MBLY - Mobileye: Putting The Brakes On A Leader In An Attractive Sector

2024-01-17 21:25:36 ET

Summary

• Mobileye is positioned as a potential winner and current leader in the Advanced Driver Assistance Systems industry.
• The company has lowered its revenue guidance for 2024, projecting a 9% YoY decrease, which contrasts with the 23% increase expected by the market.
• The current valuation at $30 remains relatively high compared to its intrinsic value, and I recommend selling the stock.

Overview

Mobileye (MBLY), a leader in the Advanced Driver Assistance Systems (ADAS) industry, recently announced lower guidance for 1Q2024, sparking discussions within the industry. ADAS, a complex sector, sees competition from various players, including Tier 1 manufacturers, semiconductor companies, pure EV car manufacturers, and software companies. This analysis focuses on the car manufacturing sector, aiming to position Mobileye within this intricate landscape.

My core thesis suggests that the industry's dynamics will empower Mobileye, positioning it as a potential winner and current leader. While the lower revenue guidance presents a buying opportunity, my valuation considers the company has a lower intrinsic value, with no anticipated upside. Recognizing certain risks, I cautiously recommend selling the stock.

The ADAS industry remains attractive even in a challenging automotive environment

The Automotive Manufacturing Industry is notoriously challenging, with companies often operating on thin profit margins. Generally, Tier 1 manufacturers demonstrate low profitability, with Magna ([[MGA]], [[MG:CA]]) at a 2.5% net margin, DENSO ([[DNZOF]], [[DNZOY]]) at 5.5%, and Valeo ([[VLEEF]], [[VLEEY]]) at 1.8%. Despite this, there is a shifting dynamic with the integration of more software into cars, potentially altering the balance of power among industry players.

Software development introduces a scalable dimension to the automotive industry, particularly with its recent integration into cars, whether associated with ADAS or not. This transformation is driven by two key characteristics. Firstly, scalability is a significant factor. In complex environments like ADAS, the sophistication and complexity of the software mean that only a select few partners, typically 2-3, will have the capability to deliver. Consequently, automotive manufacturers find themselves with fewer choices, diminishing their negotiation power. Secondly, ADAS software must be dynamic, adapting to changing conditions, maps, and objects, requiring flexibility. Unlike a traditional piece of metal, ADAS software is more akin to a service that needs ongoing maintenance and development. This creates a strong dependency on the software provider. These driving factors amplify the influence and power of ADAS providers in the automotive sector.

Customer switching costs are substantial in the ADAS software domain, as the software serves as a core platform with intricate modifications tailored for various car models. Developing these specific modifications takes six months to a year, involving significant investments of both time and money. These adjustments go beyond small tweaks; they entail substantial changes. Consequently, the software acts as a fundamental platform applicable to all models, with non-trivial personalizations for specific models. This leads to two crucial implications. First, creating software for a particular model becomes impractical, necessitating trust in the reliability of the core software. The cost of this core software is likely prohibitive for most car manufacturers, compelling them to rely on third-party providers. Even Tier 1 suppliers may find it challenging to develop and maintain this core software due to its scale and complexity. Secondly, the customization of the software is a significant undertaking, accounting for approximately 100M-250M (my estimate is around 50% of development costs). Consequently, car manufacturers commit significantly to the platform and the chosen partner. It is more likely that, when selecting an ADAS provider, the car manufacturer opts for a tech partner rather than a model-by-model supplier. This dynamic enhances the influence and power of the chosen ADAS provider in the industry.

The total software development cost for a car manufacturer amounts to approximately $1 billion. Remarkably, ADAS systems constitute 37% of the total software costs in a car , surpassing even infotainment and connectivity, which account for 30%. I anticipate that this proportion will continue to rise as the functionality of ADAS becomes more critical. Consequently, I project a 50% share of the total software development cost in a car. Drawing parallels to the evolution of the PC industry, where large computer companies initially dominated mainframe computers (NEC, IBM, etc.), the automotive sector is undergoing a similar transformation. As the significance of ADAS systems grows, the traditional dominance of car manufacturers is expected to shift. I foresee a scenario akin to the success of software companies (such as Microsoft) and microprocessor companies (like Intel) in the PC industry. In this evolving landscape, ADAS systems are poised to become a key component in the automotive value chain.

