IONQ - IonQ: Massive Upside But A Long Road Ahead

2023-11-27 09:00:00 ET

Summary

• As quantum computing advances, IonQ could potentially emerge as a big winner.
• The road to success for the Company is long and risky. I discuss three major obstacles that must be overcome.
• I rate IONQ a speculative buy, with the caveat that investors may be able to find a better entry point at a later date.

After many years of quantum computing being just on the horizon, it is finally possible for people to simply buy early generation off-the-shelf quantum computers, thanks to companies like IonQ, Inc. (IONQ) (and others). IonQ is a manufacturer of ion capture-based quantum processors that are shipping today and available for purchase or available on the cloud (for example at Amazon ). As such, IonQ is at the bleeding edge of modern technology and makes it one of the most interesting speculative plays available on the market today.

Given the gigantic (and growing) worldwide investments toward advanced computing, quantum computing manufacturers like IonQ are tempting investments because success might lead to enormous revenues in time. However, as I explain in this article, the road to profitability for ion-q is most likely going to be very long. A number of factors have to align for ion-q to survive and thrive in a very uncertain segment of computing. There are a number of significant risks along the way.

As a result, although the upside is certainly enormous, I would still give IonQ relatively low probability of long-term success despite its very impressive technological accomplishments. I rate it a speculative buy.

The Enormous Upside

Computing is a huge and rapidly growing industry. By 2030, the global semiconductor industry is expected to double and surpass a total addressable market ((TAM)) of $1 trillion (per an analysis from McKinsey ). Although quantum computing is not based on semiconductors, the size of the semiconductor industry highlights the enormous investments flowing into advanced computing. There is a lot of revenue at stake here.

If quantum computing captures even a small portion of this market, the revenue opportunities for firms in the segment could be immense. Even 1% of the market should amount to about $10 billion by 2030. For IonQ, this means that long-term success could see the company's revenues grow to billions, or perhaps even tens of billions, of dollars over the next decade - provided it can maintain its strong position and stay competitive. And if quantum computing takes an even bigger slice of the computing pie over further years, then the upside for IonQ could be gigantic.

The Lofty Valuation

Given the enormous upside and currently high investor interest in advanced computing, IonQ's valuation is steep. IonQ's market capitalization is around $2.5 billion, yet its trailing twelve-month ((TTM)) revenues are just $19 million, and its 2023 bookings are guided around $60 million. Furthermore, IonQ is not yet profitable and is experiencing rapidly increasing R&D expenses, which grew by 87% year-over-year in the last quarter.

As an early-stage company in an emerging field, it is understandable that IonQ's financials are not yet particularly robust (although its balance sheet is strong with $400m in current assets and less than $100m in total liabilities). Investors should understand that buying IonQ shares is more about a vision of the future than about financial success in the near future. IonQ is certainly not vaporware, but it is also far from a profitable enterprise.

The Long Road Ahead

For IonQ to achieve long-term success, it would have to sell its products at scale - call it around $1 billion of sales per year. I say this because even though IonQ's gross margins are excellent (around 70%), I expect R&D costs to keep increasing each year. It is difficult to develop better, more advanced computers built using more advanced processes generation after generation. At least with traditional silicon-based computing, this has meant that industry-wide R&D expenses have kept growing for decades with no end in sight. I would expect quantum computing to turn out similarly, although it is still very early to be fully confident in this assessment.

As I see it, there are three major hurdles that IonQ would have to surpass in order to sell quantum computers at scale:

• First, quantum computing would have to progress to use cases beyond exploratory research aimed at finding use cases and applications, which seems to be the market for now. For instance, IonQ's recent deal with the U.S. Air Force Lab is aimed at "quantum networking research and application development." Similarly, IonQ's deal with Zapata AI is also looking to "uncover new potential advantages of quantum computing that could help solve complex real-world business problems." To sell quantum computers at scale, quantum computing will have to progress beyond this stage and get to the point of enjoying an advantage in terms of performance and/or cost for at least some kinds of (existing or new) workloads. These workloads would have to be ones for which there is sufficient market demand to support the production of quantum computers at scale.

• Second, IonQ would have to survive against other competitors in the space - of which there are quite a few, the most famous among them probably being [[IBM]]. This is far from a certainty. Quantum computing is still in the very early stages, so there is no guarantee that IonQ's particular approach to quantum computing using ion capture will be the one to win out (or that IonQ will be able to successfully switch to a better alternative should it emerge). Moreover, as quantum computing becomes more economically viable, there is a chance that IonQ would have to contend against traditional chipmakers who have comparatively endless resources - Nvidia (NVDA), at least, are taking a keen interest in quantum and hybrid quantum-classical computing. This could be a very difficult battle for IonQ.

• Third, IonQ would need a quantum computing ecosystem to emerge. No firm is an island. To manufacture at scale, IonQ's suppliers may need to expand production. Their workforce will need to expand - and given that quantum computing is not an easy subject, the qualified pool of workers is limited. IonQ may need more people to start studying quantum computing for its vision of the future to emerge. Moreover, IonQ's customers will need to also hire their own personnel who can run quantum computers and write code for them. Again, this is a small pool of people and would probably need to grow. Software and applications for quantum computers need to be developed that could make these computers easier to use and more economically viable to own.

Now, over time all this can certainly happen (to some extent concurrently). But it is difficult to see all this taking less than 5 years or so at the minimum, and more likely a decade plus. These are big challenges, and there is no way to overcome them in short order. Investors who opt for IonQ should be ready to be very patient.

Verdict

Overall, given that the risks and challenges are immense, I would assign a low probability of long-term success to IonQ (call it 20%). However, given the potentially enormous upside, especially on an investment timeline of a decade or so, I still rate IonQ as a speculative buy at its current valuation. It is easily conceivable that the 20% success scenario could see IonQ revenues balloon to several billion dollars around 2030-2035. In this case, a valuation of, say, $20-40 billion could be very plausible if the market assigns a high multiple to IonQ in light of its growth. The market has traditionally been quite willing to do so for companies at the forefront of technology. And so I think that the potential returns here make the risk worthwhile.

However, this rating comes with a caveat. Given that IonQ is mostly valued based on a long-term vision of the future rather than current financials, its stock price is likely to be volatile and sentiment-driven for a few years. Consequently, there is a good chance that investors may be able to find a significantly better entry point at a time when sentiment regarding advanced computing is more muted. However, it should be noted that IonQ is currently in a slump compared to its highs in September, so right now may be a pretty good time to buy as well. Obviously, I don't have a crystal ball that accurately predicts every market movement, but I suspect that patient investors who wait for more of a discount will probably be better off.

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