RedBlue Newsletter: 19May22

Date
May 19, 2022

A concise yet comprehensive picture into all things mobility

Podcast: The Auto Analyst Series

Episode 1: Philippe Houchois, Managing Director at Jefferies

We’re launching a podcast - the Automotive Analyst Series. Each episode opens the floor to an equity analyst covering the space. Beyond the latest earnings, we dive into the narratives & frameworks to understand where and why the industry is moving.

You can listen on Spotify & Apple as well

For our inaugural episode of the series, we speak with Philippe Houchois, Managing Director at Jefferies and head of their automotive coverage. Philippe is known as one of the earliest major analyst to put a bold “buy” rating on Tesla. We dive into:

  • His view on the unique strengths of Sergio Marchionne, who led a dramatic turnaround of the Italian industrial giant Fiat
  • How a tour of the Tesla factory in 2018 led him to see early signs that Tesla would have strong, defensible margins - despite the fact they were assembling cars in a tent
  • How EVs create simplification - and how that counterintuitively creates new problems for OEMs!

Commentary

You can listen to a short discussion between RedBlue Partners Olaf & Prescott about the themes in this newsletter here:

You can listen on Spotify & Apple as well

Blood on the trading floor

  • The markets have been taking a beating. This is especially true for fast growing tech stocks with companies like Netflix down 69% and Meta down 40% since the start of the year. The SKYU ticker, which is an index of tech stocks, gives a sense of the depth of the rout: it’s down more than 60% this year.
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  • Two macro factors can be pointed to in explaining the carnage: a) inflation, rate hikes and the risk of recession, creating a sense that consumer spending is in the process of slowing down significantly and b) a faster than expected rebound to the way the world was pre-pandy 🐼 (a fun way to say Covid-19, because we all need more fun right now). This means consumers are moving back to brick and mortar and not necessarily buying everything online.
  • This shift and the associated pain can be seen most clearly in the digital retail channel hardest to replace virtually: the process of buying a car. The disruptors in this space have crumpled: Carvana is down a staggering 84%, Vroom is down 93% and UK competitor Cazoo is down 80% (link). More traditional vehicle retailers have sought to position themselves to hire some of the talent these disruptors are bleeding through LinkedIn messages and videos.
  • SPACs in particular have taken a hammering, even ahead of the current market turmoil. This article from Crunchbase highlights that 75% of SPACs (many of which came out of the autotech segment) are trading 60% down or more, comparing their performance to plumbing the depths of the Mariana Trench (link). Several of the companies that boarded the SPAC train were Israeli tech startups and the pain is acute. A recent article in Israel’s business journal Calcalist noted that half of Israeli companies that went public recently (a third of which are directly in the mobility space) are trading at close to zero enterprise value, meaning that market doesn’t see long term value in these businesses (link in Hebrew).
    • An important caveat: we were in board rooms where decisions were being made about going public via SPAC (which to insiders were clearly overhyped). The advantage of choosing this option was access to cheap capital and many of these companies still sit on large cash reserves, giving them time to prove the market wrong.

Uber & Lyft: a tale of two companies

Lyft’s Q1 earnings this month tanked the stock 30% in the hours after the call. The concern became contagion, dragging Uber down even before Uber’s earnings were announced. Dipping 10%, Dara rushed news to market as if to say “hold on - we’re not Lyft!” and made the rare decision to move up earnings by a day.

It worked - while Lyft remained in the gutter, Uber turned its decline around and finished off down only a few percentage points from the days prior.But why? Lyft reported a nearly $200M loss, and Uber reported a nearly $6B loss. Isn’t that worse? It certainly fed Uber naysayers.

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But why? Lyft reported a nearly $200M loss, and Uber reported a nearly $6B loss. Isn’t that worse? It certainly fed Uber naysayers.

But that $6B loss masks the real story. Let’s separate operational profit (which many tech companies call “adjusted EBITDA”) versus true profitability (generating free cash flow).

Actually, Uber is already sort of profitable

Operational profit is a question of “can Uber make more money than it spends on rides, food delivery & freight?” By successfully hitting positive adjusted EBITDA semi-regularly, Uber is now showing that this is in fact the case, and it’s how they claim “operational profitability.”

Q1 was a show of great strength for Uber’s core businesses. Food and grocery delivery kept drivers earning throughout the pandemic, priming Uber for the surge in riders we’re seeing today. CEO Dara calls this the “power of the platform.” Drivers are plentiful and getting a lot of gigs on Uber, giving Uber the breathing room to cut back on bonuses and incentives, yielding operational profitability. It is beginning to seem like Uber’s scale flywheel is spinning without help.

Understanding the $6B net income loss

On top of that operational business though, you have a lot of other heavy areas of spend. Uber previously invested a lot of resources into new market expansion (yielding a major ownership chunk of China’s Didi) and introducing new products (yielding a major chunk of autonomy leader Aurora). Recently, DiDi was slammed by China’s tech crackdown, and Aurora stock is down as well. Almost 95% of Uber’s Q1 “losses” were simply writedowns of these holdings. Those aren’t cash losses today, nor do they threaten the viability of Uber’s (increasingly profitable) operating businesses.

