Description

Put simply, Veoneer is an over-hyped vaporware auto supplier attached to two underperforming SAAR exposed assets (brakes JV, restraint controls) spun out of Swedish auto supplier Autoliv in mid-2018.  Even in the overly optimistic sell-side consensus, by 2023 VNE would be one of the lowest margin global auto suppliers and still burning cash. Despite the sell-off since the spin, I believe the Company’s recent strategy shift away from autonomous driving to commodity level 0-2+ ADAS products, combined with their inability to even properly deliver these to customers presents significant further downside potential.  With its freshly raised equity, it’s also officially the most expensive supplier on made-up 2023 EBITDA and those numbers need to come way down as VNE’s end markets melt down, orders come in below expectations and costs spiral.

From the time it spun, VNE had big ambitions, calling itself the “only pure play technology company dedicated to Active Safety (AS), Advanced Driver Assistance (ADAS) and Autonomous Driving (AD).” The company’s products were said to be addressing a +$40bn TAM by 2025 that is growing at a 25% CAGR.

Auto technology pure play!?  Autonomous cars!? Massive TAM with amazing growth!? That sounds super exciting said Mr. Market as the company spun in early June 2018 and rose as high as $56/share in late September despite already clear signs that China was melting down (18% of sales) and Europe was in the midst of a long WLTP emissions testing hangover (30% of sales)…and to be clear, “pure play” is a total misnomer - because the active safety business was too small to stand on its own, Autoliv saddled VNE with its negative op mgn Nissin brakes JV (VNE is 51% consolidated owner) and restraint controls business to provide necessary scale to the spin-off.

Unlike some other problem children of the auto supplier world right now, Veoneer’s all-important active safety products (read: commodity sensors, cameras and LiDAR they buy from Velodyne) are produced by many other larger, better capitalized suppliers (Mobileye, Valeo, Magna, Aptiv, Conti, Bosch, etc., etc.) and it’s not clear that Veoneer needs to exist as an also-ran player that can’t figure out how to execute on its promises to OEMs.

Even with the optimistic scenario laid out below by sell-side consensus, VNE will burn ~$1bn of cash in 2019/20 and need to raise capital again in 2020 while continuing to operate at negative EBITDA margins and burn cash despite revenue growth levels that are so disconnected from reality, I had to triple check Bloomberg consensus figures.  Not to mention the near-impossibility that any new business coming on will generate the 25% incremental EBITDA margins necessary to hit 2023 consensus EBITDA…

Assuming VNE trades at a generous 0.4x EV/2021 Revs multiple akin to low quality auto suppliers that at least have positive EBITDA, this is a <$11 stock or another 35%+ downside.  The reality is that China and Europe are still getting worse (see most recent IHS revisions), call-offs are increasing and cost cutting/restructuring will hamper growth, meaning more downside from the above numbers.  Finally, management will again have to revisit their 2020 and 2022 revenue and profitability targets in the next 1-2 quarters which I believe could result in full abandonment of the targets, causing those that got involved in the recent equity raise to abandon the story for a second time.

Strategy Change/Abandoning Autonomy

As part of the spin, one of VNE’s most touted investment merits was its Zenuity JV with Volvo, which aimed at the Level 4+ autonomous market (or full autonomy).  Some on the sellside were valuing this JV at $2bn, now it’s probably worth negative value as the AD story has lost a lot of shine in the last 12 months and VNE wants to refocus Zenuity’s priorities.  Worse still is that VNE is paying $60-80mm annually to support program developments at Zenuity and fears that it cannot pull funding because its JV partner, Volvo/Geely, is one of the largest customers in their backlog.

With AV much further out than expected, VNE has decided to focus its efforts on ADAS and Level 0-2+ (highway pilot, self-park, etc.)  The problem is that VNE’s products are sub-par, preventing them from being able to offer full ADAS systems…in fact, their own engineers revealed during conversations at CES that the sensors on their “LIV Autonomous Vehicle” were provided by other suppliers like Valeo and Magna despite all PR materials and displays espousing them as Veoneer products.  

