2023-05-11 09:00:00 ET
Summary
- MIPS AB is a pioneer and market leader in bicycle helmet safety systems.
- This business possesses numerous enduring competitive advantages that will prove challenging for competitors to replicate in the near future.
- It has compounded revenue by 49% CAGR, earnings by 62% CAGR, and free cash flow per share by 39% CAGR since 2014.
- The stock appears expensive on an absolute level but undervalued relative to historical levels, the uniqueness and dominance of the business, the size and trajectory of its moats, and growth potential.
Introduction
MIPS AB ( MPZAF ) ( MPZAY ) ( MIPS.ST , listed on the Stockholm Stock Exchange) is a pioneer and market leader in helmet safety systems for bicycles and adventurous sports, including skiing and equestrian.
Short for Multi-directional Impact Protection System, it’s a low friction layer between the helmet foam and the helmet liner, allowing a sliding motion of 10 to 15mm in all directions. The core technology was invented 25 years ago in Taby, Sweden, to reduce the risk of brain injuries from accidents involving rotational collisions. It was considered a leap from the old ways that only protected users from linear impacts or straight-on collisions.
Today, it is the most recognizable brand in the industry. The small yellow dot logo on the outside of the helmet, and the yellow liner MIPS, represent ‘increased safety’ and are considered the standard for the industry .
I believe MIPS is a sleep-well business and deserves a spot on your watchlist. The current twelve-month trailing multiples are at 55x PE and 70x FCF. This appears expensive on an absolute level but undervalued relative to historical levels, the uniqueness and dominance of the business, the size and trajectory of its moats, and growth potential . My DCF workings also confirm the stock is modestly undervalued at the base case (SEK 561/share) and potentially attractively priced if inflation ((CPI)) data continues to trend down, pushing down my WACC assumption and raising MIPS’s fair value (SEK 711/share).
MIPS is a sleep well business
Since launching the first helmet for horse riding in 2007, it has dominated every market it has entered , namely, road bikes, mountain bikes, and snow sports. 91 of the top 100 highest-rated helmets use MIPS technology. The first non-MIPS position is at 30th place (!). Over 200 brands, including 9 of the top 10 bike brands and 6 of 6 biggest snow sports brands, are MIPS customers . For example, Specialized, Alpina, Fox, and Poc. The next competitor has just two brands as customers (!)
MIPS has compounded revenue by 49% CAGR, earnings by 62% CAGR, and free cash flow per share by 39% CAGR since 2014 . The gross margin has remained over 70% since 2015, and the EBIT margin has stayed over 38% since 2018, showing strong pricing power and market dominance.
There is no doubt MIPS has benefited from the Covid bike-craze demand-pull and is now suffering from a bloated bike market. Sales fell by 46% YoY in Q4’22 and 7% YoY for FY22. However, before investors conclude that this is a Covid business, know that MIPS’s revenue per share compounded by 62% pre-covid from 2014 to 2019.
MIPS has a leadership position and will likely be unchallenged as it possesses multiple durable moats . Among them is the growing portfolio of 300 long-dated patents in over 40 families (including energy absorption layer and sliding facilitator), scope and depth of tests conducted over two decades with third-party validations, unrivaled distribution scale afforded by a clever business model, agnostic design of the safety component, and strong relationships with practically all helmet makers from the beginning of its product launch.
Interestingly, one of the top bike producers was MIPS’s largest investor in the early days. Lastly, MIPS's impressive 35%+ return on capital invested [ROIC] means that as it enters the motor and safety (workplace / industrial / defense) markets, the business can replicate the effective investment process to keep compounding and delivering value to all stakeholders.
With large untapped markets, the management aims to triple its annual revenue to SEK 2B and expand its EBIT margin to over 50% by 2027, an upgrade from SEK 1B and a 45% EBIT target by 2025 set in 2021 .
