Description

We believe U-blox represents an opportunity to buy an attractive, secularly growing, high margin franchise hidden within a money-losing business that we expect to be divested or shut down within the next year. U-blox designs GNSS semiconductors and modules that enable autonomous driving and other high growth applications in automotive and industrial end-markets that rely on high-precision location data. U-blox’s Positioning business is being masked by a money losing cellular module business (Connect), and a particularly nasty post-COVID inventory correction that is impacting both segments. Unlike many "story stocks", both in general and in semis specifically, we believe we can buy U-blox at a value price – nearly 3x 2022 EBIT of its high margin and secularly growing Positioning business.  Furthermore, we believe a newly installed CEO, CFO, and an activist shareholder (with a seat on the Board) are focused on divesting Connect and growing the core Positioning franchise.  We think U-blox offers 50-200% upside and limited downside given its plentiful cash (nearly 20% of its market cap), lack of controlling holder, likely strategic interest if the public markets continue to undervalue the company, and a management team and Board focused on creating shareholder value.

Brief History – The Set Up:

Up until 2023, U-blox was run by a long-time CEO originally installed by U-blox’s co-founders over 20 years ago. Despite being public for nearly as long, U-blox never specifically broke out the economics of their Positioning business to investors, and the company’s mid 40% historical gross margins and low single digit EBIT margins weren’t notable. The average of a great business and a bad business is a mediocre business, and that’s what U-blox looked like. U-blox’s Cellular and Short-Range (Connect, or the bad business) business provides cellular connectivity modules into a variety of IoT end markets (comps to Telit, Sierra Wireless, etc.).  It used to be an okay business, but the entry of two Chinese competitors, Quectel and Fibocom, has essentially destroyed the market and made it impossible for Western competitors to compete.  Our understanding is that some on the Board were wary of the Connect segment’s ability to make money, but Thomas Seiler, U-blox’s prior CEO, was unwilling to consider selling or shutting down the division.  U-blox continued in this way, until recently.

In late 2022, Seiler announced his intention to retire from U-blox. In January 2023, he was replaced as CEO by Stephan Zizala who previously worked at Infineon in its automotive segment. The company added two new Board members in 2022, one with a PE background, and recently appointed a representative from SEO, a spinout of European activist Cevian, to replace Seiler on the Board.  In our first meeting with Stephan Zizala in September 2023, when we asked him why they were still in the cellular business and how much money it was losing, he said he didn’t know but he had no tolerance to own a business that couldn’t make money.  In November 2023, for the first time the company disclosed the historical profitability of Positioning (Locate) (30%+ EBIT margins) and the historical losses of Connect (<0% EBIT margin):

Source: U-blox Investor Day presentation, November 2023.

Previous to Stephan’s tenure, our understanding is that there were no internal segment cost allocations or view of segment profitability.  Even today, we believe work is still being done by the new CFO to piece together historical losses of the Cellular business.  While the company has not given segment profitability since the Investor Day, they have begun to disclose revenue breakout by segment and will likely add additional disclosures in 2025.  We think this cultural and strategic shift to a growing, high margin, pure-play positioning business is being overlooked by the market.

U-blox’s Crown Jewel – Positioning Business

U-blox’s Positioning business designs GNSS chips and modules that receive and calculate precise location via information from satellites.  Although the largest volume application for GNSS chips is in cell phones, U-blox focuses almost exclusively on smaller / niche applications in automotive and industrial.  Despite having minimal consumer exposure, U-blox estimates it is the #1 player in the Positioning market with 28% overall market share.  U-blox chips can be found in 18 of the top 20 car manufacturers worldwide and in 1 out of every 2 cars produced today.  Additionally, the company previously estimated it had 40% share in freight/asset tracking, 80% share in drones, and 25% share in network equipment for timing sync applications.

Unlike chips used in cell phones, these components are produced in lower volumes, with higher standards for reliability and accuracy.  As such these chips carry higher ASPs, have less competition, and produce higher margins than GNSS chips used in other markets.  While an attractive space, the market for these chips is only about $700M, a relative drop in the bucket for larger competitors like Broadcom and MediaTek, who are the two largest players in the Consumer GNSS market but don’t compete head-on in the auto and industrial markets:

Head of Marketing at GNSS competitor: “Industrial and Auto are the highest margin segments, with Smartphone and Consumer being the lowest.  But there is not enough scale [in those segments].  It’s just not that big a market.”

