Description

We last wrote up Smart Eye a year ago. The shares have run and nearly doubled since the last writeup, but we believe that thanks to the built in growth from design wins there is still further upside. Arguably, the past years performance and over 100 new design wins coupled with a small capital raise have further derisked the thesis and improved the risk-reward. Smart Eye’s revenue and profitability will further accelerate as it goes through the steeper part of its S-Curve as the EU’s General Safety Regulations (GSR), Advanced Driver Distraction Warning regulation kick in in July 2024 for all new vehicle types and for all new vehicle registrations from July 2026. 

Introduction

Smart Eye is a leading provider of advanced eye tracking and driver monitoring systems (DMS) for the automotive industry, as well as eye tracking solutions for behavioral research and analysis. Founded in 1999 and headquartered in Gothenburg, Sweden, the company has established itself as a key player in the rapidly growing market for automotive safety and driver assistance technologies.

Source: Redeye Research

Smart Eye operates two main business lines: Automotive Solutions and Research Instruments. The Automotive Solutions segment, which accounted for approximately 33% of the company's revenue in the last quarter, focuses on developing and supplying eye tracking software and hardware for integration into vehicles. Smart Eye's DMS technology uses cameras and algorithms to monitor driver attention, drowsiness, and distraction, enabling advanced driver assistance systems (ADAS) and contributing to improved road safety. The company has secured a leading position in the automotive DMS market, with 296 design wins from 14 OEMs as of February 2024. More recently Smart Eye has also won its first two contracts in Interior Sensing, an entirely separate opportunity. Smart Eye has also been investing in the development of its Fleet & Aftermarket (AIS) product, which targets the retrofitting of existing commercial vehicle fleets with DMS technology. There are signs of Smart Eye’s aftermarket solutions business gaining traction as this division has just contracted its first deal with Linde.

The Research Instruments segment, representing around 67% of Smart Eye's revenue, provides eye tracking solutions for academic and commercial research in fields such as psychology, neuroscience, and market research. This segment offers both hardware and software products, including eye trackers, software for data analysis and visualization, and support services. While this is a solid business growing at 20% YoY this writeup will focus more on Automotive as we expect the majority of the value to accrue from this side of the business.

In recent years, Smart Eye has made significant strides in expanding its automotive business and strengthening its market position. The company has leveraged its expertise in eye tracking technology to capitalize on the growing demand for DMS, driven by increasing awareness of road safety and the adoption of semi-autonomous and autonomous driving features. Smart Eye's DMS solutions have been selected by major automotive OEMs, including BMW, GM, Geely, and Polestar, among others.

In 2021, Smart Eye acquired Affectiva, a leading provider of Emotion AI technology, for $73.5 million. The acquisition expanded Smart Eye's capabilities in interior sensing and human behavior understanding, enabling the development of more comprehensive in-cabin monitoring solutions. In the same year, Smart Eye also acquired iMotions, a leading provider of biometric research software, for $46.6 million, bolstering its position in the research segment.

Looking ahead, Smart Eye is well-positioned to benefit from the continued growth of the DMS market, supported by regulatory tailwinds and the increasing adoption of advanced safety features in vehicles worldwide. With a strong pipeline of design wins, a growing presence in the fleet and aftermarket segment, and a solid position in the research market, Smart Eye is poised for significant growth and value creation in the coming years.

Industry Overview and Competitive Analysis

Smart Eye operates in the rapidly growing market for Driver Monitoring Systems (DMS) and interior sensing technologies within the automotive industry. The increasing focus on road safety, the adoption of advanced driver assistance systems (ADAS), and the development of semi-autonomous and autonomous vehicles have driven significant growth in this market. The adoption of General Safety Regulations (GSR), Advanced Driver Distraction Warning regulation will kick in in July 2024 for all new vehicle types and for all new vehicle registrations from July 2026. These regulations, in particular those requiring DMS on every new vehicle start in 2026 is what will really propel growth for Smarteye going forward. As the premier player with the most design wins in DMS, Smart Eye will grow rapidly as all new vehicles will have to be equipped by a DMS system, either from Smart Eye or one of their competitors.