MIPS’s stock had returned 9x to shareholders, compounded 38% CAGR since its IPO in 2017 when it was at ~SEK 2B Market Cap, ~SEK 50/share, to the current value of ~SEK 12B Market Cap, or SEK 470/share, despite crashing 60% from the peak of ~SEK 33B Market Cap, ~SEK 1250/share.
Risks
(-) The biggest risk is execution . Management had set an ambitious target of reaching SEK 2B sales and 50%+ operating margin by 2027, an increase from the first two targets at IPO and in 2021. Unfortunately, their track record hasn’t been squeaking clean. First, it missed the sales target of SEK 400M in 2020 set at IPO while over-delivered the 40% EBIT target by 5%. Secondly, since entering the motorcycle market in 2013, sales (SEK 47M in 2022) for this segment have remained under 10%, and growth has been rather unimpressive. Meanwhile, Leatt has done very well in the off-road motorcycle market. Now, MIPS aims to enter the Safety market, a market 3x bigger than its Sports segment, but it remains to be seen if it can take market shares from the incumbents such as Honeywell or 3M.
(-) The second risk comes from competition . Current alternatives come from own-branded solutions (KASK, LEATT) or specialized safety solutions (SPIN, Wavecel) with limited commercial reach. Both are considered low-risk in the short-medium term.
(-) The third risk is the awareness of rotational motion protection . The benefits of MIPS technology may not reach the masses, particularly in the lower-range market, where it is more difficult to convince the end-users to pay more for increased safety. MIPS targets spending 7% of revenue on sales and marketing and 5% on R&D to collaborate with universities and institutions to ensure they are at the forefront of communications to end-users, market developments, and stay ahead of new test standards. The dilemma is that competition may increase due to growing awareness of rotational motion and MIPS technology.
(-) MIPS has had some customer concentration issues , with 45% of revenue coming from the top 2 customers. However, that risk has reduced to just 26% of revenue in FY2022, 30% in FY2021, and 29% in FY2020. As MIPS grows, revenue from other customers also takes more shares of the total revenue. However, MIPS dropped disclosing the top 3 customers in FY2022, which could imply that they lost a large customer during the year. I will keep an eye on this.
Recent Q1'23 results
It reported challenging Q1’23 results . The market didn’t like it, but I saw signs of market recovery within a few quarters, in line with my expectation, and sooner than the industry bellwether, Shimano, also a sleep-well business that I deep dived into and own.
Negatives
As I review the headlines, MIPS’s Q1’23 results appear rather negative.
(-) Revenue fell 35% YoY to SEK 88M from SEK 137M as MIPS continued to digest the inventory build-up during Covid.
(-) Operating profit fell 75% to SEK 15M from SEK 62M, pushing EBIT margin down to just 17.5%, far below the 2027 target of 50%+, and subsequently pushing -
(-) Operating cash flow to a negative territory SEK -42M from SEK +37M a year ago. MIPS has not burned cash on a full-year basis since 2014, so this draws a grim start to the year.
The decline in revenue, operating profit, and operating cash flow was driven by
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lower sales in the bike segment (-41% organic sales),
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high investments in research and development and marketing, which was higher than Q1’22 despite lower sales, as well as the negative impact of currencies.
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large cash tax payment of SEK 59M in relation to the FY2021 bumper profit
That’s what the market saw and may explain the sharp -12% drop in the stock. However, in my tweets right after the results announcement and conference call, I explained that there were bright spots.
Positives
+ Revenue decline is slowing to -35% from -46% in Q4’22. This could mean we have passed the worst, highlighted in the table below.
My statement is supported by the following:
(i) a lower inventory level in the quarter, which was SEK 5M, halved compared to last year at SEK 13M,
(ii) orders from the lower range helmets are coming in, which hasn’t been for a long-time (possibly 6-12 months). This segment accounts for 50% of MIPS revenue and was the worst-performing segment in the last two quarters. The remaining 50% splits into 30/20 in mid and high-range helmets. As a result, sales from Q2 could improve sequentially.