Although other players do produce GNSS chips, most of them either focus on higher volume consumer applications, or bundle inferior GNSS chip offerings into automotive and industrial markets with other products they sell.  We believe U-blox’s main competitor in automotive is ST Micro.  In Industrial, there is a wider swath of competitors, but typically only a couple of players per niche application.

Switching costs are high, the cost as a percentage of the total product is miniscule, and the cost of failure is dramatic – e.g., in a car with driver assist and/or autonomous features, the cost of failure can be death.  Product cycles are typically 5-10 years, so once you are “designed-in”, you have business for a long time:

R&D Engineer at a large Industrial customer of U-blox: “We don’t tend to switch GNSS suppliers much, as there is a risk to reliability and the whole infrastructure needs to change [if you switch].  Generally, you don’t see vendors changing for 5-10 years at a time for a product, sometimes even 20 years.”

We think within the next year, U-blox is likely to be a pure-play Positioning business targeting an attractive niche market with a TAM growing mid-teens in some of the most exciting areas of technology.  Similar businesses in semis trade at very healthy multiples of revenues and EBIT:

Source: Capital IQ, October 2024.  Market cap and enterprise values are in USD.

Inventory destocking in 2024 is myopically focusing investors on short-term challenges rather than LT opportunities

Despite very attractive financial characteristics and secular growth trends, the financial profile of U-blox’s Positioning business is being masked by the pandemic-induced hangover of over-ordering that occurred during COVID:

Source: Company reports.

We believe U-blox benefited from deliveries in excess of demand to some degree in 2022 and 2023 and is now undergoing a nasty correction as customers work off excess inventory, with revenues expected to be down nearly 50% year-over-year in 2024:

Source: Company filings, Internal estimates.

While most semi companies faced this dynamic to some degree, the magnitude of this impact at U-blox has been more extreme.  After outperforming peers in growth throughout much of 2022 and early 2023, U-blox has given all this outperformance back in the last 4 quarters (YoY revenue growth below):

Source: Company reports, Visible Alpha estimates, August 2024.

Different end markets have seen inventory destocking peak and recover at different times.  Nordic Semi, for example, saw sales begin to decline in Q1 23, whereas most of the industry didn’t see sales decline until H2 23 or early 2024.  In addition to industry checks that have been supportive of U-blox’s overall position in the market, we have also benchmarked their performance vs. peers by industry group to better account for the inventory correction specific to its two key end-markets, Auto and Industrial:

Source: Company reports, Visible Alpha estimates, August 2024.

The trend continues to hold that U-blox outperformed peers substantially in 2021/2022 only to underperform more recently.  To better illustrate this dynamic, we compare FY24E revenues to baseline revenues (FY20A – 100%).  We excluded companies that did material acquisitions (Infineon, Analog Devices, On Semi) between now and 2020, or with limited historical segment disclosures (ST Micro), but otherwise included all semi companies we could find that detail their end-market exposure.  We display revenue as a % of 2020 revenue and then the cumulative revenue over the period assuming 100 as the baseline.

Source: Company reports, Visible Alpha estimates, August 2024.

In Automotive, we believe U-blox’s weak 2024 performance vs. peers makes sense in the context of its unusually good 2022 vs. peers.

Industrial has a similar trajectory, but more extreme – the company outperformed peers more significantly in 2022 and 2023, but is seeing a harsher correction in 2024:

Source: Company reports, Visible Alpha estimates, August 2024.

Interestingly, when we analyze the business this way, U-blox actually outperformed the average peer over the whole 2020-2024 time period in cumulative revenue vs. 2020, despite poor performance in 2024.  This deep inventory correction leaves Industrial sales well below 2020 levels, despite what we believe to be structural growth in the underlying end-market.  The optics and financial impact of this decline, while temporary, have been painful.  U-blox lost CHF 36M in EBIT in H1 on revenues that were down over 60%.  According to management’s guidance based on placed orders, revenues are expected to recover ~23% sequentially from CHF 65M in Q2 to CHF 80M in Q3.  With EBIT breakeven at roughly CHF 90M, we think the company should be back to cashflow neutral in Q4 and set up for positive EBIT and cashflow in 2025.  In the meantime, investors own a modestly money losing business that is dramatically under-performing its peers, with an unclear recovery path to 2022 revenue and profitability levels.

