Investors fell in love with electric vehicle (EV) and renewable energy stocks in 2020 and 2021. Dozens of start-ups in these fields went public through reverse mergers with special purpose acquisition companies (SPACs) a few years back. Most of them have now failed or are down significantly from their IPO prices, going through a classic boom-and-bust cycle. Now, they are in the bust.
QuantumScape (QS 5.69%) was a quintessential bubble stock from 2021. At one point, the battery technology start-up had a market cap of $50 billion. It has never generated any revenue. Now, shares are down 94% from their peak, and its market cap sits at a relatively small $4 billion as investors have lost their patience for money-losing EV and renewable energy SPAC stocks.
But could QuantumScape be an opportunity for contrarian investors today? The company is making a lot of progress with its innovative solid-state batteries and could reach commercial production soon.
Making progress in battery technology
QuantumScape was formed in 2010 by Stanford University professors looking to revolutionize the battery technology space. Since then, it has narrowed its focus to making a solid-state battery for electric vehicles. Solid-state batteries are different than the batteries currently used in electric cars, which are lithium-ion batteries with a liquid electrolyte. Without getting bogged down in the technical details, solid-state batteries can be more energy-dense than the batteries used today. The promise of the technology is a safer battery with a longer life and faster charging.
The problem is that making commercially viable solid-state batteries has proved incredibly difficult for those companies that have tried. But QuantumScape -- after close to 15 years of work -- may finally be cracking the code. It recently shipped prototypes of its solid-state batteries to automotive manufacturers including Volkswagen Group, and apparently, these prototypes have exceeded performance goals in testing. Automakers would love to get their hands on solid-state batteries, which could, in theory, give EVs a 1,000-mile range on one charge and much faster charging times, essentially removing two of the huge impediments to wider adoption of electric vehicles.
While its batteries are not yet in commercial production, QuantumScape appears to be right on the edge of making the solid-state dream a reality. Financially, it could mean a windfall, particularly if QuantumScape is the only company to crack that code in the near term. Batteries are the single largest cost in the construction of an electric vehicle, ranging from $4,000 to $20,000 per car, depending on the size. If QuantumScape sold 1 million EV batteries each year at a $5,000 average price, that would equal $5 billion in revenue.
QS Free Cash Flow data by YCharts.
The stock is down, but is it cheap?
There is clearly a lot of potential for QuantumScape. But investors need to stay cautious with this stock. Remember that the company currently generates zero revenue. With its substantial research and overhead costs, the company has been burning approximately $350 million a year in free cash flow. After raising a ton of money through its SPAC merger, it still has over $1 billion in cash on its balance sheet, which should give it a few years of runway left before it runs out of money. So there is no worry that QuantumScape will go bankrupt tomorrow, but it needs to show that its solid-state batteries are viable for automakers within the next year or so.
If QuantumScape proves its solid-state batteries can be commercially used, the next step will be to ramp up its manufacturing production. While that would naturally be a good thing for the business, battery manufacturing is expensive, and getting started comes with a ton of fixed costs. Just look at Tesla in its early days of mass production. It was burning upwards of $5 billion in cash flow a year before it reached a large enough scale to start generating positive cash flow. To scale up manufacturing, QuantumScape will need to either take on a lot of debt or raise funds via secondary stock offerings (or both). Either option would present headwinds to creating value for shareholders.
There are a lot of risks to a QuantumScape investment. Despite this, there is still a ton of upside for this potentially revolutionary company. If you want to buy some shares this year, make it a small position in your portfolio. That way, if the company fails -- which is a real possibility -- your losses will be minimal. But if it succeeds, you'll still get to participate in the gains.