(iii) the CEO’s market assessment that
inventory backlog will improve in the second half but remain relatively soft (Q1’23 cc)
The other minor positive behind the revenue decline is that growth is returning to Asia, with China as the main contributor. The CEO mentioned it grew 10%, outpacing the historical growth of just 5% in the conference call. This is not MIPS’s focus (yet), but China is a pathway to expanding lower-range helmets.
Additionally, the revenue decline in Q1 isn’t too bad as it is often the smallest quarter. Hence, it has the smallest impact on the full-year numbers. The CEO, Max Strandwitz, expects MIPS to return to growth in the second half of the year, with EBIT margin ending around 40% (!).
The other bright spots are:
+ Safety - is showing potential; revenue grew 300% YoY to 3M (1M) as brand partnerships increased to 12 from 11 sequentially. The one additional brand was smaller, but it exposed MIPS to the Energy/Oil and Gas industry, which competitors do not. As the largest total addressable market of 110M helmets annually, MIPS’s future value will depend greatly on how it captures market share in Safety. I’ll be sure to monitor the progress closely. Max Strandwitz expects Safety to contribute SEK 20M by the end of the year vs 4M for FY2022, a 5x growth.
Capital allocation
During the first quarter, investments impacting the cash flow amounted to SEK 2m (12m). Investments in intangible fixed assets amounted to SEK 1m (10), where investments in intangible assets related to the previous year mainly related to acquiring patent rights and other intangible assets. Investments in tangible fixed assets amounted to SEK 1m (2m).
Despite the challenging market, I see a continued commitment to reinvest in the business as R&D, sales, and marketing increase (highlighted below).
The average number of employees during the first quarter also increased to 98 from 80 in the prior year, of whom 24 (22) were employed in the Chinese subsidiary. The number of employees at the end of the period Q1’23 was 102 (86), of whom 24 (22) were employed in the Chinese subsidiary. The number of men employed was 55, and the number of women employed was 47 at the end of the period.
MIPS has proposed a dividend of SEK 5.50 / share, a 10% increase from FY2022, 82% of earnings FY2022, with cash and equivalents remaining healthy, SEK 487M (478M).
Valuation - What is the right purchase price?
MIPS appears undervalued using the DCF method and on multiple valuation bases.
My DCF model indicates a fair value of SEK 561/ share or SEK 14.7B market cap in a base case , SEK 380/share or SEK 10B market cap in a bear case , and SEK 729/share or SEK 19B market cap in a bull case. Following are the workings and assumptions:
*CPI numbers have declined in the last ten months since the June 2022 peak. I am considering reducing my WACC rate from 8% to 7%, increasing the fair value to SEK 711/share in the base case. However, the following workings use 8% WACC to be conservative.
Base case: SEK 561/share or SEK 14.7B market cap
I assume MIPS would underdeliver the long-term target of SEK 2B sales and 50% EBIT margin by 2027 . As such, it would only grow revenue by 22% until FY2027 and reach SEK 2B sales and 50% EBIT margin two years later than expected, in FY2029. I also assume a 3% terminal growth rate and an 8% WACC, my personal hurdle rate. With 7% WACC, the fair value increases to SEK 711/share (more on this later).
The growth expectation of 22% for the next five years is reasonable considering that:
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at 22%, I assume MIPS to continue outpacing the industry growth (as the bottom line), albeit at a much lower rate than the past nine-year growth rate at 50% and pre-covid growth rate at 62%,
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the level also aligns with Q4’22’s revenue growth, which has normalized to the pre-covid level in Q4’19 at 20%,
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my assumption is likely achievable as MIPS has a more extensive installed base of customers, helmet models, and the number of helmets sold, which supports a higher revenue base as helmets go through the next replacement cycle. The more extensive installed base also implies lower costs of customer acquisition in the future,
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lastly, I assume MIPS will convert sales in the Safety market as it expands MIPS’s focused market by 110M helmets annually.
