectively, these are the ‘ears’ of any conversational computer.”
OK, so it’s an “ears” company, and it’s in Illinois. More clues?
“By combining the input of more than one microphone at a time, devices like the Amazon Echo and Google Home can better understand what you’re saying, even in a crowded room or noisy space.
“And as you might have guessed already, more microphones means more money for the companies selling them… just like the company I’m telling you about today.
“How much more, exactly? Well, the Amazon Echo uses seven of this company’s microphones in its array!
“That’s compared to just a single microphone for many of today’s smartphones.”
The Thinkolator is all fueled up and ready to go, so I poured those tidbits in, hit “liquefy”, and out the other end comes our answer: This is Knowles (KN), a still-fairly-obscure MEMS company that specializes in microphones and voice “listening” technology.
And yes, if you’re double-checking those clues, they are based in Illinois — in Itasca, which is a suburb of Chicago. And they do supply the microphones in at least some of the Amazon Echo devices.
There’s an interesting article about the sad state of microphones here from Bloomberg from last year, which essentially makes the point that microphone technology is probably holding back the advance of Alexa, Siri and all their sisters. That article cites Knowles as the “market leader” and says they shipped about 1.4 billion MEMS back in 2015, and notes that they’ve moved to AI-like software to improve the signal from microphones, though it also mentions a competitor, Vesper, that’s trying to develop better (and completely different) microphone technology.
Vesper is still private, trying to get designed into new products, but there are certainly other companies who are trying to build presence in this market — including DSP Group (DSPG), which I wrote about following a different teaser, and the more software-focused Sensory, which is also private and venture-funded, in addition to all the big chipmakers who have at least a little toe in this sub-market, like Qualcomm (QCOM) and STMicroelectronics (STM).
So what’s the story with Knowles? Well, they’re in fine shape financially — they were spun out by the big industrial conglomerate Dover (DOV) about three years ago, and the stock has come down substantially since then (it was in the mid-$30s at the peak), mostly, it appears, because the actual operating performance (revenue and earnings) peaked in 2015… but they’re not indebted or in danger, they’re just having trouble growing.
That’s sort of the opposite of what you’d expect from a spinoff — the general trend, and what makes spinoffs a profitable place to look for investments, is that spun-off companies have more freedom to invest in their future, they are more focused, and, since the owners of the parent may not be interested in the spinoff, the price often falls over that first six months as folks who didn’t want the shares they were given in the spinoff sell them into the market, at a time when the company has no analyst coverage yet and no real public presence that inspires new investors to come aboard.
Knowles did see its share price drop after the spinoff, though it took about eight months for that fall to happen… but they haven’t seen much in the way of operational improvement just yet.
Expectations have fallen considerably along with earnings, gross margin has gotten slightly worse over the past two years, not better, and revenue is pretty steady for a couple years but has remained growth-challenged and is well below the 2013-2014 peak. Looking back through the press releases, it appears that the big falloff in 2015 or so was probably mostly because Knowles either lost a “spot” or lost exclusivity in the iPhone 6 over some quality control issues, but Knowles and several competitors (including Goertek and STmicroelectronics) are still in current iPhones (the iPhone 7 has four microphones, I think).
So this shows some similarity to Stutman’s “iPhone killer” stock that he pitched for over a year — that was Himax (HIMX), another component maker (tiny displays, in that case — bringing their expertise into camcorder viewfinders into supplying the virtual reality “microdisplay” market) which has had challenges generating meaningful revenue or earnings growth (for a decade, in Himax’s case). These are interesting stories, and they do, if you read between the lines a little bit, have some potential if they can get “design wins” for their chips and technology, but they’re also markets where it’s tough to understand the dynamics or the potential without taking the time to turn yourself into an industry expert — little chipmakers who have genuinely unique and important technology are in a strong position to demand high prices (or even be bought out by big chipmakers, as happens fairly often), but little chipmakers who face strong competition from other companies often have trouble with margin pressures.
If Bosch or NXP Semiconductors or STMicroelectronics or Goertek has a microphone that’s at essentially the same technical standard, then Apple and Samsung (and Amazon) can just pressure all of them on price and take the lowest bid, or split the business among them… a relatively small company like Knowles, with a $1.5 billion market cap, probably needs to keep pushing the envelope with dramatically better “AI” built into the chips for processing audio, or allowing voice command startup without draining power, or something else that’s markedly more advanced than the competitors, large and small, who are trying to do the same thing, otherwise they’ll lose market share or pricing power.
So that’s what I worry about with little chip companies like this, and that’s what I’d probably try to understand first if I were considering an investment — what kind of design wins are they getting, what do they expect their gross margins to look like, that kind of thing (management has some insight into design wins at least a few months out, so you want management to have expectations for both growing revenue and either stable or growing gross margins, unless the stock is dirt cheap and you’re trying to buy at the bottom).
On the current financials and on the current analyst estimates, Knowles is probably reasonably priced — analysts think they’ll earn a dollar per share this year and $1.19 next year, so that’s a forward PE of about 15. Which is fair for a company that’s going to grow earnings — analysts guess that they’ll grow at 15% a year going forward, but that’s obviously just an educated guess and assumes some faith in the earnings turnaround that they believe themselves to be in right now.