Back to Lyft

As Lyft didn’t have a delivery offering, its driver base shrunk a lot during COVID. Lyft had to spend heavily on incentives to get them back - and signaled it will probably need to continue doing so. That’s a big problem that triggered the stock selloff. Lyft’s marketplace flywheel is in need of more nudging. And while Uber’s mega projects (China, autonomy, flying cars) might be falling apart, its core business is a flywheel that’s ... flying (and remember that Uber’s ridehail business is much bigger AND growing top-line much faster than Lyft’s). Lyft’s picture isn’t great.

As much as it would seem that these marketplaces are commoditized for drivers and riders, Harry the Rideshare Guy told me recently that in LA Uber drivers are averaging over $30/hr, with top drivers hitting $60/hr. In contrast, Lyft drivers have lower density meaning the network has long ETAs and a lot of cancellations, making things worse for both drivers and riders.

Newspeak

OK: Operational profitability isn’t real profitability though. Ridehailing company accounting is complicated (see this for a taste) and companies have long leaned on accounting and linguistic ambiguity to mask their losses to investors. When markets were kinder, they could get away with it. But in the height of the current tempest, Dara sent an urgent email to all employees.

Breaking rank with most tech CEOs, Dara didn't wax poetic about Uber's transformative vision. He cut straight to what most big tech CEOs ignore: what investors demand. And the message was clear - not just growth, operational breakeven, "adjusted EBITDA" profitability...

The message: Uber is going to generate free cash flows.

Dara’s forecasts are finally clear: $300M in FCF this year, and $1.8B in 2023. If Q4 looks the way they are (finally) guiding, Uber won’t just be the company famous for buying growth. It will also be the first company to take ridehailing into the next stage of its life: sustainability.

Passenger EV race

  • Tesla is the leader of the race to roll out electric vehicles in the passenger vehicle market. It was first to reach meaningful electric vehicle production scale and has clear brand advantages too, but the most important (as highlighted by Philippe Houchois in our podcast episode) is that it has a fundamentally lower cost of production, allowing it to generate large amounts of cash to reinvest in its business. Its strong performance in the public markets (although down 35% this year) has amplified this advantage by making it cheaper to raise more money. Every other carmaker right now is racing to catch up:
    • Production pressure: VW is struggling to produce EVs fast enough to meet demand with ferocious lockdowns in China (link) restricting manufacturing, and war in Ukraine slowing down the supply chain (particularly for wiring harnesses) in the two largest EV markets in the world. VW is Tesla’s best positioned competitor, delivering just shy of 100K vehicles in Q1, although this is still less than a third as many vehicles as Tesla delivered in that same quarter (link). Supply chain pressure is also forcing Lucid, Rivian and Tesla to raise prices for their EVs (link).
    • Restructuring: Ford is splitting its gas-powered and EV businesses. While both divisions will stay within Ford, the legacy business feeding capital to the EV one, the overhaul is an acknowledgement of the ways in which making EVs is significantly different than traditional vehicles, and requires dedicated focus (link). To that end, Ford is trying to squeeze costs out of its EV manufacturing, setting up a task force “dedicated to lowering the bill of materials for its battery-electric vehicles” (link). An additional $20B is also being allocated by Ford to EVs over the next five to ten years, bringing the total allocation to around $50B (link).
    • Partnerships: GM hopes that making EVs that are significantly cheaper than Tesla’s will allow it to capture a larger portion of the market (link). Honda is partnering with GM to use their Ultium EV platform which will allow cost savings through increased scale and co-investment (link). Meanwhile, Honda also announced a partnership to manufacture vehicles starting in 2025 in partnership with Sony, which has been teasing concept car designs for some time (link).
    • Subsidies: Rivian landed a $1.5B package to set up a factory in Georgia (link); meanwhile Stellantis is investing $2.8B into two new EV manufacturing facilities in Canada and receiving close to a $1B in support from the national and Ontario state governments (link).
    • Upstarts: Vinfast, a Vietnamese carmaker EV manufacturer that no one has heard of, is planning to IPO in the US, with plans to build a factory in North Carolina, and launch two SUV models and an electric bus (link). Before dismissing them, remember that NIO, Xpeng and Li Auto were also companies you hadn’t heard of not too long ago.

Fleetification

  • The growing importance of fleet buyers, especially to the rollout of EVs - is a key theme we’ll be covering in greater depth going forward. For now, it’s worth highlighting the following stories as examples of this trend:
    • Hertz has ordered 65K EVs from Polestar, a five year deal worth more than $3B (link)
    • Lucid received an order for 100K vehicles spread out over a decade from Saudi Arabia (which, through its Public Investment Fund (PIF) owns a 62% majority stake in company) (link)
    • VEMO, a Mexico-based EV fleet operator, has signed a contract with BYD to supply up to 1,000 D1 EVs, a vehicle BYD developed with DiDi for the high utilization needs of ride-hailing (link in Spanish).

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