TXN - Valens Semiconductor: Why I Am Buying The Stock

2023-04-12 11:30:09 ET

Summary

• Valens Semiconductor Ltd. has a strong track record in setting the industry standard first in the audio video market and now the automotive market, resulting in first mover advantages for the company.
• Within the automotive market, Valens MIPI A-PHY gives OEMs the highest bandwidth, longest distance, lowest error rate, and lowest total system cost.
• VA7000, its newest MIPI A-PHY product, has seen strong traction so far, and Valens is participating in several automotive OEM bids, with a design win expected in 2023.
• In the audio video segment, the growth strategy is to increase market share with existing clients while expanding to key growth opportunities in adjacent verticals.
• My 1-year price target for Valens Semiconductor Ltd. is $4.10. This implies 51% upside from current levels.

I think that this could be a hidden gem opportunity we have here with Valens Semiconductor Ltd. ( VLN ).

I recently shared with members of Outperforming the Market a Buy trigger alert for Valens because I think that Valens has an attractive risk reward perspective today. There are positive near-term catalysts like a potential first automotive design win for VA7000 and reaching adjusted EBITDA breakeven in 2023, amongst others.

The company has a strong innovation track record, setting industry standards and having the first mover advantage. At the same time, the company looks to penetrate and gain traction in the automotive market as ADAS, and autonomous vehicle applications grow. At the end of the day, Valens has a differentiated product which offers better performance and lower costs, and it is poised for market share gains and accelerated revenue growth as a result of such a strong value proposition.

Introduction

Valens is a fabless semiconductor company, and it is a worldwide industry leader in digital connectivity.

The products that Valens produce brings innovation to the connectivity space as it allows for long-reach, high-speed video and data transmission for audio video and automotive industries. The technology that Valens bring next generation performance in terms of "high-speed, high-bandwidth, error-free, long-range connectivity in environments where performance and cost are critical."

Valens operates two segments: the automotive segment and the audio video segment.

As of the full year of 2022, 82% of Valens revenue came from the audio video segment while 18% of its revenue came from the automotive segment.

While the audio video segment forms the large majority of the company's revenues today, the automotive segment is what the market is excited about.

In 2022 alone, the automotive segment revenue grew 105% year-on-year, although on a small base, to $16 million.

The audio video segment is also doing well as it grew 18% year-on-year in 2022, achieving a record revenue of $74.5 million.

By 2026, the automotive segment is expected to ramp to mass production and become a substantial portion of Valens revenue mix by then.

Audio Video segment

Valens has set the standard for long range connectivity in the audio video market as a result of its HDBaseT technology. HDBaseT technology is used by the key leading audio video product manufacturers. It enables the simultaneous delivery of ultra-high-definition digital video and audio, Ethernet, USB, control signals, and power, all through a single low cost, long-reach cable.

In addition, HDBaseT technology is a hardware-based solution, with no high-level software dependency, enabling true plug-and-play digital connectivity between ultra-HD video sources and remote displays, such as high-resolution projectors and displays.

Automotive Segment

Valens Semiconductor Ltd. provides one of the safest, most resilient, ultra-high-speed in-vehicle connectivity solutions, all transmitted through standard, simple, low-cost, low-weight wires and connectors, enabling advanced electronics architecture in cars.

In 2021, Valens was the first to market with A-PHY compliant chipsets.

Importantly, Valens’ superior physical layer (“PHY”) technology is something to watch out for. Its PHY technology enables powerful bandwidth over long-reach and low-cost infrastructure. All that is achieved while maintaining error-free links and enhanced electromagnetic compatibility (“EMC”) performance. As a result, Valens PHY technology is able to bring the safety and resilience required to handle the harsh automotive environment.

The IEEE Standards Association has signed an agreement to facilitate the adoption of A-PHY as an IEEE standard.