Mobileye is the clear winner in the ADAS space

I believe Mobileye stands out as a clear winner in this market due to its expertise and extensive market penetration, distinguishing it from other players in the field.

Mobileye has 20 years of industry experience, with its solutions integrated into 800 vehicle models and deployed in over 160 million vehicles. Collaborating with 50 Original Equipment Manufacturers (OEMs), Mobileye holds a unique set of credentials that surpass any competitor, solidifying my view as the clear leader in the industry as you can see in Fig 1.

An ADAS system provider needs a combination of complex capacities, and I believe Mobileye is the player with more qualities. The first capability is sensor expertise, involving experience with cameras, lasers, and radar—three distinct and challenging technologies. Companies engaged in auto manufacturing, including Tier 1 suppliers and vertical automakers, excel in system integrations and handling diverse apparatus. On the other hand, semiconductor companies specialize in chip management and software but may lack expertise in system integration and specialized devices. Meanwhile, software services excel in software development and maintenance but may not have the necessary proficiency in hardware. Mobileye's comprehensive capabilities across sensor technologies, integration, and hardware expertise position it as a standout player in the ADAS market.

In my opinion, Mobileye has cultivated the essential capacities required to operate these advanced systems effectively. In the current phase of innovation evolution, seamless integration of the system is paramount. While vertical auto manufacturers are poised for success in their specific models, I believe Mobileye is strategically positioned to emerge as the market leader for the broader industry. The ADAS system occupies a pivotal role at the core of a car's functioning, operating in a mission-critical capacity. As an end-to-end solution inside the vehicle, numerous interconnected parts contribute to its operation, and Mobileye's expertise positions it as the optimal player to navigate this intricate landscape.

The strong collaboration with Intel (INTC) provides Mobileye with exclusive access to manufacturing capacities and cutting-edge technologies, positioning it in robust competition with semiconductor companies.

Mobileye's tactic approach is currently centered on serving as a component provider. However, in my perspective, there is a lot of work for Mobileye yet to be done especially as a system integrator surpassing Tier 1 manufacturers or being more relevant in its ecosystem.

The current lower revenue guidance for 2024 has a direct impact on the valuation

On January 4, 2024, the company announced

In FY2024 we expect total revenue in the range of $1,830 - $1,960 million. This is underpinned by expected EyeQ® shipments of 31 – 33 million units (as compared to approximately 37m units in 2023) and SuperVision shipments of 175k – 195k units (as compared to approximately 100k units in 2023).

We currently expect Q1 revenue to be down approximately 50%, as compared to the $458 million revenue generated in the first quarter of 2023. We also currently believe that revenue over the balance of the year will be impacted by inventory drawdowns to a much lesser extent. As a result, we expect revenue for Q2 through Q4 2024 on a combined basis to be roughly flat to up mid-single digits as compared to the same period in 2023, and we expect inventory at our customers to be at normal levels by the end of 2024

It hasn't been challenging to anticipate a downturn in chip component sales within the automotive industry . Chip inventories surged across the auto industry during the challenging times of the 2020 Covid pandemic. Automakers and their major suppliers stockpiled chips to ensure they wouldn't lose any sales in the future. However, maintaining chip inventory comes at a significant cost. Chip prices can decline rapidly, and the emergence of new models quickly renders older chips almost obsolete. This trend is not unique to Mobileye; other chip makers, such as NXP Semiconductors (NXPI), ON Semiconductor (ON), and Lattice Semiconductor (LSCC), are grappling with similar challenges.

This occurs in a year when semiconductor companies are poised to benefit from an upturn in a previously down business cycle. Projections indicate that semiconductor revenue declined by 12% in 2023 but is anticipated to rebound with an 11% growth in 2024 . I note that this dynamic seems to be specific to the automotive industry, and the negative impact appears to be more of an isolated occurrence rather than reflective of weaker demand for Advanced Driver Assistance Systems ((ADAS)).

You could anticipate this issue from the last earnings report where CEO Amnon Shashua mentioned,

Operating cash flow on a year-to-date basis has been impacted by investments to rebuild our strategic inventory of EyeQ chips, which we had used to maintain a steady supply during the chip crisis. If you adjust for that investment in inventory, which is now largely complete, operating cash flow has also grown very strongly so far in 2022.

