Google, IBM, & Continental AG Teaming up on Self-Driving Vehicles?

I can't help but wonder what Google (NASDAQ: GOOGL  ) will name its car if reports prove accurate that it's teaming with IBM (NYSE: IBM  ) and German auto components maker Continental AG (NASDAQOTH: CTTAY  )  in what could be an initial step in developing self-driving vehicles. 

The Big G, Big Blue & Continental AG alliance

Continental is close to teaming with Google and IBM to develop and produce autonomous driving systems, according to an August 21 Reuters' article, which cited German newspaper Frankfurter Allgemeine Zeitun. Reportedly, Continental will announce the pact(s) at the Frankfurt Car Show, which runs from September 12 through September 22.

There's some buzz that Google is contracting with Continental to produce the systems because it hasn't been successful in convincing any automakers to integrate its self-driving technology into their vehicles. That's a likely possibility  -- $75,000 or more has been a commonly thrown around cost for Google's system. So, it would be cost-prohibitive to integrate into all but very high-end vehicles. 

However, the desire to produce the systems as soon as possible is also surely being spurred by Google Ventures' just announced $258 million stake in Uber, an on-demand car service. This is Google's investment arm's largest investment ever and represents 86% of its $300 million a year fund. There's no doubt that Google plans to incorporate the autonomous driving systems as soon as technologically and legally possible into vehicles for use by Uber. The Google-Uber teaming could not only be disruptive to taxi and limo services (especially once the cost of paying drivers is eliminated), but also give Google's nascent same-day delivery service a competitive advantage over Amazon's, eBay's, and others'.

Where does IBM fit in?

Continental's a natural partner, as it's a leading developer and manufacturer of auto systems. Further, like Google, it's been heavily investing in R&D related to autonomous driving systems.

But IBM? The initial spate of articles out on this story say zip about IBM's involvement. However, Google did purchase thousands of patents from IBM in 2011 and 2012, some of which were related to auto safety and self-driving vehicle technology. So, obviously IBM has been involved in related research going back some time. While well-respected in computing-related fields, IBM's been innovative in a more broad range of tech areas than it seems many realize.

And future steps?

Surely, Google plans to incorporate autonomous driving systems into Uber's vehicles. Given the commercial potential of these vehicles, system cost is not nearly as significant a factor here. 

In addition, Google could also license the technology to automakers and/or build its own vehicle. However, cost is a significant factor in both these scenarios. While Google seems to have the lead in developing self-driving vehicle technology, there are others -- including Volkswagen and Volvo -- working on this technology. So, future licensing can't be viewed as a sure thing anyway. Whether or not Google decides to produce its own vehicle -- by contracting out production -- remains to be seen. That seems a very remote possibility, but never say never. 

Investment implications?

Google and IBM are huge, and whatever comes of a jointly developed autonomous driving system is likely to be a drop in their respective revenue buckets and not contribute anything to earnings for awhile. So, we'll hold off on speculation until there's more info.

Continental seems a potentially interesting investment angle for those who are OK with highly cyclical stocks. And given it's a German company which trades over-the-counter in the U.S., some might not be familiar with it. So, let's briefly look under its hood.

Continental has a $32 billion market cap and is Europe's second largest car parts manufacturer. Its automotive division -- which accounted for 60% of revenue in Q2 -- develops and produces brake systems, driver assistance systems, powertrains, IT systems, etc., for passenger vehicles and light trucks. Its rubber division -- which accounted for 40% of revenue in Q2 -- makes tires for passenger and commercial vehicles, and serves other industrial markets.

Continental already has an alliance with Cisco Systems (NASDAQ: CSCO  ) , the leading network equipment maker, to work on systems for communication between vehicles, which many view as key in the development of autonomous vehicles. So, Cisco is worth watching here, too.

Here's the longer-term stock performance picture. Given its business, one would expect the stock to be very cyclical and move in-line with manufacturers of autos and commercial vehicles. For context, Ford and Volvo are included. (Volvo's a commercial vehicle manufacturer; it divested its passenger vehicle business in 2005.) 

CTTAY Chart

YCharts

Continental's stock has been turbocharged over the past year, not surprising given the automakers have generally been on fire. (Ford, GM and VW are up 73%, 65%, and 46%, respectively.) EPS is growing faster than revenue -- so margins have expanded. Continental has been investing heavily in R&D for driver assistance systems, which has affected results. However, given its recent alliance with Cisco and reported alliance with Google, the investment appears to be paying off. 

CTTAY Chart

YCharts

As to other basic metrics: Operating and profit margins are 9.4% and 6.2%, respectively, for the trailing twelve months. ROE is a solid 24.8%. Revenue and net income were up 4.3% and 34.7%, respectively, in Q2. Debt-to-equity is 0.92.

Valuation is reasonable with the PE, forward PE, and 5-year PEG at 12.2, 9.7, and 1.1, respectively. 

Takeaways

Google's role in self-driving vehicle technology is well-known, so IBM, Cisco, and Continental could be the investment angle sleepers here. 

As to the larger picture, one thing is for certain: The line between the auto and technology industries continues to become increasingly blurred. 


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