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Why this hedge fund manager remains short Ambarella in wake of GoPro debacle

·Markets Correspondent

On Wednesday, shares of GoPro (GPRO) fell over 25% before regaining some ground after reporting disappointing guidance and announcing layoffs. Ambarella (AMBA), which manufactures chips that go into GoPro's action cameras, fell in sympathy.

Last month hedge fund manager Nitin Sacheti, founder of Papyrus Capital, spoke with Yahoo Finance about why he thinks there still remains downside for Ambarella. His short idea, which can be found via Sum Zero, an online community of fund professionals, remains intact in light of GoPro's latest downside guidance.

Ambarella had a volatile 2015, rising from the $50s to over $125 before falling back down to the $50s. It traded below $40 on Thursday.

The stock has largely tracked the stock of GoPro, recently under pressure over worries about slowing growth that have been exacerbated after its recent negative guidance. And according to Sacheti, Ambarella's other businesses are facing stiff competition, making its chips more commoditized.

"Ambarella historically had the best algorithm for taking the video and shrinking it down to use as little storage as possible on the GoPro camera and also using as little battery power as possible," said Sacheti. But he added that we are now seeing a resolution technology wall, because the human eye can't notice a difference at these levels, competitors are catching up and there is pricing pressure.

How much further could Ambarella fall? Sacheti says Wall Street is currently pricing in earnings of $3.50 to $4 per share, which is based on the chips' average selling prices (ASP) of $10 to $12. Competitors are now coming into the market at $4 to $5 ASPs. "When you have that sort of structural earnings power shift, once Ambarella needs to lower its pricing, you'll see 65% gross margins drop into the mid $30s," says Sacheti, giving the stock a price target of $15-$20.

Investors of GoPro -- once an investing darling -- too are concerned that the company is overly focused on a single product suite, as demand has waned for the wearable cameras. It was not a GoPro Christmas, and not an Ambarella one either.