OUST - Ouster's Strategic Shift: A Brilliant Move Beyond Self-Driving Cars

2023-07-05 09:56:16 ET

Summary

• Ouster, a LiDAR manufacturer, has shifted its focus from autonomous vehicles to other applications of LiDAR technology, resulting in a potential sound foundation for medium to long-term success.
• The company's new strategy focuses on the industrial and robotics sector, with 60% of Q1 2023 revenues coming from this sector, while only 25% comes from the automotive sector.
• Despite a 95% drop in share price since its IPO, the company's low debt levels and recent merger with Velodyne Lidar make it an attractive investment opportunity.

Ouster ( OUST ) has always been the epitome of a company in which I would never invest, just like all the other LiDAR manufacturers who were fantasizing about robotaxis a decade ago. Those who remember the early years when electric vehicles were just beginning to be mass-produced by Tesla (TSLA) will recall that the hype, more than for the new type of energy employed, was due to these vehicles rapidly approaching "autonomous driving".

Years later, it has become evident that to truly usher in an electric revolution in the automotive market, automakers must devote all their attention and resources to batteries. Autonomous driving will likely require an exponentially higher level of complexity and certainly, given today's automotive market, it is not a priority for manufacturers.

Ouster shareholders who were expecting a swift development of autonomous driving have seen the price of their shares plummet 95% between the IPO and today. Meanwhile, the company has shifted its focus, understanding that the real opportunities for LiDAR do not reside in personal vehicles, and now presents itself in a completely different way. It remains a risky investment, but Ouster's new direction and its low indebtedness offer a sound foundation for medium to long-term success. As a result, I am seriously considering buying the stock today.

The LiDAR Market

Understanding the LiDAR market is essential to grasp the central point of this analysis, which revolves around the transformation of a broken business model into one that could function extremely well.

LiDAR is a technology that enables a scan of the surrounding environment. Unlike radar, which uses magnetic waves, LiDAR uses a laser beam for this mapping; in this way, it yields images at a higher resolution and can serve decidedly more complex applications.

The applications of LiDAR are numerous beyond autonomous driving:

• In the field of robotics, it is used to provide robots with peripheral vision;

• The defense sector employs it for reconnaissance, particularly by mounting these devices on aerial drones. It can also be used for night vision systems, as like infrared rays, it does not require light;

• At the industrial level, it can be used for all machinery that needs to measure distances precisely and map the surrounding environment;

• In the security sector, it is used in surveillance cameras;

• It can be mounted on vehicles that need to navigate in space, possibly in a much simpler way than a street car. Examples are agricultural machinery and those used in logistics centers, which often operate in an obstacle-free space, devoid of road signs and people.

LiDAR is also present in a simple iPhone. It enhances the camera's ability to operate in low light conditions and enables the phone to measure distances between objects. It was essential to specify all this to make one thing clear: the future of LiDAR is not necessarily tied to the future of autonomous cars.

Ouster's Market Strategy

Regardless of the trajectory the company has followed to get where it is today, Ouster is a genuine LiDAR technological leader. Its new REV-7 product family comprises four products, all decidedly more advanced than the competition: OSDome for 180° vision, with a resolution 4 times higher than the nearest market competitor; OS0 for short-range vision, with a range 1.5 times greater and a resolution 6 times higher than the nearest market competitor; OS1 for medium-range vision, with twice the range, 45% less weight, and a resolution 4 times better than the nearest market competitor; OS2 for long-range vision, the product designed for automotive, which is simply comparable to the best offerings from competitors.

The point is that Ouster is no longer focusing on the automotive sector. It would be positioned to benefit from a boom in interest for autonomous driving, but that's not the direction the company is looking. According to the official data , 60% of Q1 2023 revenues come from the Industrial & Robotics sector, while just 25% come from the automotive sector.

A U-Turn on Autonomous Cars

Ouster's strategy is to focus more and more on all LiDAR applications not related to autonomous driving. A rather brilliant idea, considering that the LiDAR CAGR estimated by Spherical Insights & Consulting - excluding autonomous cars entirely - is 13.8% between 2020 and 2030. At the end of this period, the market size is expected to be $4.8 billion.

