Motley Fool’s “One of Our Best Stocks Many Investors Probably Haven’t Heard of… Yet!”

Fool pitch for Next-Gen Supercycle service says "Nearly 300 million cars currently have this stock’s technology integrated into their systems; and just about every major automaker is coveting this stock’s software!"

By Travis Johnson, Stock Gumshoe, July 26, 2021

The Fool’s Investor Digest over the weekend included a little tease about one of their favorite small growth stocks, so I thought we’d dig into that for you on this lovely July Monday.

The pitch is for their Next-Gen Supercycle service, which is one of the many premium-priced, no refunds upgrade services ($1,999/yr) that the Fool has been launching willy-nilly in recent years — it used to be called Extreme Opportunities: Next-Gen Supercycle, but they must have had a few internal branding meetings recently because it’s now tied to the Rule Breakers franchise built by Fool bro-founder David Gardner (who himself has stepped back from stock picking, incidentally), so it’s now called Rule Breakers: Next Gen Supercycle. This particular ad is signed by Kael Dixon, but the leading Fool analyst whose name is pegged to this service is Rex Moore.

The general theme is unchanged — it’s basically a premium-priced stock-picking newsletter that chooses a few dozen stocks that play on that trend, and rebalances and updates a portfolio of those stocks periodically. The trend is mostly focused around the upgrade to 5G mobile networks, so that’s nothing new, lots of pundits have been picking stocks in that area as we’ve prepared for and begun to roll out 5G over the past few years, and, again like many others, they tie in the impact of 5G to lots of other related tech trends like augmented reality, self-driving cars, remote medical care, artificial intelligence, etc.

And it’s one stock in particular from the portfolio that they’re hinting at in this particular ad… here’s the intro:

“And out of the top twenty-five favorited GOLD stocks to own right now, I noticed one stock that many investors have probably never heard of.

“It’s a software company with a $4B market cap based in Massachusetts, that is harnessing the power of 5G and artificial intelligence (AI) to potentially transform the driving experience in connected cars worldwide.”

OK, so that narrows it down pretty nicely… what other hints do we get for the Thinkolator?

“I’m not talking about self-driving cars. Although this company is benefiting handsomely from its growth as automakers compete for autonomous driving technology…

“What I’m talking about is concierge voice assistance.

“For instance, imagine asking your car to prepay for gas before you get to the station. Or better yet, imagine asking your car to add your favorite latte to your gas order while you’re still in route!”

As I grow increasingly fuddy-duddyish that sounds not all that appealing, perhaps because I’m never in enough of a hurry to talk to my car about my troubles, or give it my credit card number, but certainly preordering and interconnectedness and shaving off a minute or two for convenience everywhere are big trends in general, as are the safety advancements made possible by both AI and voice commands in the automobile. Similar trends have certainly minted buckets of money for companies like Starbucks (SBUX), who built up the infrastructure for service that’s far faster than anyone would have thought to ask for a decade ago.

So what’s this stock? A few other clues…

“Nearly 300 million cars currently have this stock’s technology integrated into their systems; and just about every major automaker is coveting this stock’s software!

“Companies like BMW… Mercedes-Benz parent Daimler… Volkswagen… Fiat Chrysler… Ford… General Motors… Toyota, and many more!”

And one specific little nugget:

“Last year, the company inked the two largest contracts in its history, including a $125 million deal with a large European automaker.”

Finally, we’re told that the stock has already returned “over 198.7%” for investors since it was recommended in June of 2020, so we can narrow it down still further to stocks that have roughly tripled over the past year. Where does that get us?

Well, it gets us to a firm and quick answer from the Mighty, Mighty Thinkolator, which had to chug along for but a few moments to match those clues: This is Cerence (CRNC), which is best known for its voice-enabled automotive cockpit systems, and which has indeed tripled over the past year (though that was all in the final half of 2020, the stock since then has been roughly flat).

Cerence does see itself as the “global front runner” in AI and voice-powered driver assistance in the automotive sector, and as well-positioned to take market share as cars become increasingly digital, and investors have begun to be pretty interested in their potential to grow beyond being an automotive supplier and begin to become more of a SaaS platform operator with recurring revenue. And yes, they did announce a $125 million deal with an unnamed European car brand last year, along with a couple other major deals, and that no doubt contributed to the huge surge the shares had in 2020.

The stock might appear to have come out of nowhere a couple years ago, but it’s really just a name change and a spinout — they used to be part of the voice tech leader Nuance Communications (NUAN), which spun them out into a separate company in 2019. That also ended up saddling CRNC with a chunk of debt, which is always a little surprising for a high-growth tech company, but it was not a huge amount relative to their market cap (about $250 million in debt at the moment, with a market cap of $4 billion), they restructured that debt last year, and it seems to not be much of a weight on their operations. That might change in a crisis, of course, but at the moment the company is generating cash, not consuming it, and they have plenty of flexibility.

They are partnered with pretty much every automotive brand and supplier out there, and that’s certainly key for a business that is sometimes resistant to rapid change (cars are long-lived and carry the brand’s reputation with them for a decade or more, so car companies don’t “move fast and break things” the way tech companies sometimes can). And they believe one of their key accomplishments is in forming a link between cars and those fast-moving tech services, so the Cerence-enabled voice assistant system in your Ford, for example, can contact Alexa or Apple Music, update Facebook or LinkedIn, consult Yelp, etc.

So that’s interesting, and it does seem likely to be an ongoing trend — they say that 55% of cars have some “connected services” designed in, and that they’re basically turning into rolling smart phones (music, navigation, weather, recommendations, etc., all of which are opportunities for recurring revenue), and that this is up from 41% two years ago and is likely to keep climbing steadily to 68% in 2024. The long life of an automobile means that the upgrades of systems like this sometimes take a considerable period of time, but that’s certainly the direction we’re going.

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And Cerence says that 52% of the cars produced in the world use at least some Cerence technology, so that certainly sounds like “leadership.” They certainly had a negative impact from COVID, since car production stalled for five or six months and has been somewhat uneven in coming back, thanks partly to semiconductor shortages, but they do also have long-term contracts and now, they say, a $1.8 billion backlog for connected services and licensed use of their technologies (and licensed technology, which makes up about half of their revenues, is among the best businesses to be in — you can license the same intellectual property over and over to more cars each year, so margins should grow). And their new Connected Services business, run from the cloud and operating as a SaaS business, is still quite small, at $12 million last quarter (out of a total of $99 million in quarterly revenue), but it does let us imagine something much larger growing in the future… and it is their fastest-growing segment today.

On the valuation front, Cerence is, as you might expect, fairly expensive (45X current year earnings)… but showing some positive signs of accelerating growth. They expect to have about $385 million in revenue this year, up from $331 million in 2020, and had been on a gradually slowing growth trend (from 15% or so per year down to 8-10%), so this is a bounceback in growth of about 15% on the top line, and that’s often a very good sign. Analysts think that will lead t