I also like that third party analysis and benchmarking has been done to prove that Valens has a superior product. They showed that there were significant cost saving opportunities for automotive OEMs using MIPI A-PHY-based technology. According to a recent third party ( A2MAC1 ) report, MIPI A-PHY-based chipsets for higher-resolution camera sensors and serializer-deserializer ("SerDes") solutions would result in a total system cost reduction of up to 15%, relative to existing proprietary solutions. This includes a 63% reduction in wire harness and connector costs, which together form a significant portion of the total system cost. Moreover, the report stated that there are further cost reduction opportunities for OEMs resulting from native integration of A-PHY into image sensors.

Valens Head of Automotive, Gideon Kedem, had this to say about the achievement of Valens MIPI A-PHY thus far:

For a long time, we’ve known that A-PHY gives OEMs the highest bandwidth, the longest distance, and the lowest error rate – and today, thanks to this first-of-its-kind research by a 3rd-party benchmarking firm, we can add to that list another important metric – lowest total system cost.

As a result, Valens is on track to gain market share from automotive OEMs as its MIPI A-PHY-based chipsets allows for better performance and lower costs.

Growth opportunity in the Automotive segment

I think that the optimism surrounding the automotive market lies in autonomous vehicle and ADAS applications. There is a huge opportunity within the autonomous vehicle and ADAS applications for Valens as its products are required to enhance a vehicle’s ability to send large amounts of data quickly, reliably, and with fewer wires than existing solutions.

Also, as a result of an increasing number of sensors like cameras, radars, LiDARs, and high-resolution displays being used, there is a need for high-speed data processing capabilities. Thus, these applications require a robust networking solution to support the significantly increased amount of data required to be processed within the car, which Valens products can provide.

The products that Valens bring to market will bring automotive OEMs a smart high-speed connectivity solution with lower total system cost, reduced complexity and lower power consumption. This is critical for vehicles and more importantly, for electric vehicles. Valens is able to bring this strong value proposition to automotive OEMs because his is primarily because its current and future products provide very high bandwidth over simple, unshielded wiring infrastructure, as well as an increased link resilience with built-in diagnostic and analytic capabilities.

For the full year of 2022, the strong sales in the automotive segment came from the strong sales of its current generation automotive product, the VA6000 chipset. The VA6000 chipsets were integrated into most Mercedes Benz car models.

VA7000 is its new MIPI A-PHY product, which has seen strong traction so far. The company has shipped VA7000 evaluation samples and engineering samples to customers and the new product will ramp up sometime in 2025 and 2026.

Valens has spent the year expanding the ecosystem towards mass production of its automotive VA7000 A-PHY compliance chipsets.

There are multiple testing that has been done on VA7000.

The Japanese alliance JASPAR , whose network includes Toyota, Nissan, Honda, Mazda and DENSO, validated for its network of OEMs and Tier 1 the MIPI A-Valens VA7000 chipsets passed their rigorous testing for electromagnetic compatibility, which is required by automotive OEMs. This is a huge milestone for Valens as it means that the company is another step closer to integrating its products into ADAS and autonomous vehicle applications.

Also,VA7000 is gaining traction in Japan as Hosiden Corporation, an automotive electronic equipment components provider, also completed its validation of its connectors and cables with VA7000 chipsets.

Valens is currently participating in several automotive OEM bids and the focus in 2023 will be achieve a design win. The company believes that it will be able to secure its first design win for VA7000 this year.

In the near-term, as of the last earnings call, Valens expects automotive revenues to be substantially higher in 2023 compared to 2022, and the company expects that they are making good progress in achieving adjusted EBITDA breakeven by the end of 2023.

Growth opportunity in Audio Video

In the audio video segment, the growth strategy of Valens includes increasing market share with existing audio video clients and expanding the available market by addressing key growth opportunities in adjacent verticals. The company intends to use products from the automotive segment in the audio video market. This includes both the VA6000 and VA7000 family chipsets.

Some of the industries in which Valens has gained strong footholds include industrial, medical imaging and transportation. These industries require long-reach, high-resolution, zero-latency video connectivity while using simple, standard, low-cost cables.

