Tippapatt
After watching the company closely for some time now, I have decided to downgrade Valens Semiconductor Ltd. (NYSE:VLN) to a Sell rating, which I will elaborate in greater detail below.
I have covered Valens Semiconductor on Seeking Alpha for some time now. In my latest article, I argued that if the company is unable to produce an automotive design win, which is key to the investment thesis, this will result in a downgrade for the stock. The Q4 2023 results have been published, and not only did the company push back on its target of achieving an automotive design win in 2023, its commentary suggests a lower confidence in achieving such a win in 2024 given the longer decision process and the cyclical downturn in the automotive industry.
Reasons for exiting position
Uncertainty about VA7000 design win
I have been mentioning this for the whole of 2023, and this was central to the investment thesis for Valens Semiconductor.
I wrote last May after the Q1 2023 results:
However, I am of the view that the key for the investment case for Valens remains to be an automotive design win, which will bring in new interest for the stock as a player with ADAS exposure. On top of that, its continued execution towards adjusted EBITDA breakeven by the end of the year will also bring added catalyst to the stock as this means that Valens will be operating on positive cash flows while having the room to grow.
To be fair, Valens Semiconductor did meet one of the investment thesis, given that adjusted EBITDA was $2.2 million in Q4 ’23. However, this was likely an easier one to achieve given that it is within the control of the team. In fact, in June 2023, Valens Semiconductor likely saw that it was not on track to achieve this goal of adjusted EBITDA break even by the end of the year and thus, announced a plan to improve operational efficiency.
This plan included streamlining development platforms and reducing research and development spend, along with reducing the employee headcount by 15%.
Based on the $9 million operating expenses this plan was expected to save annually, it likely contributed about $2.25 million each quarter. As such, in Q4 ’23, without this intervention in 2023, the goal of adjusted EBITDA breakeven would not have been achieved as well.
So for the automotive design win, what did Valens Semiconductor say in the Q3 ’23 quarter?
In the Q3 ’23 quarter, Valens Semiconductor did make progress on the bids that they are participating in for the VA7000, but there was increasing expectations that any potential design win could be potentially pushed back to 2024. This, according to management, was due to the longer than expected decision process of these automotive players.
And finally, in the Q4 ’23 quarter, the messaging seems to have changed once again. While management earlier said that the design win could be potentially pushed back to 2024, it does seem that they are less optimistic about this target in the Q4 ’23 quarter.
Firstly, CFO Guy Nathanzon mentioned that they are not providing any more information on new automotive design wins, changing course from the earlier disclosures.
This may help manage investor expectations because if the consensus is that 2024 will the year for a new automotive design win, and the company does not deliver, this might hurt the reputation of the company further.
Secondly, CEO Gideon Ben-Zvi was also more cautious about the new automotive design win that he was expecting in 2024 which was mentioned earlier in Q3 ’23. He merely commented that he expects to “continue to make progress towards securing the first VA7000 design wins.” He also did comment that the company continued to “make progress with various evaluation processes that they are participating in and have expanded their pipeline of opportunities.”
I do think that the change in messaging does highlight some form of difficulty in securing an automotive win or at least having any sort of visibility into this, which brings me to my next point.
Challenging environment
Valens Semiconductor has limited visibility into its own business not just in the first half of 2024, but for the whole of 2024, particularly so for the automotive business.
This is attributed to a weak market where the automotive market is experiencing a cyclical downturn. In turn, this has resulted in both demand slowing and weakening, and decisions being made more slowly.
Even for the overall semiconductor commentary, this was what management had to say, which does seem quite divergent with what other semiconductor players are saying:
As with the rest of the semiconductor industry, Valens Semiconductor continues to encounter challenging macroeconomic conditions and shorter lead times, which influence ordering and inventory consumption patterns.
Apart from the weakness in the automotive sector, inventory consumption patterns continue to be weak in the audio-video segment.
Just an audio-video player
The main problem I have with Valens Semiconductor is the fact that automotive has been a key opportunity and story management has been advocating since it went public.
The automotive opportunity is clearly huge for Valens Semiconductor in the connectivity side of things. The main supporting evidence for the company’s ability to compete meaningfully in the space is its earlier win with Mercedes, which has been around before it went public.
Since then, the company has failed to successfully announce another automotive win, which leads me to suspect the company’s value proposition and competitive positioning within the automotive space.
For now, I have to say that I am disappointed by the progress the company has made, and for now, I can only classify Valens Semiconductor as an audio-video player.
Deteriorating financials
Without any announcements made about a VA7000 automotive design win, the financial outlook for the company looks bleak.
From a revenue perspective, 2023 marks a high, and we will likely only see revenues return to 2023 levels in 2026. For 2024, revenue is expected to fall by 36% and recover partially in 2025.
Margins are also expected to deteriorate. For reference, gross margins for Q4 ’23 was 61.7% and for the full year of 2023 was 62.5%. For Q1 ’24, management guided for gross margins to be between 52.2% and 53%.
In addition, adjusted EBITDA is going back to a loss in Q1 ’24, with it expected to come in between an adjusted EBITDA loss of $9.7 million and $9.1 million.
This compared with the positive adjusted EBITDA of $2.2 million achieved in Q4 ’23.
To make things worse, management said that the current environment makes it very hard for the company to have any visibility on its business in the first half of 2024 and for the whole of 2024.
The rough expectation is for Q1 ’24 revenues to fall 54% from the prior year and for Q2 ’24 revenues to be flat sequentially.
Overall, the uncertainty surrounds the company’s financials, and worsening outlook does not look good for Valens Semiconductor, at least in the near-term.
Conclusion
All in all, I do not think that investors are rewarded sufficiently for the risk that they are taking in the name.
The company has initially pushed back the automotive design win to 2024, and now seems uncertain whether this can happen in 2024.
While the company went public with Mercedes as a customer, the company has had a lackluster track record in attracting and winning new automotive design wins. This does cause me to cast a shadow over their ability to be “just an audio-video player.”
In addition, the financials of Valens Semiconductor are expected to deteriorate significantly, with revenues falling from 2023 levels and not expected to recover to 2023 levels until 2026. The margin profile is also expected to worsen in the near-term as well.
Last but not least, both of the company’s segments are challenged. Its main audio-video segment has been weak and continues to be weak, while the automotive segment is experiencing a cyclical downturn.
With the Valens Semiconductor Ltd. management team not having visibility into even its first half 2024 results, this makes it incredibly hard for investors like me and you to forecast the company’s financials and come up with a reasonable estimate of its valuation.
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