Mobileye: $11B Valuation Has Zero Basis In Reality, 60%-Plus Downside Ahead
seekingalpha.com
Summary- MBLY designs chips and software for Advanced Driver Assistance Systems (forward collision warning, pedestrian detection, etc.).
- If the company captured 100% of the world total addressable market, it would still be trading at 2x sales and 10x earnings.
- The recent $100 upside price target by Ravi Shanker at Morgan Stanley is completely disconnected from anything plausible.
- The company is over-earning due to first-mover advantage in a new industry. It currently has 80% market share and 74% gross margins.
- The company is a poster child for tech overvaluation in the current day and could be the most overvalued stock on the market. It currently trades at nearly 100x sales.
Mobileye (NYSE: MBLY) is an Israeli designer of camera-based Advanced Driver Assistance Systems (ADAS). The company shipped its first units in 2007 and has been growing extremely rapidly since then.
From the F-1 (S-1 equivalent for foreign filers):
We estimate that our products were installed in approximately 3.3 million vehicles worldwide through March 31, 2014. By the end of 2014, our technology will be available in 160 car models from 18 original equipment manufacturers (OEMs) worldwide. Further, our products have been selected for implementation in serial production of 237 car models from 20 OEMs by 2016.
Source: Created by author.
The company either has or will have its product in production vehicles of most of the large global OEMs. The company derives 78% of revenue from these OEM sales with the remaining 22% coming from aftermarket sales. The system shipped to OEMs consists of a chip and attached software that the OEM can incorporate when building the car. The aftermarket sales consist of a dash-mounted warning system, which is significantly more expensive.
Mobileye OEMs:
(click to enlarge) 
Source: Mobileye F-1.
Although the Mobileye product is extremely innovative, the company trades at 2x world-total addressable market (TAM) for its product. Furthermore, the company currently has an 80% market share and 75% gross margins, both of which should deteriorate over time as competition enters the space. Under optimistic assumptions, the company should be worth, at best, 40% of its current valuation.
Poster Child for Crazy ValuationsIn order to judge whether this company is overvalued, let's take a look at what would happen if their product were installed in every single car sold in 2013 worldwide. According to CNBC, 82.3 million cars were sold worldwide in 2013 -- the most ever. Mobileye shipped 1.4m units and brought in $81.2m in revenue, or $58/unit.
Source: Created by author.
If they were to have placed their units on all 82.3m cars, total revenue for the company would have been $4.8B. This means that their current market cap of $11.1B is two times the revenue they would make if they had 100% of the world total addressable market:
Source: Created by author.
Assuming competition in the space drives down net margins to 20% over the long run (which is still 2x what other car-parts manufacturers make), this means the company is trading at around 12x earnings. That's assuming they are able to capture 100% of the world TAM, which is clearly an absurd assumption.
Unfortunately, the adventure into fantasy land doesn't stop there. In the Sept. 3, 2014, note "How MBLY Can Be a $100 Stock," Morgan Stanley analyst Ravi Shanker puts a $100 upside price target on the stock. In his base case of $49/share, Shanker pegs both long-term net margins and market share at around 50%. For context, of the 6105 U.S.-listed stocks, only 24 non-financial ( three technology) companies have 50% net margins.
The $100 upside price target represents a market cap of $23.1B, a world sales multiple of 4.8x, and a world net income multiple of somewhere around 20x. It would also make Mobileye one of the largest car parts manufacturers in the world. Again, this is assuming that they have 100% market share going forward. If market share deteriorates, the assumptions get even more ridiculous.
Source: Created by author.
In addition to that, the assumptions in their base case 15-year DCF single-handedly disprove the stereotype that investment banks are not creative.
Assumptions:
| | | | Risk Free Rate
| 4.00%
| Levered Beta
| 1.4
| Unlevered Beta
| 1.1
| Market Premium
| 5.50%
| Cost of Equity
| 10.30%
| Cost of Debt
| 10.00%
| Equity/Capital
| 80%
| Debt/Capital
| 20%
| Tax Rate
| 10%
| WACC
| 10%
| Terminal Growth
| 5%
|
Source: Created by author.
Their DCF yields the following free cash flows and present values (these are directly from the MS note):
Doing the simple present value addition results in the following share price:
Source: Created by author.