We believe a bloated cost structure against a depressed revenue base is masking the go-forward economics of U-blox’s business:

While it's hard to quantify exactly how much cost can be cut and exactly how much money Cellular is losing, we have a few clues. 

1. U-blox announced the first ever material layoff in the company's history in 2023, a notable development for a company in a notoriously cyclical industry. The company announced further restructuring initiatives with H1 results, and we expect additional cost actions to be taken until the company eventually right-sizes its cost structure closer to higher margin peers.

2. For many years, U-blox pursued a strategy of developing its own Cellular chipset, despite the tremendous advantages of scale and technology that Qualcomm has relative to U-blox.  We estimate the company spent roughly ~CHF 20M/yr (or 11-15% of total opex) for many years pursuing what we believe was an obviously losing strategy of competing with Qualcomm. Concurrent with announcing that SEO would join the Board in late 2023, U-blox announced it would suspend development of its Cellular chipset business. Rather than eliminating this R&D spend by laying people off, U-blox instead shifted all of these R&D staff to their Positioning business, essentially increasing R&D expenses in Positioning by roughly ~50% overnight.

3. Ultimately, we believe the company is focused on right-sizing the cost structure for their Positioning business.  So far, U-blox has announced over CHF 20M of annualized costs reductions, and we believe more is likely if business remains depressed. We expect 2025 to be an inflection year both in terms of recovery in the Positioning business and further right-sizing of costs. Given the historical profitability of this segment and the high profitability of similar gross margin businesses, we believe U-blox can return to 30%+ EBIT margins in Positioning over time.

We believe U-blox should return to strong secular growth post inventory correction:

U-blox and industry forecasts expect the automotive and industrial GPS market to grow at a 13% CAGR, nearly doubling by 2028.

Source: U-blox, ABI, TSR.  Red bars are Automotive, dark blue is Consumer, and lighter blues are Industrial end markets.

You’d be hard-pressed to find another semiconductor company at 2.9x 2022 EBIT that has the use cases and customer wins of U-blox – reading through the emerging applications and use cases for U-blox’s GNSS chips sound more like what you’d expect from a highly valued 2021 SPAC than a cyclical trading at an attractive multiple of normalized profits.  Below are a handful of penetration statistics and growing use-cases that U-blox powers:

• Autonomous Driving Applications (Auto / Industrial)

  • Within the last year, U-blox announced $100M of cumulative design wins with APAC Auto OEMs for Level 3 autonomous cars.

  • U-blox powers Mercedes Drive Pilot, the first certified Level 3 Autonomous system for the US and European markets.

  • We believe U-blox’s high-precision GNSS chips are used in most of Tesla’s cars as part of the functionality of auto-pilot.

  • U-blox is bundled into off-the-shelf autonomous driving solutions compiled by Tier 1 auto suppliers like Bosch, and by other semi companies like Nvidia.

  • Within the last year, U-blox has announced $100M of design wins for GNSS chips to power autonomous lawnmowers.

• Attractive Industrial Applications

  • UAVs (Unmanned aerial devices / drones)

  • Telematics / asset tracking

  • Healthcare applications – wearable health devices, remote patient monitoring, etc.

  • Autonomous robots (delivery, cleaning, service)

  • Remote vehicle control (e.g. remotely controlled industrial machines)

Higher levels of automation tend to lead to more GNSS chips per device and higher ASPs per chip. On its website, U-blox’s product prices for high-precision GNSS ($100-200) are 4-5x higher than the prices for standard-precision GNSS ($20-35) – while these prices are heavily discounted for scale purchasers, they help give a sense of the order of magnitude of the upside from higher ASPs in higher precision chips. U-blox forecasts ASP of ~$150 per car in autonomous driving over the next 5-7 years, with the current content closer to $5-30 per car.  We believe gross margins are much higher on high-precision chips as the difference is mostly one of software and computation, less one of hardware:

Former U-blox Executive: “They probably make 90%+ gross margins on some of their highest-precision chips.” 