The broader DMS market is characterized by a high degree of technological innovation and intense competition among a few key players. Smart Eye's main competitors in this space include Seeing Machines, Tobii, and Xperi (formerly Fotonation).

Seeing Machines, an Australia-based company, is Smart Eye's primary competitor. The company offers DMS solutions for automotive, aviation, and other industries. Seeing Machines has secured several major design wins with automotive OEMs, including Jaguar Land Rover, Mercedes-Benz, Volvo and Ford. Unlike Smart Eye, Seeing Machines has focused on developing its own proprietary hardware and software stack, which includes its "Fovio" embedded DMS platform. This approach differs from Smart Eye's hardware-agnostic software solution, which can be integrated with various camera systems across OEMs. While Seeing Machines' integrated hardware-software approach may offer some advantages in terms of optimized performance, Smart Eye's flexibility allows it to work with a broader range of OEMs and Tier 1 suppliers.

Tobii, a Swedish company, is another significant player in the eye tracking and DMS market. Originally Tobii has a strong presence in the consumer electronics and gaming sectors, with its eye tracking solutions being used in virtual reality (VR) and augmented reality (AR) applications. In the automotive space, Tobii has partnered with Tier 1 suppliers such as Veoneer and Nidec to develop DMS solutions. Recently, Tobii acquired Xperi's Fotonation, a provider of in-cabin monitoring solutions, to strengthen its automotive offering. While Tobii has a broad portfolio of eye tracking applications, Smart Eye has maintained a stronger focus on the automotive DMS market, which may give it an advantage in terms of expertise and customer relationships within this specific segment.

Source: Seeing Machines Presentation

Smart Eye’s competitor Seeing Machines does a good job illustrating the growth that lies ahead in DMS citing “100%+ CAGR in production volumes for awarded programs to FY26” and illustrating the potential for growth from future RFQs. Seeing Machines sees itself as having about 40% share of the DMS market over this timeframe. The shape of the curve for Smart Eye would look very similar, but we are intentionally not going into post 2026 numbers in this writeup. 

Source: Smart Eye

Smart Eye has put out similar numbers for DMS market adoption that also illustrate the large impact of Covid on auto production numbers (which has pushed out the revenue curve for DMS as well). Note that the above are DMS market numbers while Seeing Machines is illustrating its own future revenue potential based on a 40% market share assumption.

Source: Redeye Research

Redeye (a brokerage) illustrates the dynamics of the revenue ramp through a parallel to Mobileye, where design wins (in automobiles) also led the ramp up in sales by several years.

Smart Eye itself estimates its own market share stands around 40% based on cars on the road. When looking at design wins, Smart Eye’s market share is likely higher than that. Over the past year more incremental design wins have been going to Smart Eye than Seeing Machines. Seeing Machines has a temporary advantage in terms of current production volumes, possibly due to its presence in high-volume models like the Ford F-150, while Smart Eye seems to recently be taking the lion’s share of design wins.

As mentioned previously competition between these two players over the past years has been intense, despite their slightly different business models and approaches and at different points in time either Smart Eye or Seeing Machines has been in the lead. While recent design wins point more towards Smart Eye becoming the #1 player in the DMS a market structure where 40% of the market goes to Smart Eye, 40% to Seeing Machines and the rest accrues to smaller players is also a reasonable outcome. 

We view a new entrant gaining a significant share of the DMS market as unlikely at this point in time as we are very close to the implementation of regulations that will force every car manufacturer in the EU to have a DMS system. These decisions are made on a RFQ basis for each car model/platform and are unlikely to be renewed before a new model/platform is rolled out. A market structure dominated by Smart Eye and Seeing Machines is therefore the most likely outcome for the next 5 years.

Smart Eye has several key strengths and differentiating factors:

1. Market leadership: Smart Eye has established itself as a market leader in the automotive DMS segment, with a significant number of design wins and a strong reputation for technology innovation and reliability.
   
   

2. Software-focused approach: Smart Eye's emphasis on developing hardware-agnostic software solutions allows it to work with a wide range of camera systems and provides flexibility for integration with different OEM requirements.
   
