There's Nothing Nuanced About This Buy-In Opportunity

Updated

When Nuance Communications (NAS: NUAN) lined up for this week's first-quarter report, I expected a blowout. Fellow Fool Evan Niu was so excited, he started a real-money options position on the stock with a $34 break-even point. That's about a 13% premium to Thursday's closing price, so Evan picked a very bullish bet.

The results are in, and Nuance didn't exactly live up to our lofty expectations. Shares are down more than 13% in early action, hanging just below $27 a share.

The raw numbers played an important role in this drop. Nuance saw $0.34 of non-GAAP earnings per share on $382 million in adjusted revenues (to create an apples-to-apples comparison over some acquisition-related accounting rule changes). Analysts were looking for another $5 million in sales and $0.02 of EPS. That's Nuances only earnings miss in the last four quarters.

Three of the company's four segments enjoyed sales growth above the 22% company-wide average Wall Street had expected. The laggard was Nuance's enterprise division, which only managed a meager 4.6% YOY boost. That weakness will continue; Nuance is introducing some new applications for that market, but even then doesn't expect more than "upper-single-digit growth" for this segment in 2012.

So that's an obvious anchor latched to the company's otherwise nimble growth vehicle. Enterprise is also the least profitable of those four segments, with a 20% operating margin; health care is the richest at 51%.

Mobile ain't just a town in Alabama
Like everybody else, Nuance bends over backwards to avoid talking about Apple (NAS: AAPL) as an important customer. But Nuance's voice recognition technologies are widely accepted as a key ingredient in the iPhone 4S and its revolutionary Siri voice assistant. Somehow, you just have to address the pink elephant in the room, lest investors start questioning your poor eyesight and common sense.

So Nuance acknowledged that the mobile segment was pushed by high "consumer interest in conversational natural language applications," including new products announced at January's CES show and -- ka-ching! -- virtual assistant applications.

Overall, Nuance notes that its relationships with mobile customers is growing "more comprehensive and complex," which sounds at least partly like an effect of embedding Siri-like functionality deep into mobile operating systems. That trend doesn't include just Apple, as Nuance actually counts nearly every handset maker that matters (and some that don't) among its top customers.

On the downside, these complicated relationships drag out Nuance's mobile revenue flows. On the upside, we should see stronger and more-stable mobile sales in coming quarters, as formerly instant payments turn into renewable contracts covering several quarters or even years.

The Foolish takeaway
That's why I'm inclined to see this huge price drop as a buy-in opportunity rather than a sign of weakness. The "Siri effect" means not only direct sales to Apple, but also industry-wide interest in voice recognition from other handset makers. Beyond that, Nuance reports rising interest in, and sales of, products outside the realm of virtual assistants like the Dragon dictation tool.

I believe it when management talks about mobile sales becoming a greater part of Nuance's business. That's a very positive change, including a strong 31% operating margin and nearly endless market growth ahead.

Moreover, Nuance is running out of credible competition in the crucial voice-recognition market. IBM (NYS: IBM) gave up on its ViaVoice dictation package a long time ago, and even handed its distributions over to Nuance for a while. Nuance just bought Vlingo. At your favorite local retailer, I dare you to find a voice recognition package not named Dragon NaturallySpeaking.

So Nuance hit a little speed bump and investors are treating it like a spike strip? Fine by me -- the company is a human-to-machine interface juggernaut that is just getting started. The long-term opportunity is larger than ever, just hidden behind those lumbering but unstoppable long-term mobile agreements.

Evan will be fine with the long investment horizon on his call options. Me, I'm starting a bullish CAPScall on Nuance right now. This stock will bolster my all-star CAPS rating for years to come. Snag a free CAPS account of your own to voice your own opinion -- or just weigh in via the comments box below.

At the time thisarticle was published Fool contributorAnders Bylundholds no position in any of the companies mentioned. The Motley Fool owns shares of International Business Machines and Apple.Motley Fool newsletter serviceshave recommended buying shares of Nuance Communications and Apple and creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days.We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check outAnders' holdings and bio, or follow him onTwitterandGoogle+. We have adisclosure policy.

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