2023-07-30 06:53:01 ET
Summary
- The regulatory go-ahead for Amazon's $1.65 billion bid for iRobot has been delayed due to investigations on data protection and antitrust concerns.
- In the meantime, due to its declining revenues and cash, iRobot is having to finance operations through a loan.
- While regulators are likely to take time, the deal should eventually be approved in light of the evolution of AI.
- However, the main risk facing the Roomba vacuum cleaner is the possibility of having to contract another loan due to the depletion of cash as it waits.
- It has initiated a restructuring plan involving cost cutting and is scaling down on inventors, but with regulation-related volatility, the stock could fall further.
Soon it will be one year since Amazon (NASDAQ: AMZN ) made a $1.65 billion bid for iRobot (IRBT). Matters have been delayed as regulators on both sides of the Atlantic Ocean have launched investigations pertaining to consumer data protection and risks posed to the home appliance maker's competitors.
More recently, the merger terms have been amended with Amazon to pay only $51.75 per share instead of the initial $61.00 which is one of the reasons why the stock now trades at about $20 below its August 2022's peak of $59.90 as shown below.
Share price evolution during the last year (www.seekingalpha.com)
Now, in a context where AI is gaining wider acceptance with the popularization of ChatGPT, this thesis aims to assess the prospects for the merger materializing and also whether the current share price of $39.55 constitutes a buying opportunity in view of risks. Also, with the company expected to report results for its second quarter 2023 (FQ2) on August 8 , I first provide some insights into the finances so that investors know what to expect.
Revenues, Cash, and Competition
As shown in the blue chart below, quarterly revenues have gone up in the aftermath of the Covid pandemic when people bought more vacuum cleaners to clean their living space after being forced to stay at home for a long time. This resulted in sales peaking in 2021, before declining as people returned back to normal life and spent less time in their apartments.
Things appear to have worsened substantially in the first quarter (FQ1), as revenue decreased by 45% partly due to orders from a major customer being rescheduled for the second quarter. Cash levels are also on a downtrend as charted in orange, with iRobot recently having to finance operations through a $200 million facility. Additionally, according to the management the company suffered from low consumer sentiment.
However, there is also competition.
Hence, according to a review by the New York Times , while two iRobot Roomba i4 EVO models were found to be excellent cleaners and smart, other makes like Roborock's Q5 also performed relatively well, except that they lacked certain advanced features, but, on the other hand, were cheaper.
Consequently, in addition to changing buying patterns , there is also competition resulting in people prioritizing price at the expense of sophistication, possibly influenced by the economic uncertainty in the first half of this year. Subsequently, the latest acceleration in GDP and progression in consumer sentiment for July both augurs well for iRobot in the second half, but, those for the months of April, May, and June were lower , which means that next quarter's (FQ2) sales numbers are unlikely to show any positive surprises other than input from the major customer who delayed orders in FQ1.
Furthermore, the New York Times review also reveals that iRobot's products have the highest degree of automation which makes it less probable for them to bump against furniture compared to other makes, which may be one of the reasons why Amazon chose to acquire the company.
However, this acquisition which was initially a boon for the stock is now proving to be more of a drag as shaded in yellow in the table below. I also list the factors impacting the share price and grade each on a score of 10. Finally, a total score of 33 out of 60 is obtained, or an average of 55% which is not enough to warrant a buy position, as there are also regulatory risks as shaded in red.
Table Built using data from (www.google.com)
Regulations in a More AI-Savvy World
For this purpose, iRobot provides connected home automation products and its Roomba domestic robot is autonomous with its own navigation system to map the rooms and also comes equipped with functionalities, such as voice and facial recognition.
This means that the robot collects data through its onboard cameras as it moves, which, by itself, is not a problem as this is information about dimensions and recognizing objects with the intention of avoiding obstacles except in one circumstance when personal data (intimate photos) of residents were collected and posted online. However, this was during a training session and by a special-purpose device, not those which are sold as consumer products.
Still, this event can provide arguments to regulators who mostly fear that Amazon could combine the data it already collects through its Echo Dot speakers and Blink video doorbells that are bundled with the Alexa assistant with the spatial information obtained by the Roomba. In this way, the giant online retailer would possess the complete set of data pertaining to how people are spending time at home, and, combining these with their shopping habits (obtained through Amazon’s website), it can have at its disposal enough actionable insights to drive more sales, even at the expense of iRobot's competitors. On top, it has the necessary artificial intelligence infrastructure on its AWS cloud platform to process the data rapidly.