In February 2023, Ouster also completed the merger with Velodyne LiDAR to further secure its grip on technological leadership in the sector. The merger is expected to result in increased revenues and reduced costs, as commented in the dedicated paragraph.

The fact that Ouster has chosen to focus on the industrial and robotics sector is confirmed by the company itself. At the Deutsche Bank Global Auto Industry Conference presentation on June 14 , it was expressly stated that non-automotive customers are a priority and preferable. This is because:

• Margins are higher as demand elasticity is lower;

• Customers tend to prioritize product performance over price;

• The company can focus on long-term partnerships that ensure a stable revenue base and direction in research and development.

Indeed, one should now think of Ouster as a company that wants to serve the industrial automation sector through LiDAR. Autonomous driving, if and when it becomes reality, will be a future concern.

Path to Profitability

The first step towards positive GAAP EPS is to have a good operating margin. Ouster has always demonstrated strength in this regard, operating with a 25-30% operating margin to date. The Q1 2023 stands as an exception, but the company has clarified that this was a transitional issue due to the shift of many resources to the production of the new product series.

The second step is a strong customer base. Given a sufficiently high volume of orders and a good margin on sales, net income becomes a consequence. It should be noted that the acquisition of Velodyne was a smart move, contributing $6.4 million to Q1 2023 revenues. Without this boost, Ouster would have reported revenues of $10.8 million, still up 25% YoY.

The company also reported a loss on firm purchase commitment of $2.8 million: further confirmation that not receiving orders from "robotaxi" companies that survive while waiting for the next round of financing is a sound decision in terms of profitability.

In the Q1 2023 presentation, the company set a target of $18-20 million for Q2 revenues; this forecast was reconfirmed just a few days ago . Ouster is also dedicating a lot of effort to offering software to manage data from its LiDAR, on which the foundation for an ARR and a high-margin business could be laid.

Lastly, it is interesting to note that the merger with Velodyne is expected to result in $80-85 million annual cost synergies, a crucial factor in bringing Ouster closer to profitability. For reference, the total costs for 2022 (excluding COGS) were $156.35 million.

The goal of generating positive net income is still a long way off: it's realistic to think that, with a 30% margin on sales, the company must reach revenues of about $680-750 million per year before breaking even. This implies a 6x growth relative to the current size of the enterprise: this means capturing 15.6% of the estimated TAM for 2030, a challenging but certainly not impossible mission for the technological leader in the sector.

Low Indebtedness is Key

Frankly, if the debt levels weren't so low, I'm not sure I would be considering investing in Ouster. This was one of the factors that most convinced me to assign a buy rating.

Clearly, Ouster is still in the phase where it burns cash with its core business, but not at an alarming rate.

The merger with Velodyne has occurred too recently to judge the impact on this variable, so we can only ignore this element for now.

As much as the merger may impact, it's likely that Ouster still has enough cash to cover a year's expenses without having to issue new shares. This will happen in the future, and it's important to bear in mind, but with a valuation of $200 million, it's fairly easy to say this isn't the problem. Even if outstanding shares were to double, the real key to generating long-term value for shareholders remains to make the core business profitable.

Conclusion

Since Ouster decided to shift its focus to LiDAR applications outside of autonomous driving, prospects for shareholders have improved. Instead of chasing a future that seems as distant as it did ten years ago, it is now truly riding the wave of an industry growing at over 18% annually.

If the company continues to be a technological leader in LiDAR, a position that doesn't seem to be seriously threatened by any competitor, it has the potential to become what Pirelli is to tires or Nvidia is to graphic cards. I expect the LiDAR sector to consolidate around a few firms in the next 3-4 years, with Ouster being the go-to choice for high-performance, high-value-added products.

Regardless, mine will be a "buy and forget" investment. An amount I can afford to lose, but if it were to revalue 20x, it would represent a considerable added value to my portfolio. Ouster shares have already been 20 times higher than where they are today, so it's not an impossible prospect over a span of 7-10 years.

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