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I believe Garmin is one of the most overvalued publicly-traded companies on an absolute basis.  Current trends are good, but longer-term issues are troubling. 

Garmin sells GPS receivers.  These are sold into marine, outdoors, aviation, and automotive markets.  Automotive is growing very quickly, while the other markets grow at single-digit rates.  They have around $800m of cash, and the non-automotive businesses generate EBIT of around $250 million, so say they are worth 14x or $3.5 billion.  Garmin has 220m shares and trades at $97, so the implied value of the automotive business is roughly $17 billion.

The current ASP on automotive is around $300 and prices should decline around 15%.  Operating margin of 25% and normalized tax rate of 20% (still low because of a holding-company structure and Taiwanese capex-based tax breaks) means that if we assume—generously—a $250 ASP x 20% net margin, then they make $50 per unit sold.  To justify $17 billion of market cap, they need to sell—on an undiscounted basis, and assuming away all price deflation—350m units.  Since their market share in US/Europe is around 50%, that places the market potential at around 750m units.  So with roughly 200m families in US/Europe, and say another 100m rich enough in the rest of the world, that means everyone will be buying 2 of these things.

That is if everything goes well.  Before I discuss what can go wrong, I will state that I believe that the product they sell will be functionally obsolete in five to ten years.  All smartphones will have mapping capabilities, and all automobiles will have built-in navigation.  If this is correct, than the company will ultimately be worth no more than 20% of its current value.

But nearer-term there are issues as well.  Here are some of them:

1)     Gross margin should be pressured as LCD prices and flash prices have increased dramatically in the last few months.  This will add $20 of cost per unit, roughly.  Generally speaking, Garmin’s margin has been flattered by some prescient component pre-buys, but over time, a 30% operating margin has not been sustainable in any consumer electronics device, ever.

2)     Gross margin should be pressured by mix, as lower-priced GPS devices now are fully-functioned, in that they have built-in maps and voice-guided navigation.  These are features that are worth paying for, which are now standard in all models.

3)     The I phone is a real threat.  Prior generations of cellular phones were badly suited to function as GPS devices, as they did not have large screens or touchscreen displays.  The I phone, if anything, is a better interface for GPS than current stand-alone GPS devices.

4)     Their competitor, Tom Tom, just bought one of the two providers of maps.  Maps are the key piece of intellectual property that is very difficult to replicate.  So, Garmin will likely buy or try to buy Navteq, their current provider.  This will cost them $8 billion.  In addition, I could see someone like Google outbidding them for it, or some other GPS manufacturer raising anti-trust issues.  In any case, this is a distinct issue for them.

5)     If you believe there will be a consumer recession, GPS devices should be hurt quite a bit.

6)     Competition is getting better and more widely varied.  When I went to Amazon recently (where the Garmin Nuvi is the #1 best-selling item in the electronics section), I was offered on the home page a new Harman Kardon GPS system with a free 2g memory card.  Of course, Garmin has repelled all competitors so far, but the field just gets more crowded.

7)     If the US ever gets serious about reforming its tax code, it might consider Garmin to be a primary offender.

I will put this in the bucket of “momentum ahead, size accordingly”, but I believe the downside potential is dramatic.

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