However, all is not gloom.
First, this is based on the U.K Competition and Markets Authority giving its go-ahead on June 16, stating that the deal would not substantially reduce competition in the country. At that time the stock surged by over 20%.
Second, with the launch of ChatGPT by OpenAI, artificial intelligence has become mainstream with OpenAI now also available to more corporations as Microsoft (NASDAQ: MSFT ) and other public cloud service providers make the technology available through their SaaS offerings. Therefore, in a more AI-savvy world where access to the latest intelligent algorithms has been "democratized" to corporations of all sizes (including iRobot's competitors), regulators need to think differently.
In such a context, more realism is required to create a balance between market forces and the need to protect competitors in order not to stifle innovation. For Generative AI, this innovation comes through analyzing tons of data to generate the most insightful report and for Amazon, it is obtained through scanning databases of its Alexa-enabled devices. Viewed from this perspective, iRobot's Roomba can be envisioned as just another Alexa-enabled device.
Thus, if Amazon satisfactorily answers regulatory queries and guarantees that it will provide quick access to data for verification purposes in case there are suspicions of any unlawful usage, a go-ahead is possible by the end of this year. For this matter, Amazon reported " substantial compliance " with the FTC (Federal Trade Commission) in June.
Stock's Value Impacted by Financing Needs
In the meantime, for those wondering whether it is the right time to be positioned due to the discount of $12.2 ($51.75 - $39.55), this is not the case with the Price-to- Sales being above the sector median by 13.5% . Moreover, with the European Commission extending the timeline for its decision to December 13 this year, volatility should persist and the stock could even drop to its previous $31.8 support level.
Moreover, investors should not be swayed by the roughly 1.5% upside seen for the last two days, driven mostly by positive consumer sentiment data. In this respect, since iRobot belongs to the consumer discretionary sector, it is subject to cyclicality meaning that sales depend on the evolution of the economy and the amount of disposable income people have, but, as shown in the above table, there are other factors determining the share price.
In this connection, in addition to competition for products, iRobot competes with larger companies for talented engineers who possess expertise in AI, machine learning, data science, and cloud computing. Also, some staff are already leaving due to acquisition-related worries while new recruits need an intensive training period to grasp the logic behind the company’s product. In these circumstances, iRobot's growth prospects can suffer if one of its competitors develops a better appliance and it is unable to fight back rapidly. If this happens, then the $947.35 million of revenues estimated for this FQ2-2023 could take a hit.
However, with the restructuring plan (see above table) involving a 15.7% reduction in staffing (from the end of FY-2021 till the end of FQ1-2023), the company could surprise positively on EPS for FQ2 as has been the case during 7 out of 10 most recent quarters.
Talking risks, the most pressing problem right now is the cash position.
In this respect, the firm had to borrow $200 million at a relatively high-interest rate, and together with the combined effect of the acquisition price being slashed by 15%, the downside was substantial. Therefore, going forward, the main risk facing the stock is further delay by regulators in approving the deal again resulting in the further need for cash and at the same time, devaluing the stock.
What to Look for in FQ2's Results
However, in the meantime, equipped with $247.9 million of cash, including the $47.9 million already held in the balance sheet, the company has ensured that it continues as a going concern. Additionally, as of the end of the latest reported quarter, it had $229.7 million in its inventory to convert into cash. Noteworthily, these were reduced by 19.5% since the end of December 2022 and in case the company can reduce its stocks rapidly there is less need for an infusion of cash.
In conclusion, a mixed picture emerges when averaging the different factors which determine the share price as tabled above. Moreover, despite regulators taking longer to scrutinize the deal due to Amazon's sheer scale and breadth of portfolio, I believe that eventually it will be OKed. In the meantime, volatility should persist, and, till there is clarity as to when the available cash will last, it is better to avoid the stock. To this end, watch out for relevant updates pertaining to cash consumption, inventory reduction, and any additional financing needed in FQ2's financial results.
For further details see:
iRobot: Mixed Picture, Amid Regulatory Scrutiny In An AI-Savvy World