On a trailing basis, of course, it looks a lot less rosy — they’ve never posted an annual profit as a public company, and the December quarter in 2016 was their only profitable quarter since 2014, so the PE for pretty much any trailing period is negative.
The company does have quite a few active funds with major positions, so that’s interesting to see — unlike most stocks, the largest shareholders are not index funds. I don’t know if that means anything positive, but it’s noteworthy — the Janus Contrarian Fund, in particular, owns a huge 12% position. This is what that mutual fund’s manager, Daniel Kozlowski, noted about Knowles in his Q1 commentary:
“Knowles Corp. was another contributor. The stock was up after the company reported another quarter of better-than expected earnings growth and anticipated likely solid demand for its micro electrical mechanical system (MEMS) microphones over the next one to two years. Knowles was spun out of Dover in 2014, a transaction that facilitated improved focus on the company’s core MEMS microphone and hearing aid businesses, as well as cost savings. Knowles stumbled with some execution issues after its spinout, and we took advantage of the stock’s weakness at the time to build a position in our portfolio. We believe Knowles, the leader in MEMS microphones, currently enjoys its best growth prospects in some time as key mobile phone manufacturers seem likely to spur phone demand through innovation. At the same time, Knowles is well positioned to exploit emerging demand for “voice as interface” consumer devices, such as the Amazon Echo, where Knowles is presently the exclusive MEMS microphone supplier.”
For what it’s worth, Knowles is still a major holding in that Janus fund — though it was a detractor in the second quarter, not a contributor… this is what he said in that commentary, which was quite a bit more terse:
“The company was spun off of Dover. We believe the market has failed to appreciate the growth potential of its microphones, which are used in mobile devices and hearing aids.”
I wouldn’t listen to the promised the 12,000% gains he hints at in the ad (based, it seems, on extrapolations from the performance of some select tech stocks going into the peak of the dot-com bubble) … but I do think the stock got cheap enough, now that the forward PE has dipped down to about 13, to be worthy of a small speculation this week as we head into the iPhone 8 cycle and the possibility that Alexa, Google Home, and the Apple HomePod will increase demand for high-end microphones.
So I bought a small position in March call options — that’s highly speculative, but it wouldn’t take much of a sales boost in the holiday quarter to substantially ramp up revenue and, perhaps, earnings at Knowles, which seems to not yet have real high-volume-capable competition at the high end of the microphone market. The real drivers of their possible success are the continuing trend to adding more microphones — phones moving from two microphones to four, for example, to improve voice-command performance — and the continuing move toward more voice-controlled “Internet of Things” devices, of which we’re told Alexa and HomePod and the rest of the “smart speakers” are just the first salvo.
There’s no guarantee of that trend continuing, of course — and there are negative trends as well, including the loss of some lower-margin business in China as Chinese handset manufacturers go with cheaper solutions, and Knowles was more or less flat this past quarter in operational terms so they’re not currently in growth mode… they’re in really thinking they’ll grow soon mode.
The conference call transcript from their July 26th earnings release is here if you’d like to check it out for yourself. The Q3 earnings bumped down by about six cents after the earnings call, as KN management guided to .23-.29 in adjusted EPS for the quarter and disappointed analysts (who were guessing that it would be 33-35 cents). That’s apparently mostly because their “large North American customer,” which everyone believes to be code for Apple, is likely to have their next handset out in the fourth quarter instead of the third quarter, but analysts are hedging their bets a bit and being a bit more conservative, and only bumped the Q4 earnings estimate up by about two cents.
We get a little silly when we try to split hairs form one quarter to the next like that — we’re playing around with a couple pennies here and there, and it shouldn’t really matter in the long run if Knowles is really able to get design wins in more and more handsets and IoT devices to boost revenue substantially next year, but the growth has clearly been pushed back a little bit, and that’s clearly a risk because investors hate to see missed estimates.
In the end, I nibbled a little because the stock is cheap and pretty broadly disliked and their niche is growing… whether or not they can maintain their market share and outgrow that niche or not, we won’t know for sure for a while — analysts are expecting them to increase earnings at 15% a year for the next several years, and the stock trades at a forward PE of 13, so that’s a pretty good value at a Price/Earnings/Growth (PEG) ratio of under 0.9 (Peter Lynch used to get excited about anything below 1 as a possible value). That doesn’t mean Knowles is guaranteed to be successful, there are a couple dozen semiconductor stocks that have lower PEG ratios and double-digit earnings growth expectations, thanks to the fact that the chip sector is so relentlessly competitive and difficult, but it’s a good first indicator.
But it’s not really my opinion that matters — it’s your money, so it’s your call… what do you think? See some potential in Knowles that makes you want to jump aboard? See problems we should be wary of? Let us know with a comment below.
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P.S. If you’re curious about those other “special reports” being hawked by Stutman, the “Next Intel” one is still that same “Death of the iPhone” pitch we’ve written about a few times over the years, teasing Himax, and the “Ride the Robot Revolution” we have not looked at recently but is probably an updated version of the robots teaser pitch they sent out in 2014 and 2015, I last covered that here.
Disclosure: I own shares of Amazon, Apple, and Alphabet, which are all mentioned above, and March 2018 call options on Knowles shares. I will not trade in those shares or any other stocks covered in this article for at least three days per Stock Gumshoe’s trading rules.