Related Tickers: MBLY, GPRO, AMBA

• Shares of leading driverless car technology company, Mobileye, have been selling off heavily after Citron Research released a bearish report about the company.
• Citron raised several pertinent issues about Mobileye, including the apparent overvaluation of the shares, growing competition, and minimal R&D spending.
• A deeper look at the Citron report, however, reveals that it contains some serious flaws that discount the bear thesis.

Shares of leading driverless car technology Mobileye (MBLY) have been selling off heavily since buy-side analysts Citron Research issued a damning report about the company short-term and long-term outlooks.

Since Citron released the shares on Sept. 9, Mobileye shares are down close to 13% and still falling.

Source: CNN Money

In its report, Citron Research raised the following salient points about Mobileye:

Mobileye stock sports an absurd valuation

Mobileye shares sport a Price-to-Sales of 66. In comparison, tech companies with significant exposure to driverless car technology sport much lower valuations. For instance, Nvidia (NVDA) and Marvell Technologies (MRVL) sport low PS ratios of just 2.20 and 1.83, respectively.

Source: Citron Research

Further the company pointed out that Mobileye stock would find it hard to grow into its stratospheric valuation even if the company maintains a high revenue growth of 50%-60% over the next two years.

For good measure, Citron pointed out that while Mobileye might maintain high growth rate over the next two years, the fact that it no longer owns a monopoly in ADAS (Advanced Driver Assistance Systems) due to increasing competition from companies such as Bosch, Continental, and Delphi will make it hard to maintain high growth rate over the medium-and long-term. Moreover, companies such as Denso and Autloliv that formerly partnered with Mobileye for ADAS have already started supplying their own ADAS products.

Mobileye’s R&D Spending is miniscule

The second important point that Citron raised regarding Mobileye is that the company has been spending very little on R&D, especially when you compare it to what other chip companies are spending. Mobileye spent $36.9 million on R&D, which translates to a mere 0.3% of its enterprise value.

Source: Citron Research

Citron Research also pointed out that there has been a massive amount of insider selling of the shares. The research company reported that Mobileye insiders had sold shares worth $1.6 billion since it’s IPO, or about 396% of gross revenue during the period compared just 39% and 10% for GoPro (GPRO) and Ambarella (AMBA), respectively.

Citron Research said that Mobileye is going through a ''Hype Cycle,'' similar to the one 3D printing stocks went through barely two years ago. Citron Research gave Mobileye shares a near-term PT of $25 and a long-term PT of $10, well below the current $45 price. This came as a stark contrast to recent upgrades by Citi, CLSA, Wells Fargo, Baird, Wells Fargo, and Baron Capital.

Why Citron Research is wrong about Mobileye

Let me start by giving credit where it is due. