VLN - Valens Semiconductor: Turning Cautious As Automotive Design Win Pushed Out (Rating Downgrade)

2023-12-29 08:42:24 ET

Summary

• Valens Semiconductor achieved positive cash flows in 3Q23, generating $6.1 million in cash from operating activities.
• Revenues, gross margin, and adjusted EBITDA in 3Q23 beat guidance, indicating improved financials for Valens Semiconductor.
• The company revised the full-year gross margin and adjusted EBITDA guidance upwards following the beat in 3Q23.
• While to VA7000 automotive OEM bids continued to progress in 3Q23, the decision process may take longer than originally anticipated and design win awards could be extended into 2024.
• The VS6320 chipset was launched, with a revenue ramp expected in 2H24.

I am turning less constructive on Valens Semiconductor ( VLN ) after its earnings report and thus, I am now neutral on the name.

I have written multiple reports on Valens Semiconductor, which can be found here .

Recall that I mentioned in that an earlier article that there are two main points for Valens Semiconductor before the end of 2023. The first being a significant VA7000 automotive design win by end 2023 and the achievement of adjusted EBITDA breakeven.

As of 3Q23, the one on adjusted EBITDA breakeven has been somewhat achieved given the guidance for 4Q23, but the other one on an automotive design win may require more time beyond 2023.

With uncertainty on the latter, I am turning less optimistic on the management's ability to execute, and thus I am reducing it to a Hold rating.

Let's first dive into Valens Semiconductor 3Q23 results.

3Q23

Firstly, one of the most important points in the 3Q23 quarter that may have been overlooked is that Valens Semiconductor pivoted towards positive cash flows in the quarter. Compared to the prior year when its cash from operations was negative $3.6 million , it pivoted the cash from operations to positive territory in 3Q23, generating $6.1 million in cash from its operating activities.

From the net cash generated from operating activities of $6.1 million, removing the capital expenditures spent in the quarter, the company generated $5.9 million in free cash flows for the quarter.

Based on an annualized free cash flow basis, the company is trading at almost 10% free cash flow yield.

Based on the current cash on hand of $143 million, and positive cash from operations and free cash flows, Valens Semiconductor is growing its business sustainably and has a balance sheet that cannot just execute its strategy, but also fund future growth.

Secondly, in 3Q23, we saw revenues come in at the high end of guidance, and both gross margin and adjusted EBITDA beating guidance by a considerable margin.

Revenues came in at $14.2 million, at the high end of its revenues guidance range of $14.0 million and $14.2 million. Gross margins came in 58.9%, beating the guidance for gross margin in the range of 57.6% and 58.0%. Lastly, adjusted EBITDA loss came in at just $(8.8) million, also handily beating the guidance range of $(12.2) million to $(11.9) million.

Guidance goes up

As revenues came in at the high end in 3Q23 and gross margins and adjusted EBITDA beat guidance, this suggests an improvement in the financials of Valens Semiconductor and thus, a more favorable and positive financial outlook for 4Q23.

For the 4Q23 guidance, management is guiding for revenues to be between $21.6 million and $22 million. Gross margins for 4Q23 is expected to be between 61.6% and 62.7%.

One of the most positive takeaways from the quarter is that management does not just expect its adjusted EBITDA guidance of breakeven to be met at the end of 2023, but it now expects to revise that upwards. As a result, the adjusted EBITDA guidance for 4Q23 is expected to be between breakeven to profit of $0.6 million.

As a result of these positive developments on the margin front, there are also positive upward revisions to the full year 2023 guidance. The revenue guidance for 2023 is expected to be between $83.8 million and $84.2 million, which is a reiteration of the earlier guidance. Of that, automotive is expected to contribute to 30% of revenues. However, the gross margin guidance is revised from the earlier range of 62.2% to 62.5% to the new range of 62.5% and 62.8%, an improvement of 30 basis points at the midpoint.

Also, with the upward adjustment of adjusted EBITDA in 4Q23, the expected adjusted EBITDA loss improves from the earlier range of $(16.2) million to $(15.6) million, to the current range of $(12.5) million to $(11.9) million. This marks a $3.7 million revision of adjusted EBITDA upwards at the midpoint, or +23% improvement from the earlier adjusted EBITDA.

Automotive OEM design win

This is one of the key catalysts for the company, as the market has not yet priced in any automotive OEM design win.

To recap, Valens Semiconductor has been working with automotive OEM for its VA7000 chipset, which is made for ADAS and autonomous driving, and the company has been optimistic about a potential win in 2023.

