General Motors (NYSE:GM) unveiled its first production-ready driverless car in San Francisco earlier this year. The Cruise Origin is the result of decades of work and billions in investment the automotive giant has been making behind the scenes, while the rest of the world was distracted by Elon Musk’s (Tesla (TSLA)) endless adventures.
After reading the reviews and seeing all the demonstrations, I must admit GM’s pet project is a sleek and exciting look at the future of transport. I love the way this car looks and what it implies about the way we’ll all move around in the future. But, most of all, I love the valuation it comes with.
Exciting and valuable technologies packaged in mundane and overlooked businesses is my favorite sort of investment opportunity. At this stage of the market cycle, finding a reasonably-priced tech company is about as rare as a Loch Ness sighting. Which is why GM’s Cruise division has me as excited as that time I realized Yahoo held a 40% stake in Alibaba before its IPO.
I was excited enough to take a deep dive into GM’s books back in February 2019. The company already is ahead of the pack when it comes to autonomous miles driven in the U.S., has attracted major talent from the Valley in recent years and is valued at $19 billion, which could expand rapidly in the years ahead based on the estimated market size.
Now that the product has been unveiled and the reviews are in, it’s time for an update and a closer look at GM's underlying numbers that justify its shift to autonomous driving and why I believe Cruise could unlock a lot more wealth for investors as a standalone firm.
Wall Street's Dream
Turns out I'm not the only one who believes Cruise could deliver more value as a standalone firm. Morgan Stanley's Adam Jonas has been pushing GM's management for spin off since 2017. Bloomberg reported the company was considering such a move in 2018. Later, they rejected Greenlight Capital's David Einhorn's proposal to split GM's stock into two classes: One for dividends from the core business and one for growth from the tech startup segment.
Considering the enthusiasm for such a move, Business Insider's Matthew DeBord has described the potential spin-off as "Wall Street's dream."
However, GM has been reluctant to actually go ahead with the plan. Kyle Vogt, Cruise’s chief technology officer, said the Cruise division already was attracting the capital it needed without being spun off and developing the technology with GM's support was easier.
I believe both reasons are about to fall apart if the economy plunges in 2020 (more on that later). But first, let's take a closer look at Cruise's potential.
Calculating the value of a subsidiary business unit is usually very imprecise and complicated. Fortunately for us, GM’s Cruise raised a funding round just last year and publicly acknowledged its market value in the process.
Global asset management firm T. Rowe Price Associates, along with existing partners GM, Honda (HMC), and the Softbank Vision Fund (OTCPK:SFTBY), collectively deployed $1.5 billion into the tech startup in mid-2019, raising its market value to $19 billion. For context, GM’s current market capitalization is $42.6 billion, which means Cruise is worth nearly half of its parent’s value.
Of course, like any other startup, Cruise’s valuation is expected to expand rapidly. Self-driving and vehicle automation is a market that experts estimate could be worth $556.67 billion by 2026 with a compound annual growth rate of 39.47% until then.
Meanwhile, partnering with a ride-sharing firm or launching an independent ride-hailing app could unlock the robotaxi market for Cruise vehicles. The market for autonomous ridesharing is estimated to be worth more than $2 trillion when the technology becomes viable and safe enough for mainstream adoption, according to research by UBS (UBSG).
Cruise already is a leader in the space, according to Navigent. If the Cruise team can manage to capture just 10% of the overall market within the next decade, it could easily be worth more than GM’s current $42 billion market cap.
While the mainstream consumer seems prepared for an autonomous future (21% of respondents to a Brookings survey conveyed interest in the technology), the technology could be decades away from being anywhere close to viable.
“It’s going to be around that decade-plus before that is going to be an option for consumers to purchase a self-driving vehicle,” said Kristin Kolodge, executive director, driver interaction and human machine interface research at J.D. Power, told CNBC last year.
The problem is, GM may not have that much time or resources to keep this ambitious project going.
I have no doubt that GM’s Cruise is an underappreciated gem that investors haven’t fully priced into the stock yet. Nevertheless, investors need to weigh the strength of the rest of the business to ensure that this unique opportunity isn’t squandered by a declining parent.
At the start of the year, the core business seemed as strong as ever and was well positioned for better cash flows. Analysts estimated the company could earn $6.36 per share in 2020, while its stock trades at just $29.6 at the moment, implying a forward price-to-earnings ratio of 4.65.
Now, however, the lock-down in China has created a supply-chain issue while the number of vehicles sold in the country has fallen off a cliff. Passenger car sales tumbled 92% in February alone and I wouldn't expect the supply chain to regain normalcy until later this year.
GM was on track to generate $10 billion in free cash flow this year, but that seems less likely now.
Meanwhile, the company’s $100 billion debt load is more than double the value of its underlying equity, which is another reason investors remain skeptical about the stock. A sudden global recession or a spike in corporate interest rates could plunge the firm into trouble yet again.
In my opinion, if the economic cycle turns against GM, the company may be inclined to sell its underlying assets or list them publicly to tackle its debt burden. As a standalone business Cruise could finally be valued as the innovative tech startup that it is.
The Cruise division accounted for nearly $1 billion in adjusted-EBIT losses last year. That hefty sum would have been sustainable if the core business picked up in 2020, but that seems unlikely now.
Source: GM Corporate Earnings report Q4 2019
The tougher the market gets for GM's legacy business in 2020, the likelier it is that Cruise is either acquired by a private equity shop, sold to a tech giant or spun off. All three scenarios would unlock value for shareholders and potential investors who believe in the future of autonomous driving.
If you believe the stock has priced in GM's near-term challenges, it could serve as the perfect proxy for the future of personal transport. However, risk-averse investors may want to wait on the fence and see what happens to the Cruise division before taking any long-term bets.
This idea was first discussed (in much greater detail) with members of my private investing community, Betting on Tomorrow . To get an exclusive ‘first look’ at my best ideas, subscribe today >>