The other problem is that the products on which VNE is focused are becoming increasingly commoditized.  Mgmt has told investor meetings that products like their dual camera system that in years past would have commanded $300+ per unit price points are now $125-150/unit with paper thin margins.  With these hardware products becoming commoditized and extremely competitive, VNE saw the writing on the wall that value-add is going to be through offering comprehensive L2+ ADAS systems AND software, which is where VNE is now trying to play.  However, as evidenced by their recent earnings call, they made promises to OEMs on which they having trouble delivering…integrating sensors, cameras and software from disparate suppliers (who are also competitors that won’t help you) has resulted in cost overruns, loss of focus on winning new business and finally a need to cap R&D expenses for the year to slow cash burn…let CEO Jan Carlsson tell you about it:

“we are currently in the middle of some short-term challenges in a rapidly changing market, including lower light vehicle production, a negative model mix due to our current high content per vehicle on premium models and higher development costs due to increased program complexity. We, as many others in our industry, have probably underestimated the extent and impact of these challenges on our company”

Though shares reflect that the street is beginning to understand things are not going as expected at Veoneer, what is not reflected in consensus numbers that are still too high is that this engineering problem is not going to be solved in the near term, meaning costs are going to be nearly impossible to control, while future business wins will be harder to come by under the burden of capped R&D, making VNE’s path towards profitability, absent a miracle, likely not viable.

Out of Control R&D

Runaway R&D costs are the primary driver behind the recent capital raise as costs have gone from elevated but manageable to totally out of control in only a few quarters.  Mgmt would like you to believe this is because their opportunity set is just so robust that they have to hire tons of engineers to meet their “record order book” however, less than a year ago with an almost identical (flat) order book, guidance was for R&D operating leverage to drive margin expansion.  Instead, RD&E for 1Q19 came in at a whopping 31.6% OF REVENUE AND WILL BE EVEN HIGHER IN Q2!! Current RD&E run-rate is between $625-650mm or 31% of 2019 consensus revenue, nearly double 2017 levels – keep in mind the current portfolio only generates high-teens gross margins

While the bull case is eyeing a ramp in revenue expected to start in 2020, the reality is that VNE is still attempting to develop solutions for programs that are launching this year and have been unable to meet customer expectations in the active safety space.  A senior member of Valeo recently corroborated to me what other suppliers have alluded, that the industry is having difficulty executing the type of sensor fusion and system integration they believed possible when they initially bid Level 2+ ADAS systems. Suppliers trying to offer system level solutions (like VNE) have it the worst as alluded to on their most recent earnings call:

“…we are now developing Active Safety technologies for 12 customers, and in many cases, multiple products at subsystem or system level. This has added a diversity to our product portfolio and many of these systems are much more complex than our -- than both ourselves and our customers originally anticipated. In some cases, we are even integrating our competitors' products into the system.

Magna’s most recent quarterly comments echo this sentiment with just three programs responsible for cost overruns so large they are necessitating long-term guidance revisions.  Elevated engineering spend is being driven by scope creep and program complexity that will result in higher costs through at least 2020.

In reality, VNE’s massive engineer hiring and cost overruns are not being driven by a robust order book, but by poorly bid business, scope creep and complications with integrating parts from competitors into full active safety systems for customers.  To conserve cash, mgmt has now capped R&D at $600mm for 2019 despite the current run rate being much higher, which this will undoubtedly limit ability to win new business - how many OEMs are going to sign up programs with VNE when there are many other competitors making the same products and development costs may not support getting product to the finish line???

Sales/Orders Indicate Problems

VNE’s order book has been essentially flat from their capital markets day in May 2018.  Because engineers are focusing all their time on delivering existing business, they appear to have taken their eye off bidding new business, as evidenced by one of their new “Efficiency Improvement Programs” in their equity offering documents - “prioritization initiatives aimed at winning more orders within the core product portfolio, making the right strategic investments and engaging in ongoing discussions with customers and suppliers on the terms and scope of contracts” i.e. we aren’t winning contracts because we have to focus on delivering our order book and the contracts we’ve won are WAY more expensive to develop than we priced in our scope so we need to ask OEMs if they’ll share some of the cost burden or we’re in trouble…

With a 2-4 year lag between bookings and start of production, the growth expected in current consensus numbers will need to come down significantly.  The bookings ramp from 2015-2017 represents sales growth expected in 2020, however, less revenue will come in than previously expected because SAAR is much lower than when orders were booked and the revenue will come on at significantly lower margin than expected (as evidenced by abandonment of its 2018 capital markets day margin targets) while further sales growth is not supported by current book of business and new order intake will be challenged by RD&E spending caps.