In 2Q23, just one quarter ago, management had this to say about its automotive OEM pipeline for VA7000:

Our VA7000 chipset family is a perfect fit for vision-based systems and in Q2, we grew the bid pipeline with automotive OEMs considering the deployment of the VA7000 in mass production. We remain on track to announce first design wins this year.

In 3Q23, the messaging changed to suggest that while progress is being made, the decision may take longer than expected and thus, the first design wins may be extended into the next year instead.

Our VA6000 chipset, which is being broadly deployed across many Mercedes-Benz car models, including electric vehicles, continued to contribute to our automotive revenue. In parallel, we continued to gain traction with our VA7000 MIPI A-PHY compliant chipsets.

LG Electronics Vehicle Component Solutions, for example, selected our VA7000 for its active safety next-generation camera system project, and we are also making progress on the various OEM bids we are participating in for the VA7000.

As the decision process may take longer than originally anticipated, design win awards could be extended into 2024.

Most important, once customers embed our chipsets into their vehicles, Valens Semiconductor should benefit from a long-term recurring revenue stream.

While this is definitely disappointing, I think we have to acknowledge that predicting the timing of an automotive design win is incredibly difficult. There are many moving parts to this. If anything, I think it is a positive that it is merely being extended or pushed out to 2024, rather than disappearing.

Management continues to predict that a design win will come and hopes that it comes sooner rather than later.

Perhaps one thing that management emphasized about these design wins is that they are confident about their technology and once obtained, a design win brings along runway and a long-term recurring revenue source.

Of course, it is also a positive that management mentioned that progress continue to be made on the various automotive OEM bids.

In addition, as highlighted before, in 3Q23, LG Electronics Vehicle Component Solutions selected the VA7000 for its active safety next-generation camera system project. The VA7000 chipset will be the main connectivity solution to integrate multiple camera sensors along with LG's own next-generation camera system.

This solution should be ready for mass production for automotive OEMs starting 2026.

Audio-Video

Within the audio-video segment, Valens Semiconductor launched the VS6320 chipset.

The VS6320 chipset is for long-reach, high performance extension of USB 3.2 peripherals, at up to 100 meters or 328 feet.

Valens Semiconductor has started shipping engineering samples to some customers in 4Q23.

For the VS6320 chipset, management expects the revenues to ramp up in the second half of 2024. The management believes that it can also win a substantial share within this currently untapped market for high-performance USB extension.

Valuation

As I reiterated in the earlier Valens Semiconductor article , my 2024 EPS forecasts heavily depends on the automotive design win, which was initially expected to be achieved by 2023. With that, it should unlock EPS profitability.

That said, it seems like the automotive design win is being pushed out, if any at all. This continues to be a drag on earnings and scale for the company. As a result, despite achieving the adjusted EBITDA breakeven by end 2023, I expect profitability to be pushed out to potentially 2025.

Applying the 40x P/E multiple on the now expected 2025 EPS breakeven and discounting that, the 1-year price target goes down to $3.50. Given the higher growth rate relative to peers and turnaround EPS in 2025, I think that the 40x P/E multiple is justified for the company.

Conclusion

I will be putting Valens Semiconductor on my watchlist of companies to potentially cut in 2024 given the likely miss on the automotive design win in 2023.

That said, cash is king and I like how Valens Semiconductor pivoted towards positive net cash generated from operating activities in the current quarter, and its free cash flow yield today on an annualized basis is almost 10%.

On top of that, the margin expansion that Valens Semiconductor has achieved resulted in the beat in gross margins and adjusted EBITDA loss, while revenues are also relatively strong.

The key here for Valens Semiconductor will be the automotive design win that it has mentioned multiple times, given that the adjusted EBITDA breakeven goal for the end of 2023 has largely been achieved given the guidance.

Looking ahead, I am cautiously optimistic about an automotive design win in 2024. While management has not met its own target of an automotive design win in 2023, I think to some extent that can be justified given the complexities surrounding the automotive industry design wins. The key thing here is that the pipeline continues to progress as these discussions continue, I expect we can hear something positive soon.

The reason the company is in the portfolio is because I think that there are still positive idiosyncrasies for Valens Semiconductor. Firstly, the margin expansion and pivot to positive adjusted EBITDA continues to be a catalyst for the company. Secondly, the VS6320 revenue ramp expected in 2H24 also sets up top-line upside for the company in 2024. Lastly, in the automotive space, with the progress in the automotive OEM bids over 2023, I expect decisions to be made in 2024 that could be in favor or an automotive design win for Valens Semiconductor.

I would also add that given that the company has pivoted to profitability and positive free cash flows, along with a strong balance sheet, the company looks fundamentally and financially strong.

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