   

3. Comprehensive offering (not just DMS): With the acquisitions of Affectiva and iMotions, Smart Eye has expanded its capabilities beyond DMS to include interior sensing, emotion detection, and behavior analysis, enabling the development of more advanced in-cabin monitoring solutions.
   
   

4. Proven technology: Smart Eye's DMS technology has been extensively tested and validated in real-world conditions, with over 1.5 million cars on the road equipped with its software as of February 2024. It has the most design wins out of any company in the space and has further extended its lead with a recent spate of incremental design wins.
   
   

Despite these strengths, Smart Eye faces challenges in the highly competitive DMS market. The company must continually innovate to stay ahead of the technological curve and maintain its leadership position. Additionally, as the market matures and DMS becomes more widely adopted, there will be increasing pressure on pricing and margins. While Smart Eye has recently scored its first design win as a T1 supplier (as opposed to T2) thus moving up the value chain, Smart Eye is just one tiny supplier in the automobile value chain.

Capital Allocation

Smart Eye has a mixed track record on capital allocation. The company missed the bull market in small caps to raise money and instead was forced to do a dilutive rights issue of SEK 325 million in 2022 due to nearly running out of cash and while the stock was trading around 40 SEK. The more recent rights issue of SEK 150 million in 2024 with the stock at 91 SEK was better timed and came after a spate of new orders, among other things in the more capital intensive Fleet & Aftermarket (AIS) business. This smaller (4% of sharecount) rights issue was pitched as being able to help them bridge the gap to cashflow breakeven while continuing to invest in the business and deal with all the recent new design wins and orders.

In addition Smart Eye has made several acquisitions in the past: The Affectiva acquisition, completed in 2021 for $73.5 million, brings industry-leading Emotion AI technology to Smart Eye's portfolio. Affectiva's software uses facial expression analysis and deep learning algorithms to detect and analyze human emotions and cognitive states in real-time. This technology has applications in various industries, including automotive, market research, and healthcare. By integrating Affectiva's Emotion AI capabilities into its DMS and interior sensing solutions, Smart Eye aims to provide more comprehensive and valuable insights into driver and passenger behavior, enhancing the overall user experience and safety features in vehicles.

The iMotions acquisition, also completed in 2021 for $46.6 million, strengthens Smart Eye's position in the research and academic markets. iMotions provides a comprehensive software platform for multimodal human behavior research, integrating data from various sensors such as eye tracking, facial expression analysis, and biometric measurements. The acquisition enables Smart Eye to offer a more complete solution for academic and commercial researchers studying human behavior and decision-making processes. By leveraging iMotions' software platform and customer base, Smart Eye aims to drive growth in its Research Instruments segment and create cross-selling opportunities with its automotive solutions.

These acquisitions were partially made in stock when Smart Eye’s stock was trading around 200 SEK in 2021, have helped diversify the business and bridge the cashflow gap until Automotive/DMS turns profitable. Hence we view them as reasonable.

Financial Overview

As we have already discussed revenue and growth dynamics in a previous section, let’s next turn to margins. Smart Eye's gross margin has remained relatively stable over the past few years, averaging around 88% in 2023. The high gross margin is due to the company's software-focused business model, which allows for scalability and cost efficiency.

The company's strong gross margin is a key competitive advantage, as it allows Smart Eye to invest heavily in research and development while still maintaining a clear path to profitability. In 2023, Smart Eye invested approximately 25% of its revenue in R&D. Once DMS reaches scale in 2025, we would expect the high gross margins to also begin translating into much higher FCF margins.

Looking ahead, Smart Eye's financial outlook is promising, supported by a strong pipeline of design wins and the growing adoption of DMS and interior sensing technologies in the automotive industry. The company's design wins, which represent contracts with automotive OEMs to integrate Smart Eye's technology into future vehicle models, provide a solid foundation for future revenue growth as today’s design wins get translated into tomorrow’s revenue. 

