Mobility Part 3: Three Key Considerations for Investing in Autonomous Vehicles

This week we visit our second category within the mobility thematic, that is autonomy. A topic that is arguably more important than the general electrification of transport, we arrive at three key considerations for those wishing to take advantage of the thematic. 

Think for a moment about the impact of this autonomy theme, not only within the automobile segment but the broader economy. The questions that spring to my mind include the impact on automotive sales, especially in densely populated geographies such as China? The economic impact in nations such as India where driving as a profession makes up the primary income source for over 150m people? On the flip side, the ultimate nirvana of fully autonomous vehicles (connected) should also reduce road accidents and fatalities. This is one topic that has clear benefits and will potentially lead to large dislocations in the overall economy. 

​Autonomy and shared mobility, which we refer to as ACES (Automated, Connected and Shared Vehicles), has already had a tremendous impact upon the border economy. Just think of the more well-known Uber and Lyft IPO’s and, in emerging markets, companies such as Ola. The way I try to contextualise this trend is to think about the evolution from the simple mobile phone to the smartphone, trends that are mutually reinforcing. Where the hardware (in this case the Electric Vehicle) is evolved into the fully autonomous vehicle (in this case software that enables connectivity in the same way as the iOS or Android systems make up the vast majority of the underlying interface that enables the features of the smartphone). As of today, the market for automotive software has been silently growing at about 7% annual CAGR with the market expected to grow to over $469bn USD by 2030 (Source: McKinsey). This is the first thing that the discerning investor should be aware off, the overall automotive market (characterised by end-user sales) is, in contrast, expected to grow at 3% p.a. over the next decade (assuming current trends are not changed). Simply put, the best opportunities do not necessarily lie in access to final producers or downstream so to speak, but rather in the components that make it up. As if that were not enough, it is more than likely that we will see the same creative destruction trends that we saw in other markets. Think about it in the same way that Apple revolutionised the smartphone market and now the market share of Nokia today. 

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​Within automotive software, as is the case with any new industries, there is significant divergence and segment-level variation. We have yet to see a centralised software or a player take the lead within the space. My view is that, unlike the automotive industry in general, the software itself might just be a winner takes all market (with the caveat being that it will be hard to judge who the leader might be), just as Google took close to the entirety of the search market and Windows (Apple’s iOS nonwithstanding) with the PC market. This is a place where the watch and wait approach might be best with a diversified pool of bets in the portfolio. Some listed companies within the space include, Keysight Technologies Inc (KEYS.NYSE), Thermo Fisher Scientific (TMO.NYSE), Materialise (MTLS.NYSE) and Silicon Laboratories Inc (SLAB.NASDAQ). Existing incumbents such as Microsoft, SAP, Autodesk, Dessault and Oracle are also making headways in building out divisions. 
 
Aside from software, we will continue to see advances made with regards to sensors. One can reasonably expect to reach double digit growth in this market as incumbents scramble to perfect the segment. These include shared mobility players and the more traditional auto manufacturers. Looking more in-depth, the backbone for the technologies can be categorised into two segments, ECUs (Electronic Control Units) and DCUs (Domain Control Units), which underpin VxV (Vehicle to Vehicle communication). The relevant leaders within these segments currently include Nvidia (NVDA.NASDAQ) and QualComm (QCOM.NASDAQ). We expect that high-voltage harnesses within ECU to increase whilst the converse is true for lower voltage (i.e. EV vehicles). 
 
That said, major players have already made certain headways including Volkswagen, which plans to adopt a unified automotive architecture, and BMW, introducing a central communication services and service-oriented architecture (SOA) providing a certain level of scalability. To date, the issues remain the security of the underlying software, the efficiency and efficacy of VxV communication and circuit level complexity. Rather than going into detail that might very well bore, think of it like the problems associated with making an iOS system communicate with Windows. The alternative could be open source and a centralised system with regulators effectively operating as the middle-man. For the more impatient investors, the companies that currently dominate the DCU market are Visteon (VC.NASDAQ), Continental AG (CON.ETR), Bosch (a private company other than their Indian operations) and Aptiv PLC (APTV.NYSE). The upcoming contenders include Chinese player, Huawei (not publicly listed), Desay (part of Huizhou Desay SV Automotive Co Ltd, 002920.SHE), Shenzhen Hangsheng Electronics (HSAE is also not public) and Neusoft (600718.SHA). 
 
What is perhaps interesting about the incumbent players vs. the upcoming players is the geographic segmentation and it adds a secondary consideration for the discerning investor. The first group are domiciled in the EU and US whilst the second are all domiciled in China. This is where we must consider geo-politics, as the Huawei situation has undoubtedly shown with regards to 5G, there will be lines drawn that makes the supply chain and investing a little more complex (and perhaps more profitable for the same discerning investors) since companies are not necessarily competing on a global landscape but within  particular spheres of influence.

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If regulatory responses were to go toward preferential treatment for certain players, this will almost certainly create scenarios of greater economic profit than would otherwise be the case in a truly competitive environment (in economics this is termed economic rent-seeking). It might very well be the case that it would be better to diversify portfolios across not only market-leading companies but also geographies with the added advantage that risk is mitigated somewhat by ensuring a base-level of profitability (i.e. even if the company is not necessarily best-of-breed globally, they may be profitable purely based on jurisdiction). 
 
To conclude, recognise the following:
 
1) There is a developing and evolving ecosystem of companies within the broader AV thematic;

2) The industry is still in its infancy and, if the past is anything to go by, then the winners are not so easily discernible, hence it is best to diversify at this stage;

3) Find market-leaders but with the caveat that it might be best to also diversify geographically since the macro political situation warrants and creates a scenario whereby the winners are not necessarily best of breed. For the older generation or the historians amongst you, think back to the creation of keiretsu firms in Japan (which now encapsulate the likes of Toyota and Mitsubishi) or chaebol firms in South Korea (think companies like Samsung, Hyundai and LG) which eventually became best of breed by economic rent-seeking, thus enabling the profits to be reinvested and allowing them to move up the value supply chain. Or, going back even further, American protectionism and policies that created the industrial giants of the late 19th and early 20th centuries. To put it even more simply, take the example of aeroplane manufacturers and ask yourself the following question: If I were to invest in aeroplane manufacturers, would it be more reasonable to choose Boeing or Airbus? Personally, I would spread the investment either equally or proportionally based on market share and it would help me mitigate the risk of regulatory intervention or tit-for-tat scenarios based on the vagaries of politics. Assuming of course that all I care about is a return on my investment and not normative questions.

Keiretsu:
Keiretsu is a Japanese term referring to a business network made up of different companies that have close relationships and sometimes take small equity stakes in each other, all the while remaining operationally independent.

Chaebol 
The chaebol structure is a South Korean business conglomerate structure that creates global multinationals with huge international operations. These structures are owned, controlled, and/or managed by the same family dynasty, generally that of the group's founder.

Source: Investopedia