This is the portfolio I run for The Motley Fool in which I try to find companies that are being mispriced by the market such that the expectations baked into the price (as explained in Alfred Rappaport and Michael Mauboussin's Expectations Investing) don't reflect what I believe the company is capable of. In addition, there must be a catalyst for those expectations to be corrected and for the share price to appreciate as that happens.
Given that description, you'd expect this to be a value-based approach. However, I don't ignore growth opportunities, either, especially when I believe the growth is going to be even higher than what is expected. Such situations can be incredible drivers of wealth creation -- think Wal-Mart (WMT -1.61%) or Microsoft (MSFT 0.67%) back in the day. They always "look" overpriced, yet the businesses performed even better than what's expected and the share prices went up phenomenally.
I believe I might have found another today in Mobileye.
Maybe you've seen the Hyundai commercial in which a dad saves his son from all kinds of accidents while the boy is growing up. At the end, we see the car save the young man during a female-distraction moment by automatically braking before a rear-end collision can happen. The company behind that auto-braking system is Mobileye.
For 15 years, Mobileye has been developing ways for automobiles to see and respond to what they are seeing, just the way we humans do -- but better, faster, and all the time. Management said in the recent second-quarter conference call that by using cameras mounted in cars "we have collected millions of recorded miles of road experience data across more than 40 countries at all times of day and in all types of weather." That database lets the company train algorithms to recognize road signs, lane markers, pedestrians, bicyclists, and other vehicles in all kinds of lighting conditions and at all kinds of speeds.
Knowing what's around the car enables the system to calculate things like car position, distance, and closing speed, and to not only give auditory and visual warnings if the driver does something dangerous (like drift out of the lane), but take over the vehicle to prevent an accident, as in that commercial.
According to the World Health Organization, there were 1.24 million traffic fatalities worldwide in 2010 (latest data). Half of those killed were motorcyclists, bicyclists, or pedestrians. If the vehicle could see those accidents coming in time to warn the driver or take action itself (called an advanced driver assistance system, or ADAS for short), a great many lives would be saved and injuries reduced, to the benefit of victims and drivers alike. The safety implications are enormous.
There's convenience, too. How much do you enjoy being stuck in a traffic jam's seemingly endless stop and go? Wouldn't it be much less frustrating if the car did all that while you used your smartphone, read, or closed your eyes and listened to music, without having to worry about hitting the car in front or keeping a safe distance? It's coming.
Beyond that, in 2016 cars will begin showing up that will drive the freeways for you. Shortly thereafter, the company expects its systems will be helping drivers navigate country roads, and by the end of the decade, city streets.
Computers are faster and more accurate than humans, and they don't get distracted by pretty girls. Now that computer and camera components are getting cheap enough, it's possible for a longtime dream of millions to come true: let the car itself drive.
Since the company went public last month, shares have risen steadily from the opening day price of $36, though recently they fell back a bit. Near the recent high of about $59 per share, priced-in free cash flow growth was 66% annually for the next five years, 33% for the following five years, then 2.5% going forward (at a 12% discount rate). Using a 15% discount rate, the respective growth numbers were 75%, 38%, and 2.5%. Using last night's closing price of $47.60, the growth numbers are 61%, 31%, and 2.5% (at 12% discount). No matter how you look, that's a lot of growth priced in.
However, I believe the company will not only meet those expectations, but beat them. In other words, the market and Wall Street analysts are underestimating what will happen.
1. As of 2012 (latest data), there were over 1 billion cars, trucks, and buses registered around the world.
2. In 2013, 87.3 million cars and commercial vehicles were made, split 3:1, respectively. Just 2% of new cars have ADAS today.
3. In the most recent quarter, Mobileye sold 627,000 units (up 126% year over year), and revenue was split about 85% OEMs, 15% after market.
Let's look at some implications. First, very few safety regulations today require systems such as Mobileye's to be installed in new cars, though that is likely to change. Europe is already moving in that direction, and the rest of the world is likely to follow suit (and Mobileye is pushing on this front). One analyst predicted that by 2022, 50% of new cars will have ADAS, a growth of at least 25 times in eight years, translating to 50% annual growth.
Note that the systems Mobileye sells today will not be the systems it sells in 2022, as the company keeps adding new features (moving from auto-braking today to full driving tomorrow). It can raise system prices for those new features -- as it demonstrated last quarter -- so revenue growth from OEMs is likely to be higher than 50% per year.
Second, installing ADAS into vehicles already on the road is a small market for Mobileye, but is likely to become much bigger. Right now, few insurance companies offer discounts for this safety feature (let alone require it), though Mobileye is working on this front as well. Furthermore, it takes a mechanic to install, which means time and hassle for the consumer. Here, Mobileye is working to develop an ADAS with ease of installation that will approach that of plugging in a GPS system and mounting it on the windshield.
Once consumers become more aware of ADAS and what it can do, and it becomes easier to install aftermarket (and more insurance companies offer discounts), I expect this part of the business to grow substantially, possibly faster than OEM revenue growth.
Third, Mobileye has a lot of operating leverage because it doesn't require much capital investment or growth of SG&A expenses at the same pace of revenue growth. As a result, net income is growing faster than revenue. For instance, over the first six months of the year, revenue grew by 136%, but non-generally accepted accounting principles net income (excluding share-based compensation) grew by 183%. That translated to free cash flow of 748%. Now, I don't expect that free cash flow versus net income growth discrepancy to last long, but I do expect net income to grow faster than revenue and for free cash flow growth to pace that (as management suggested).
Finally, both personally and in the MUE portfolio, I'm a long-term investor. I can buy shares of what might appear to be an overpriced company and wait for the company to gain traction and grow faster than anticipated. Thus, the MUE portfolio will buy shares of Mobileye soon.
This article has run fairly long already, and there's more that I've learned and expect to happen that won't fit, so I urge you to come over to the MUE discussion board, where I will share more and we can discuss more implications of what I expect to be a megatrend.