2023-12-18 18:35:20 ET
Summary
- Abu Dhabi's CYVN Holdings will invest $2.2 billion in NIO Inc., easing cash crunch fears.
- The deal gives NIO around three quarters of a year in additional time until its cash position runs out.
- The investment indicates management's willingness to sell shares at a low price, potentially signaling that NIO is trading ahead of fair value.
Article Thesis
NIO Inc. ( NIO )( OTCPK:NIOIF ) is getting a multi-billion dollar investment from Abu Dhabi's CYVN. This is great news for the company on an operational basis as it reduces the risk of capital running out substantially. But on the other hand, this causes significant dilution, and management's willingness to sell shares at a rather low price might indicate that NIO is trading ahead of fair value today.
What Happened?
Chinese EV player NIO announced that CYVN Holdings, which is an investor based in Abu Dhabi, UAE, will spend $2.2 billion of cash to acquire 294 million shares of NIO in a deal that values NIO's shares at $7.50. Shares reacted positively to this announcement- at the time of writing, NIO is trading up 5% compared to the previous closing price.
Past Coverage
I have covered NIO several times in the past, mostly giving the company a Hold/Neutral rating due to the fact that the company has potential in the growth market it's active in, but since NIO also can't be described as low risk. There are execution risks, financial risks, and since NIO is based in China, there also are political and geopolitical risks investors should keep an eye on.
I last wrote an article on NIO in September, giving the company a Neutral rating. Since then, over close to three months, NIO has essentially been flat. In this report, I will look at what the deal with CYVN means for NIO - when it comes to the opportunities for faster investment and also when it comes to the risk of ongoing dilution.
CYVN Investment Eases Cash Crunch Fears
Many startup companies and young companies are not profitable yet, and due to heavy investments in capacity expansion, their cash flow picture oftentimes looks even worse compared to net profits. This also is the case with NIO and most other electric vehicle pure plays that have emerged over the last couple of years - including Rivian ( RIVN ), Lucid ( LCID ), and many more. Tesla ( TSLA ) is profitable, but even Tesla does not generate especially high free cash flows, at less than $4 billion over the last year, which makes for a free cash flow yield of less than 0.5%.
NIO, like most of its peers, is burning cash on an operational basis, i.e. even before accounting for new investments (capital expenditures). Over the last year, NIO's operating cash burn totaled $1.9 billion, somewhat better than the reported net loss of $2.9 billion. But after accounting for $1.2 billion of capital expenditures, the free cash flow number stood at -$3.1 billion. Some competitors burned even more cash, but NIO undoubtedly can't go on like this forever before eventually running out of balance sheet capacity.
The automobile industry is capital intensive, as inventories, parts, finished vehicles that have not yet been sold, and so on need to be financed. On top of that, the electric vehicle industry is very competitive as more and more players are entering the industry, which forces more and more of these companies to lower their prices in order to protect and maintain their market share.
In a situation like this, it's unlikely that NIO will stop burning cash in the very near term. Eventually, the company should get into a position where it can self-fund its future growth, like Tesla, but NIO is not there yet. At the end of the most recent quarter, NIO's cash and short-term investments totaled a little more than $5 billion - when the company keeps burning more than $3 billion per year, that will not last forever, but for less than two years. This does not mean that NIO was in grave danger, but NIO was in a position where it was forced to access new capital in the not-too-distant future.
The deal with CYVN, which will give NIO $2.2 billion of additional capital, gives NIO around three quarters of a year in additional time until its cash position runs out, assuming the cash burn rate remains at the current level for the foreseeable future. Almost an additional year of funding is great news for NIO from an operational viewpoint - the company can now continue to spend for growth, e.g. by expanding its manufacturing capacity, by building new stores and battery swapping stations, and so on.
This is, I believe, the main reason NIO's shares reacted positively to the announcement of the deal with CYVN, although one also can argue for another positive factor. CYVN is a major investor from an oil-rich country, and it's likely that the employees of CYVN have taken a very in-depth look at NIO. When they decided to invest more than $2 billion in the company, they most likely liked what they saw when delving into the details. They also likely liked what they heard when they talked to NIO's management about a potential deal. Of course, it's possible that Abu Dhabi's CYVN decided to invest heavily in an EV company solely due to the fact that Saudi Arabia, one of Abu Dhabi's neighbors, invested heavily in Lucid, but I believe that this is an unlikely explanation. The more likely explanation, I believe, is that CYVN wanted to put billions into NIO due to liking the company's potential in the growing EV market - and with NIO's unique selling point of offering battery swaps, the company has potential for sure, although there were some execution problems and a less-than-great growth rate in the past.
CYVN Deal Highlights Dilution Risk
While the deal is great for NIO's balance sheet, and while the huge investment by a major investor can be seen as an important "vote of confidence," the deal also highlights the risk of ongoing dilution.
Assuming NIO is able to scale up its business relatively efficiently going forward and that NIO becomes a major player in the electric vehicle industry, the value of the company should grow substantially over the next few years. But if NIO has to issue a huge number of shares over the years, then current investors will not necessarily participate a lot in the rising value of NIO on a company-wide basis. After all, for an investor, the most important question isn't how the value of the company changes, but rather, how the value of the investors' shares changes over time. If NIO's value were to double, but the share count doubles as well, then shareholders would not see any return on investment, as the value of each share would stay unchanged despite the company becoming a lot more valuable over time. Of course, the contrary can be true as well - if a company's share count keeps declining, then investors will see a higher return compared to the change in the value of the entire company.
In the above chart, we see that NIO's share count has risen by around 80% over the last couple of years. When we account for the new deal with CYVN, which will see the share count climb by another 294 million shares, then NIO's share count will be more than twice as high compared to around five years ago. Dilution should be less pronounced in the coming years, I believe, but dilution will most likely continue - due to shares being issued to employees and NIO's management, and due to further equity raises (or convertible debt raises) being likely, as it will take time for NIO to be able to fully self-fund.
So while the deal with CYVN is good news for everyone who was worried about the company's cash burn rate, the easing of that fear goes hand in hand with the fact that each share's portion of the entire company will decline meaningfully - by around 15% due to the CYVN deal alone. Future equity placements would cause additional dilution, of course. While that doesn't mean that NIO must be a bad investment, the ongoing dilution is a factor that should not be ignored. Opting for a company that's profitable and where dilution is less pronounced is a way to avoid the hefty dilution headwinds NIO and many other unprofitable EV players are facing.
Takeaway
There are good and bad things to say about NIO: The battery swapping tech is a nice USP, the brand is solid, and the vehicles are high quality. On the other hand, growth hasn't been great for an EV player, the cash burn rate is quite high, and NIO has had more execution problems than some other EV players (although NIO hasn't been the worst by far). The deal with CYVN has advantages and disadvantages as well - it bolsters NIO's cash position and is a nice endorsement, but the deal also causes significant dilution. Overall, I remain neutral on NIO.
For further details see:
NIO: Abu Dhabi Steps In