We have interviewed and surveyed over 10 customers in Automotive and Industrial, and the feedback on U-blox’s reputation and prospects for growth have been almost universally positive:

ADAS Manager @ European Auto: “U-blox’s performance levels are considered the best in this industry.” 

C-Level Executive of IoT Device Manufacturer: “The price-performance curve is just so bent in U-blox’s favor at this time…High accuracy with low error rates is most important, and there, U-blox is hands-down the best.”

Purchasing @ Chinese Auto: “U-blox is the leading supplier in this space, their development capability is very strong… We expect them to continue to have a strong position here in the next 2-3 years.” 

Hardware Engineer @ Industrial Conglomerate: “U-blox offers the best positioning accuracy of all players… they have algorithms built in their modules that focus on refining the accuracy more.”

Valuation: Putting it all together

Potential Connect proceeds could be sizeable and act as a strong catalyst to re-rating:

The company announced with their Q2 earnings that they are “exploring strategic options” for Connect and that they will report back by the end of 2024.  We believe the two most likely outcomes are a sale or wind-down of the Connect operations, with a sale being more likely.  We are optimistic there will be value here based on calls we have done with competitors and others in the market.  Many of U-blox’s key pure-play peers in Connect have been acquired in the last few years, at valuations typically at 1-2x 2021-2023 revenues:

Source: Company Reports, media releases.

The competitive environment for U-blox’s Connect business is arguably better than it’s been in years.  The US is increasingly scrutinizing the use of Chinese suppliers in industrial and automotive applications that U-blox focuses on.  It is widely rumored and speculated that the two price aggressors in the market – Fibocom and Quectel – will be added to Entity Lists in the US and Europe, as happened with Huawei, which would prevent US firms from doing business with those companies.  The US FCC Chairwoman, Jessica Rosenworcel, as well as bipartisan members of the House’s China Select Committee, has recommended adding both companies to the Entity List.  Concerns center around the risk that if “China can control the module, it may be able to effectively exfiltrate data or shut down the IoT device.”  In January, the bipartisan committee recommended specifically adding Quectel to the blacklist (link).  Subsequently, multiple other organizations have come out in favor of a ban, including a UK-based organization, the Coalition on Secure Technology, in March, whose report can be found here.  In August of 2024, it was rumored that the US would ban Chinese software in Level 3 autonomous vehicles (link).   On September 23rd, the US proposed a rule that would ban connectivity hardware in US cars in 2029 (link).  While this is a few years further away than we would have liked, it is still possible that an Entity List designation happens before then. We also believe that noise around the ban and further potential bans has already led companies to begin looking at Western sources for cellular modules, which could have a positive impact even if an Entity List ruling remains elusive. 

Former Telit Executive: “Quectel and Fibocom are dominating in cellular modules right now.  If they get placed on the Entity List, U-blox will be in the strongest position to benefit, alongside Telit and Sierra Wireless.” 

We are encouraged that U-blox seems to be using these headlines to try to divest their Connect assets, rather than as an excuse to invest more in them or delay a decision. We’ve spoken to multiple players in the cellular module market, including executives who were involved in prior sales of comps, and believe U-blox should be able to divest it for somewhere between CHF 40-235M, and hopefully also divest the R&D staff that was previously associated with cellular chip design.  A buyer would likely either put the business into run-off and use their scale to extract synergies, or aim to position the business for growth post the potential ban of Chinese players in the Western market.  

Below we assume different ranges of value for U-blox’s Connect business and what it implies we are creating U-blox for as a multiple of 2022 Positioning revenue and EBIT.  We note that Positioning must have been >38% EBIT margins in 2022 to get Connect as loss-making (as disclosed by U-blox).

Source: Internal estimates.

Note that U-blox’s Connect business did CHF 275M of revenues in 2022 vs. our assumptions that are 40-66% below those levels in 2024.  There could be upside to sale proceeds depending on what revenue base a buyer ascribes to the business.

Positioning:

We expect Positioning to rebound strongly next year as the company laps inventory destocking in H1 2024 and as its end-markets continue to grow.  Below we’ve included the same comp table of standalone businesses that look like Positioning and the multiples they trade at vs. where U-blox would trade pro forma for a sale of Connect (assuming Connect is sold for 1.0x 2024E revenues, i.e. scenario #3):