Bear case – SEK 380/share or SEK 10B market cap
My bear case scenario assumes that MIPS misses the long-term management target by 50% . It would only achieve SEK 1B sales in FY2027 instead of SEK 2B. Over the next ten years, it will only grow sales at the industry average of 11% and represent roughly 15% downside from today’s price (SEK 450-470/share 6th April 2023).
Bull case – SEK 729/share or SEK 19B market cap
My bull case scenario assumes MIPS meets management’s long-term target of SEK 2B sales and 50% EBIT margin by FY2027. MIPS would capture more market share and successfully enter the Safety market, growing at about 29% CAGR for the next five years and 19% CAGR for the next ten years. At this rate, MIPS is valued at SEK 729/share or SEK 19B market cap, which translates to a 62% upside from today’s price.
Looking at valuation multiples, MIPS’s 55x PE and 71x EV/FCF appear undervalued compared to the last 5-year average of 61x PE and 152x FCF. If one owns MIPS for five years, the earnings and the FCF will grow to SEK 761M and SEK 627M, respectively, implying a SEK 15B business on a 25x PE multiple and SEK 18B business on 30x FCF multiple, or 30-60% upsides from today’s value of SEK 12B.
Overall, my assumptions are conservative, given:
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There is a lack of competitive threats.
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I assume MIPS will fail to deliver long-term targets at the base case.
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I use a high WACC rate while inflation ((CPI)) data is already trending down to 5% annualized from a peak of 9.1% in June 2022.
If these assumptions prove to be better than imagined, MIPS offers further upside or an additional margin of safety.
For example, if we adjust WACC to 7%, MIPS’s value would increase to SEK 711/share at the base case, implying a 51% upside from today’s price, at which point my purchase price will increase to SEK 550/share, providing 30% margin of safety.
In addition, in my opinion, valuation matters less as we extend the investment horizon. I feel, in the next 1-3 years, MIPS's share price will be sensitive to multiples and industry headlines. But in the next 5-10 years, MIPS’s FCF and ROIC performance will determine its value, an outcome I am rooting for given MIPS’s durable competitive advantages and management’s focus on protecting them.
Sleep Well Investments Scorecard
Let’s see how MIPS fares under my Sleep Well Investments stress test.
It’s a final step in my investment process to filter out only businesses that can perform over multiple economic cycles and continue winning market share. Inspired by Nassim Taleb’s anti-fragile concept , Anthony Deden’s notion about irreplaceability, and studies from various reputable investors, it divides investment criteria into three groups in order of importance:
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Business quality [13 points]
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Competitive position and risks [4 points]
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Valuation [3 points]
I deduct points for an unconvincing corporate mission, commoditized products, intense competition, and high operational risks.
The following table shows how I assess these categories and the corresponding score for MIPS.
No business gets full points, but from 13 points, I rate a business as robust and investable. A score above 15 means the business is anti-fragile, thus, time-tested. A score above 16 points means the business is anti-fragile and durable, which likely helps it thrive over competition and future adversities. Below is how much capital I am comfortable allocating to my portfolio accordingly.
13 = robust business - 1% of the portfolio at cost-basis
15 = antifragile business - 3%
16+ = sleep well business - 5%
Additionally, scoring high doesn’t automatically mean an investment. A quality asset that everyone knows about would often mean a high price. Thus, each stock would need to have a price below the bear case scenario and provide a necessary margin of safety (depending on the type of the business and range of outcomes) - to constitute a good investment. Each to its own, and all method has trade-offs. No investment or checklist is perfect.
MIPS scores 13/20 . It’s a high-quality business with strong upside potential if it meets management's long-term targets.
At ~SEK 500/share, it offers ~15% margin of safety below the base-case scenario, SEK 561/share. I will wait for the price to fall to SEK 430/share to accumulate more shares to make MIPS a 3% position, rising from 1.5%, as I require a 30% margin of safety.
However, I would add more shares at a price as high as SEK 550/share if CPI numbers continue to decline, reducing my WACC to 7% from 8% and increasing my MIPS's fair value to SEK 711/share.
For further details see:
MIPS AB: A Sleep Well Business At A Fair Price