The most concerning aspect of this narrative is a potential erosion of credibility from the management.

I plan to assess the business value without factoring in this particular effect, and subsequently, I will incorporate it. This approach aims to scrutinize the actual impact of the inventory adjustment, helping determine whether the market reaction has been overly reactive or justified.

Valuation

In the base case and drawing upon the long-term prospects analyzed earlier in the article (anticipating that ADAS systems will be an attractive industry and Mobileye will lead the market), I envision a business poised for a 20% growth with Adjusted EBITDA/Revenues margins at 35%. The total investment requirement is projected to be at a pace of -10% (comprising -4% in Net Working Capital and -6% in CAPEX), while the cost of equity stands at 12%, and a long-term free cash flow rate of 3%. Illustrated in Figure 3, the company's valuation is estimated to be $33.1/share, reflecting a roughly 10% premium from the current market price.

Now, we need to factor in the impact of the lower sales due to the inventory adjustments, resulting in a 50% reduction in revenue for Q1 and translating to a 9% reduction in revenues for the entire year. This contrasts sharply with the previously anticipated 23% increase projected by analysts on Wall Street. Extending this impact to 2025 with a growth rate of 15%, the valuation decreases by approximately $8/share, reflecting a roughly -25% reduction as you can see in Figure 4. I interpret this adjustment as indicative that the market previously valued the company with a premium at a higher intrinsic value, factoring in potential options for growth. With a more realistic revenue outlook for this year, the valuation has now shifted to a lower intrinsic value.

In my valuation, I have considered a 20% debt allocation as optimal, mirroring the company's position at the end of 2022. I posit that, for effective management of net working capital, the company may strategically employ short-term debt to leverage its position.

Secondly, my computation of the Price to Free Cash Flow (P/FCF) ratio is derived from dividing my intrinsic value calculation by the actual free cash flow per share. This ratio serves as a key benchmark for comparison with the market multiple. Specifically, in Figure 3, my P/FCF stands at 50.1, while in Figure 4, it is 33.7, as opposed to the market multiple of 43. Notably, in my realistic scenario (Figure 3), the valuation is comparatively lower. In addition, I gauge the Free Cash Flow ((FCF)) Yield by dividing the average free cash flow per share over the next 10 years by the current stock price. This metric offers insight into the future yield the business is poised to generate relative to the investment, assuming the acquisition of the stock at its present price.

Risks

I have identified two types of risks associated with Mobileye. The first is a structural risk related to the competitive position of the company. While Mobileye currently holds a leadership position in the market, its primary revenue source is the sale of semiconductor cards, particularly EQ. To remain competitive, the company needs to transition towards providing a more integrated solution, with software playing a crucial role. There is a risk that Mobileye may struggle to take this step and evolve into a comprehensive ADA (Advanced Driver Assistance) system provider for cars. The potential consequences of this risk are two-fold. Firstly, revenue growth may not meet expectations, with my estimate being two-thirds of the base case. Secondly, profit margins may further decline, leading to an Adjusted EBITDA of 25%. This unfavorable scenario cannot be offset merely by increased investment in CAPEX; rather, Mobileye would need to adopt a more aggressive approach to product innovation to remain relevant in the automotive ecosystem. Consequently, the valuation in this case is expected to decrease to $15.6, a -48% decrease from the current price.

The second risk pertains to the possibility of multiple clients reducing their orders due to inventory adjustments. While we are aware of the impact in the first quarter of 2024, uncertainty surrounds whether other clients will face similar issues later in the year and in the coming years. Although there is a lack of concrete news confirming this, considering the ongoing challenges in the industry, exemplified by companies like NXP, ON, and Lattice, it is reasonable to anticipate a continued downturn in the cycle with more adverse news emerging. If we extrapolate the current impact to potential future events, the resulting valuation is estimated to be $23, a -23% decrease from the current price.

Conclusion

My central thesis proposes that the dynamics within the industry will fortify Mobileye, establishing it as both a current leader and a potential winner. With the lower revenue guidance, which could be viewed as a buying opportunity, my valuation assesses the company at a lower intrinsic value without anticipating a significant upside. Acknowledging certain risks, I exercise caution in my recommendation, suggesting a sell of the stock.

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