Autonomous driving is not legal in Israel or most of the world. Meanwhile Mobileye, an Israeli maker of autonomous driving chips, has reached an absurd valuation due to hype from an exuberant sell-side. Amidst claims about Mobileye’s “monopoly” on autonomous driving, Jalal Faruki of Dubai-based Suhail Capital decided to go short, and has since reaped a 22% return. Faruki sees competition closing in on Mobileye’s turf in the ADAS (Advanced Driver Assistance Systems) space, and he predicts more downside to come as the market is steered back to reality.
SumZero: What about Mobileye initially caught your attention as a value investor?
Jalal Faruki, Suhail Capital: We’ve paid attention to Mobileye since it listed as we have accumulated a good deal of experience shorting specialty fabless chip companies. That being said, despite trading at 80x sales there were some elements to the name that gave us pause and convinced us it would take considerable work to prove out this seemingly obvious short hypothesis. So we figured we’d give it some time and see what the street would have to say on the name. We also fully expected someone on the buyside with a lot more human capital resources or related automotive supply chain expertise to pick this apart long before we’d be able to get the requisite research done. Amazingly this never happened. Instead, the sell-side just kept getting more and more enamored with the name even as drips and drabs of information started to filter out that cast clear doubt on the monopolistic narrative being put forth by the street. We saw this as an opportunity to come out and clearly articulate this in an investment thesis. Essentially, even if Mobileye owns this market for the next 15 years you will lose 25% of your money long at the current share price, and that this is most likely your ‘dream scenario’ because the evidence points to rapid and intense competition in this space as the market scales.
SumZero: Why do you feel so sure Mobileye is overvalued and doomed to decline?
Jalal Faruki, Suhail Capital: The investment literature around the name is pretty clear; Mobileye’s forward camera monocular approach to ADAS [Advanced Driver Assistance Systems] is superior to everything else in the space, they are leagues ahead of any other potential monocular competitor.
In reality, Mobileye is a small piece of a much larger puzzle which doesn’t support long term monopolistic margins predicted by the sell side. Especially if you know the automotive industry, it’s easy to be highly suspicious of sell-side assumptions that assume a market that is a few million units today is going to look very similar to the market at 30-40 million units. Four of the top five tier one competitors to Mobileye have been investing in their own monocular technologies. Considering these competitors have incumbent positions at OEM’s for billions of dollars in total safety systems, the levers that they can pull are numerous. When combined with how OEM’s notoriously squeeze the supply chain, the multi-source nature of this market is virtually assured.
Then you have competition from chip-land. $100m in annual revenue doesn’t exactly move Freescale, Texas Instruments, NVIDIA, Rensas, Xilinx, Altera, and Toshiba’s needles. However, that all changes as adoption picks up. The unfortunate thing here is as good as Mobileye’s technology has been, this a business where those with billions in R&D at their disposal can catch up in what will seem like a blink of an eye. Now there is no certainty here, but look back over the last 30 years of silicon chip design and find me one company that has ever held margins like are being modeled for Mobileye.
This has more to do with the preposterous financial engineering being employed by the sell-side to drive higher targets than actual business model assumptions. If this is going to be the greatest free cash-flow generator the world has ever seen then why does every sell-side model assume the Israeli Government will tax them at 10% in perpetuity or essentially less than a third of the existing corporate tax rate? Total nonsense, a first year MBA student could probably shred these reports apart after just a week’s worth of work.
SumZero: Is Mobileye still attractive to short at today’s prices?
Jalal Faruki, Suhail Capital: Yes. The stock is an attractive immediate short until it hits $30. Longer-term the downside could be much greater so for a patient investor anything over $50 is a great entry point.
SumZero: What key metrics should investors be paying attention to as your thesis matures?
Jalal Faruki, Suhail Capital: There are several things to focus on going forward:
1) Adoption of competing technologies and providers by manufacturers, whether developed in-house or externally. Tier 1 competitor design wins should become much bigger part of the news flow going forward as well as what is going on in chip-land from a broader competing standpoint. Since we published our report to SumZero, Freescale made the move of acquiring Cognivue to bolster their ADAS chip portfolio.
2) Pressure on Mobileye margins and average selling prices for their chips as competing Tier 1 suppliers and others step in; no ‘monopoly’ with 50%+ net margins is sustainable especially in the cutthroat automotive supply chain.
3) Significant disconnect between what Mobileye does and applications/opportunities for them in ‘Autonomous Driving’ cars. Mobileye has been caught up in the hype, and to an extent is playing into it themselves. A better understanding of what will be deemed semi-autonomous/autonomous and the tech driving it versus the components accomplishing certain elements would help.
4) More information on the regulatory timetable for Automatic Emergency Braking (AEB) as well as more clarity on what the mix of radar and radar/camera fused AEB will make up the mass market and what role Mobileye-like camera only systems will play. Will Mobileye remain focused on high end automobile launches like Tesla, or move to a mass market?
SumZero: Was execution difficult given that this is a short?
Jalal Faruki, Suhail Capital: No, the stock was easy and reasonably priced to borrow. In contrast to some of our other shorts that were focused on niche industries such as Healthcare IT (Veeva Systems or Medidata Solutions), Mobileye has been a darling long of the hedge fund, momentum and active trader community which made it an easy position to build as the stock regularly trades sufficient volume on a daily basis.
SumZero: What were the biggest risks associated with the trade in your view?
Jalal Faruki, Suhail Capital: Over a reasonable investing frame we saw almost no risk, which made our argument so compelling. In the short term there was obviously the risk of the company announcing some new customers wins, though based on our extensive due diligence this was actually no longer much of a risk as they have done so well so far and essentially there was nothing really left for them to announce OEM-wise. You also have ludicrous analyst upgrades like the one we saw from Morgan Stanley a day before we published our report. However in our view both these short term scenarios would just provide a better opportunity to add to a short position which we aimed to build as aggressively as possible over $60.
SumZero: Is this thesis representative of the Jalal Faruki and Suhail Capital investing style?
Jalal Faruki, Suhail Capital: Mobileye has been our highest conviction position since Veeva Systems which we initially published on in December 2013. The more we worked on this report, the more compelling it became and at many points in time we believed we may be missing something as the gap between their market opportunity and implied valuation based on where it was trading simply couldn’t be so large. To answer the question, yes, this is in our view a great example of what we perceive as one of our best opportunities. A heads you win tails you win type of short on a company that is executing extremely well..
SumZero: Where else do you see value in the market today?
Jalal Faruki, Suhail Capital: We think a better question is where we don’t! Our bias has been largely to the short side over the past 12 months, and increasingly so since May of 2015. We have taken advantage of some long opportunities in the commodity/energy space but the pace of movement there makes it difficult to pin-down specific ideas yet, and you essentially need to be comfortable with horrible fundamentals. The recent volatility has hit what’s worked for the past two years the hardest, and that was largely chips, pharma, and healthcare stocks. One sector where we see fundamentals moving in the other direction but stocks still generally performing great has been the restaurant industry. This space has had a bubbly feel to it for quite some time, and while some one off shorts have worked here like El Pollo Loco and Pot Belly, the broader group looks awfully stretched valuation wise. A basket short here is worth exploring.
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