The design win pipeline provides strong visibility into Smart Eye's future revenue potential, as each design win represents a long-term contract with an automotive OEM. These contracts typically have a duration of 5-7 years, corresponding to the lifecycle of a vehicle platform. As a result, Smart Eye has a high degree of revenue predictability and stability, with a significant portion of its future revenue already secured through existing design wins.

Based on the current design win pipeline and market trends, Smart Eye expects to achieve revenue of SEK 463 million in 2024, representing a 53% increase compared to 2023. The company anticipates continued strong growth in the Automotive Solutions segment, driven by the ramp-up of production for existing design wins and the acquisition of further new contracts. The Research Instruments segment is also expected to contribute to overall growth, benefiting from the increasing demand for eye tracking solutions in various research and commercial applications.

In terms of profitability, Smart Eye aims to reach positive EBITDA by the fourth quarter of 2024 and maintain a long-term EBITDA margin of around 40%. 

As Smart Eye continues to scale its operations, the company expects to achieve significant operating leverage, with a larger portion of its revenue growth translating into profits. This operating leverage is driven by the company's ability to spread its fixed costs, such as R&D and general and administrative expenses, over a larger revenue base. As a result, Smart Eye expects its EBITDA margin to expand rapidly in the coming years, reaching 17.3% in 2025 and 46.0% in 2026.

To illustrate the potential financial impact of Smart Eye's growth strategy, the company has provided the following guidance for the period 2024-2026 which seems reasonable (or at least reasonable given the uncertainty of making projections for any high growth stocks)

• Revenue: SEK 463 million (2024), SEK 659 million (2025), SEK 1,217 million (2026)
  
  

• EBITDA margin: -0.3% (2024), 17.3% (2025), 46.0% (2026)
  
  

• Net income: SEK -162 million (2024), SEK -37 million (2025), SEK 425 million (2026)
  
  

The revenue guidance beaks down into automotive CAGR of approximately 60% between 2023 and 2026, driven by the ramp-up of existing design wins and the acquisition of new contracts. The Research Instruments segment is expected to grow at a more moderate CAGR of around 20% during the same period, in line with the overall growth of the eye tracking market.

The above should be treated as approximate estimates as its tough to pin down exact 2026 numbers. Auto sales and further design wins will still affect this number. What we want to emphasize is that Smart Eye’s end market in DMS is finally approaching an inflection point in terms of mass adoption as every new vehicle on the road in the EU will be required to have a DMS system in the EU starting in Q2 2025. This volume inflection will also lead to a inflection to cashflow breakeven in early 2025, then full year 2026 should be the first fiscal year to show Smart Eye’s high gross margins translate to profitability at scale. Assuming SEK 1.2bn of revenues translate to 46% EBITDA margins and applying a 20% tax rate in Sweden, the business is currently trading at 5x 2026 EBITDA and 6.7x 2026 earnings.

Its difficult to pinpoint exactly what a fair multiple for Smart Eye should be as it’ll require more data on unit price compression over time and a view on whether DMS will be around for multiple decades or fully autonomous driving will eventually render driver monitoring unnecessary.

For now I would argue that sales and earnings are about to massively inflect upwards over the next 2 years and don’t see a reason why, as a high growth business, Smart Eye shouldn't trade for at least 10-12x earnings. That would leave upside between 115-140 SEK per share by 2026. There's upside optionality from these numbers if:

1. Smart Eye proves it is a true growth (or even rule of 40!) stock that can consistently grow at 20%+ even after its high growth period over the next 2-3 years in which case one could argue it deserves a much higher multiple

2. Further design wins happen. Design wins have been happening at a robust pace, and there is a high chance for further meaningful design wins before 2026, especially given that Smart Eye is just beginning to focus on the Interior Sensing and AIS opportunities. 

These projections underscore the significant growth potential of Smart Eye's business and its ability to generate strong profits as it scales its operations and benefits from the expanding market for DMS and Interior Sensing solutions as well as revenues from design wins ramping up. Unlike guidance from other companies, much of this growth is already locked in through design wins and depends more on the underlying car models selling in line with projections than Smart Eye's business performance. 

Catalyst