Even current sales of active safety products, representing 45% of revenue, are completely underwhelming…AS sales have fallen sequentially each quarter since Q2 2018 and sales are essentially flat over the last two years despite a massive uptick in take rates and adoption of active safety products across the broader auto sector.  Compare this to Aptiv, which has seen AS revenue grow 57% in 2018 and just recently 69% YoY in 1Q 2019. Also note that at Aptiv’s recent analyst day, even they noted that elevated engineering spend would be necessary for several years to commercialize active safety products - anyone that follows this space or rode in the test vehicles at CES knows that Aptiv is light years ahead of VNE, so if you think VNE’s funding needs are going to improve...good luck

VNBS and Restraint Controls

For good reason, neither management nor the sellside spend much time on these two businesses that make up 65% of current sales, because they are low multiple, low quality, business that have proven to be largely dead weight to financial results and the stock story.  In brief, the VNBS brake JV has a large exposure to Honda, for which VNE expected to win additional business before the spin, but failed to do so and is now seeing business roll off as Honda also loses volumes in Japan and China. VNBS is a bit player with 4% global market share.  Most recently, Veoneer just settled a long-standing funding dispute with JV partner Nissin and decided to buy out their partner stake in the North American business for $1. The market briefly saw this as a positive on the day of the announcement, however this clearly speaks to the attractiveness of the business going forward that Nissin would essentially abandon it despite a revenue ramp from a new NA contract (Fiat Chrysler) that mgmt has discussed periodically.  With 100% control and disclosure in their recent equity offering that Brakes and AS have not realized expected synergies, I believe VNE will likely explore a sale of the asset. Wolfe Research’s optimistic scenario is the business may be worth $100mm, not nearly enough to fill the funding hole of the next several years from active safety and will require further investment before the FCA contract rolls in 2020. In a sale scenario, stock probably pops, but proceeds are nowhere near enough to fund losses, sale will occupy mgmt mind share, business probably loses some scale, etc..

Restraint controls is grouped in with active safety to form the “Electronics” division of VNE, so it’s not totally clear at what margin it operates, but it’s likely in the high single digit operating margin, not horrible, but not great.  VNE lost significant restraint business to Bosch/Conti before the spin and is now trying to regain share, but with ~25% of the market, VNE is very exposed to slowdowns in global auto sales and even the company does not see the overall TAM of restraint controls growing through 2025, so not much to get excited about…

Capital Raise

Lastly, as I was writing this as my application to VIC, VNE’s new upsized equity raise began trading and broke significantly below the deal price before rebounding to just above by the end of the week ended 5/24.  The 27.6mm shares of equity (incl greenshoe) along with the converts, which have a $22.3125 strike and 44.82 shares/$1,000 ratio, amount to ~42% dilution to existing shareholders. Because VNE doesn’t have any clear path towards cash flow that would allow them to raise debt, they forced themselves into a classic death spiral financing that will play out in a mad rush for the exits if the stock keeps falling as convert holders continue to short the stock to hedge their long convert position and weak hand longs sell as the price declines

https://en.wikipedia.org/wiki/Death_spiral_financing

With notes like these in the S-1, it’s amazing they were even able to get a deal done at all, but you can thank the backstop Swedes that have been holding shares all the way down for a large chunk of this buy:

“Our operating environment is increasingly challenging, and our business and strategic plans may consume resources faster than we presently anticipate. In the future, should this be the case, we may need to raise additional funds through additional financings, including the issuance of new equity securities, debt or a combination of both

With respect to VNBS, synergies with our core Active Safety business are not evolving as previously anticipated and we intend to review and re-focus investment priorities with a view to optimal product setup and to seek to ensure the business is set-up for long-term success. We believe Zenuity would benefit from re-focused investment priorities towards collaborative driving”

Risks to Thesis

The primary risks are in a macro melt-up environment, VNE would be a primary high-beta “dash to trash” name that would be bought.  Given the relatively high short interest, especially with convert holders now involved, VNE’s price decline could flip rapidly as was seen in early January as suppliers across the board were bought on the theory that 2H19 would improve and they had simply become “too cheap”.  With no expected cash flow and the low-quality dynamics of VNEs business, I believe holders that can withstand or add to short positions in this move will be rewarded handsomely.

The other primary risk is profitable order book growth – management has proven itself to be promotional around its order book in the past despite the clear evidence that order momentum is stalling and orders coming on are not margin accretive, yet markets have bought this PR before.  Given the dynamics around capped expenses and the extremely competitive market in which VNEs products operate, I don’t see a high likelihood for an order surprise that would materially change results for the next 3-4 years and even if the order book grows, given its weak competitive positioning, VNE is almost certainly going to be taking on some of the least profitable business available to keep backlog from imploding

Finally, there is a risk that another supplier or even an OEM could purchase VNE for their engineering talent and ability to absorb some of the losses in a larger scale combined business; however, this seems unlikely due to the complexity of the restraints and brakes JV which an acquirer would be unlikely to want to own and the fact that years of loss-making contracts would be acquired on which the acquiror would need to deliver for fear of losing business with an OEM, all of which make it an undesirable asset

Catalyst

Downward consensus revisions

Disappointing order book/loss of active safety share

Downward revisions to management targets, more cash burn