Mobileye - Great Product, Great Business, Non-Compelling Investment Opportunity

| About: Mobileye (MBLY)

Summary

Mobileye has seen a hugely successful public offering despite continued tensions in the Middle-East.

The company's solutions are very appealing, as the company reports accelerating growth and is actually profitable.

Yet the current valuation relies on a lot of optimistic assumptions going forwards, limiting the risk/reward opportunity in my eyes.

Mobileye (NYSE:MBLY) designs and develops technologies for camera-based Advanced Driver Assistance Systems, also known as ¨ADAS¨. These solutions are aimed to keep passengers safe, reduce the risks of traffic accidents and enable autonomous driving.

The company's products are very cool and are adopted by the world's largest original end manufacturers. Yet despite the only accelerating growth and profitable operations, I find the current risk-reward opportunity very limited with operating assets being valued at a whopping $7.5 billion.

The Public Offering

Mobileye is a company based in Israel focusing on technologies which allow camera-based ADAS. The company has developed software and the EyeQ chips which allow for the interpretation of the visual field to identify obstacles.

The first solutions being developed by the company were included in cars back in 2007. By now some 3.3 million vehicles across the globe are fitted with the company's solutions. By the end of this year, the company aims to supply 18 OEMs for some 160 car models in total. The company stresses the dominance of the company in the field, having provided its services in 80% of the cases in which it was asked to submit a quotation.

With the solutions, the company aims to benefit from two major trends. For starters is the quest for safety which pushes the exponential growth of the ADAS solutions while the focus on autonomous driving is very helpful as well, especially going forwards.

Mobileye sold 35.6 million shares for $25 apiece, thereby raising $890 million in gross proceeds. Some 8.3 million shares are sold by the company which therefore will raise $208 million in gross proceeds while the remainder of the proceeds will benefit selling shareholders.

Shares were offered above the high end of the preliminary offering range of $21-$23 per share. At the public offering price of $25, with some 212.3 million shares outstanding, shares are valued at $5.3 billion.

Banks which aided the company in its process to become a public firm were Goldman Sachs, Morgan Stanley, Deutsche Bank, Barclays, Citigroup, Wells Fargo, Baird, William Blair and Raymond James.

Valuation

As discussed above, Mobileye's solutions are in great demand as they increase both the safety of driving while also enable further progress in autonomous driving. No wonder that some of the most prominent original end manufacturers are using the company's products including the likes of Audi, BMW, Chrysler, Ford (NYSE:F), GM (NYSE:GM) and even Tesla Motors (NASDAQ:TSLA).

The company likes to point out that its solutions aid in safer driving, a huge opportunity to solve. Following a World Health Organization report dating from 2010 there are some 1.2 million deaths per year around the globe being linked to car accidents. The cost savings of preventing just a small percentage of all accidents in terms of economical and human costs can quickly outweigh the cost of an advanced camera. Other benefits are the strong tie-ups with all the Tier-1 manufacturers, the scalable business model and design of its own cost-effective EyeQ microchip.

For the year of 2013, Mobileye posted sales of $81.2 million which is up by 101.7% compared to last year. Technically the company posted a $226.0 million loss versus a break-even result the year before, but this loss was due to benefits for certain participating shareholders.

The company's real profitability was a $17.6 million profit before tax numbers, with the net income line coming in at $20 million thanks to modest tax benefits instead a tax provisions.

Revenue trends for the first quarter of this year are even more encouraging. Total revenues more than tripled towards $35.6 million which does make a sizable impact given that the business reports gross margins of over 75%. Losses rose sharply from $2.6 million towards $19.6 million as general and administrative expenses increased by a factor of 13 to $30.9 million.

Before the offering took place, Mobileye held nearly $130 million in cash and equivalents while it does not have debt outstanding. Following the $208 million in gross proceeds from the offering, and Mobileye will operate with a net cash position of little over $300 million.

Trading at $37 per share with 212 million shares outstanding, Mobileye is valued at little over $7.8 billion. After backing out the net cash position of the firm operating assets are valued closed to $7.5 billion. This in its turn values the company at little over 90 times annual revenues, not earnings, being achieved in 2013. Yet if I multiply the first quarter revenue run rate by a factor of 4, this multiple comes down towards 50 times.

Investment Thesis

As noted above, the public offering of Mobileye has been a huge success. Shares were sold above the high end of the preliminary offering range. Shares ended their first day trading at $37 per share, trading some 68.2% above the midpoint of the preliminary offering range.

Like many smaller and emerging companies, Mobileye faces a particular set of risks. Of its 404 employees, some 325 work in R&D and they work predominantly in Israel which poses some real risks given the current geo-political situation. Other risks are the reliance on its current technology, making the company vulnerable for a shift in technologies being used. Mobileye currently basis its camera's on the so-called monocular technologies.

For its EyeQ chips, the company relies on chip manufacturer STMicroelectronics (NYSE:STM). Another big reliance for the company is of course its founding members and key staff. The enforcement of IP rights around the globe is challenging and costly too, and last is of course the excessive customer concentration. General Motors was good for 29% of total sales in 2013, while Honda represented another 25% of total sales for that year.

Don't look too much in the reported first quarter loss as that is an incidental, yet focus on the growth. The growth acceleration is impressive as total sales roughly tripled. As a matter of fact in 2013, first quarter sales appeared to be seasonally weak as they fell compared to the fourth quarter of the year before, something which did not happen this year. More importantly, fourth quarter operating income of 2013 already came in at $10 million, showing some of the real leverage of the business model with operating margins of over 30%.

Further growth could very well be anticipated given the strong position, and new product developments which could allow for hands-free driving as soon as 2016. The company unfortunately did not specify its average-selling price as far as I could tell. Given that cumulative revenues between 2011 and the first quarter of this year totaled about $175 million, this implies an average selling price of around $60. This is based on the assumption of roughly 2.7 million camera shipments over this period versus the 3.3 million to date shipments of its products.

A simple Statista report indicates that the global automotive market could reach the size of about 72 million vehicles in 2014, so let's peg the potential very best market opportunity at about 100 million vehicles across the globe including buses, trucks and vans.

In such a scenario a potential $5-$6 billion market opportunity exists given equal selling prices and that all newly sold vehicles would be equipped with such a camera. Assuming no competition and healthy margins of 30% on an operating basis, this could result in operating earnings of $2 billion, leaving some real upside to the current valuation.

This scenario is not very realistic however. If I am a bit more conservative and would use a 25% adoption rate three year's ahead in time and a 50% market share to account for potential competition, I would end up with estimated revenues of $750 million. This could translate into operating earnings of $250 million, still valuing the company at about 30 times operating earnings.

You get the point, unless the company hits an absolute home-run, there is little appeal in my eyes at current levels.

Disclosure: The author is long F. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.