Valens has a strong track record in being able to set standards

Valens Semiconductor Ltd. has set the standards in the markets it operates in.

By being the standard-setter, this also implies Valens has the first mover advantage and that this will translate to share gains and outsized revenue growth.

In the audio video space, Valens achieved this with its HDBaseT technology. The HDBaseT Alliance has grown into a mature organization with more than 200-member companies.

After its success in the audio video space with its HDBaseT technology, it is now replicating the formula again in automotive with the new MIPI A-PHY standard.

Valens technology was selected by the MIPI Alliance as the basis for their new high-speed in-car video connectivity specification. This is huge for Valens, as it appears the company is once again having the first mover advantage in the automotive market. The standard was validated by the IEEE standards association as it adopted A-PHY in full as one of its own automotive standards.

Some companies supporting Valens include Intel ( INTC ), leveraging on Intel Foundry Services, Mobileye ( MBLY ) and Sony ( SONY ).

Differentiation in technology

The differentiation in Valens technology lies in the digital signal processor ("DSP") managed layer, called PHY. Valens has more than 100 patents in digital signal processing, analog front end and physical coding sublayer.

In the market, Valens currently has the solution with the best high speed, long reach digital connectivity technology. Specifically in the automotive markets, Valens products work over simple, cost-effective wiring infrastructure to drive different protocols simultaneously at multi gigabit bandwidths with zero latency and no errors.

Competition

The biggest challenge to the investment thesis on Valens Semiconductor Ltd. is competition. There are major competitors in the market, most of which are large players. These include Texas Instruments ( TXN ) and Maxim, which was acquired by Analog Devices ( ADI ), as some examples.

That said, the technology of competitors is more analog-based while Valens technology is DSP-based.

DSP based technology is seen as more versatile, accurate, repeatable, requiring more power consumption and more easily implement mathematical processing algorithm than analog based ones.

In fact, Valens mentioned that competitors are struggling to scale up the bandwidth to 8-Gig, 16-Gig and 32-Gig as a result of electromagnetic interference. This is a key challenge in the car environment, and Valens technology gives it better electromagnetic immunity.

Valuation

As Valens Semiconductor Ltd. is expected to become adjusted EBITDA positive by end 2023, I expect that we will see positive profitability in late 2024 and early 2025 should the ramp-up in VA7000 go according to plan. I expect EPS to grow rapidly from 2024 to 2026.

Applying a 40x P/E multiple to 2024 EPS, I derived a 1-year price target of $4.10 for Valens. This implies 51% upside from current levels. The risk here would be whether Valens is able to achieve adjusted EBITDA breakeven in 2023 and EPS profitability by 2024, which hinges on the automotive design win for VA7000 in 2023.

Risks

Competitive pressures

While there are large competitors within the industry competing against Valens, I do think that Valens has a competitive advantage over them in terms of technology. With its differentiated offering and being ahead of peers in terms of setting standards, Valens is clearing setting itself up for success.

Automotive design win

While there are expectations for a design win in the automotive market for VA7000 in 2023 and the current momentum in VA7000 looks great, there is a risk that this design win may not materialize in 2023. Given that Valens has a limited track record in the automotive market, there are some risks for the segment to reach mass production and increase penetration in the market.

Conclusion

I think that this could be a hidden gem opportunity we have here with Valens Semiconductor Ltd. The company is operating within large multi-billion addressable markets of audio video and automotive, with room to grow as ADAS and autonomous vehicle applications grow. Valens has been a leader in connectivity and has set the standards not just for the audio video market but also the up-and-coming automotive market. There have been validations from industry players for its new VA7000 product and management is optimistic about an automotive design win in 2023 that will propel the business forward. Valens has got the ecosystem ready when such a win comes. Valens is a strong contender in the market, as large competitors use different technology and are struggling to keep up to Valens innovation.

My 1-year price target for Valens Semiconductor Ltd. is $4.10. This implies 51% upside from current levels.

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