However, having a terminal growth rate of 5% per year is not logical, as the economy only grows at between 2% and 3% per year. If the company were able to grow at 5% in perpetuity, it would eventually become the entire economy! By not changing Morgan Stanley's original assumptions for the ongoing business (which, as mentioned above, are exceedingly unlikely) and simply changing the terminal value to 2% we get the following:
Source: Created by author.
This translates to a stock price of $37.40:
Source: Created by author.
Simply by adjusting the terminal value to something realistic, we have 20% downside compared to the current share price. This is still assuming that net margins and market share stay above 50% over the long run, an assumption that is almost definitely false and will be discussed later.
Correct ValuationAssuming that over the long run the company can capture 30% of the total world addressable market and maintain net margins in the 20% range (both huge assumptions considering they currently have less than 2% of the TAM and most car parts manufacturers have single-digit margins), we can create a more realistic valuation scenario. The assigned multiple represents a company growing in accordance with global car demand (2%-3% per year):
Source: Created by author.
This represents 61% downside to the current price realistically optimistic assumptions. I'll leave it up to the reader to do the math and come up with his or her own price target.
Bull ArgumentThe bulls on this story claim three factors justify the current valuation. First, they claim that the company's product has applications beyond car safety. Second, they will also claim that the company can become a major player in the autonomous car space and therefore the total addressable market is closer to $30b rather than $5b. Third, they claim that the company has an insurmountable lead in the space and will be able to maintain 50%+ market share and 50%+ net margins for decades, as assumed in the Morgan Stanley report.
Argument 1: "The product has applications beyond car safety."The first argument contains the following flaw: The self-proclaimed competitive advantage that the company has is that they have more data for their algorithms than anyone else. From the F-1: "Mobileye's more than 15 years of research and development and data collected from millions of miles of driving experience give us a significant technological lead."
Clearly, data collected through driving experience is not applicable for broader use of the technology outside of driving. Therefore, if the company is able to expand product lines beyond car technology, they will not have the same competitive advantage that they do on the road. Competition will be fierce and, without a first-mover advantage, they will not be able to generate the same kind of profitability that they do currently.
Argument 2: "Mobileye will be a major player in the autonomous car space."The second argument that the company can expand their technology into driverless cars faces a similar rebuttal to the first. Not only will the company be competing with some of the largest names in the tech and car space (Google, Mercedes Benz, etc.), many of whom already have viable autonomous technologies, but the company does not appear close to developing such technology. Also from the F-1: "We are still in early development of our next generation self-driving features (namely, our country road capabilities and city traffic capabilities), which will require significant algorithmic innovation by us."
There is very little doubt that Mobileye's technology will be utilized in self-driving cars. However, there is a good chance that it remains a similar product to what it is today: a great safety feature, rather than an entire system of driving autonomy.
Argument 3: "Mobileye has sustainable first-mover advantage."The third argument, regarding lack of competition, is equally flawed, as the analysts at Dougherty & Company point out in their initiating coverage report from Aug. 19, 2014. On page 6 of their report, they outline competitors, stating that: "Bosch's 'automated driving' project team formed in 2011 … Volkar Denner, chairman of the Bosch board of management, said that Bosch should be generating $1.3B in sales in driver assistance systems by 2016. Continental AG's ADAS business unit was created in 2012 and now employs more than 1,000 people, including about 400 engineers."
Clearly, major car part manufacturers have noticed the potential opportunity in the ADAS market and, although Mobileye does have a distinct first-mover advantage, it only is a matter of time before they need to drop pricing in order to maintain market share (and will eventually lose market share absolutely). To think that a technologically advanced car-parts manufacturer can maintain 50% market share and 50% net margins in the face of major competition is implausible. As mentioned above, less than 0.3% of non-financial companies have 50% net margins and only two auto parts manufacturers have net margins above 20%.
ConclusionIt is beyond belief that a rational person is willing to pay 100x sales for a company whose market cap is twice the TAM and will be facing significant competition in the next few years. The company, under optimistic assumptions, faces 60% downside. However, it may take a long time for this company to realize its true value and significant losses may occur in the short term. Two times a silly valuation is still a silly valuation. |
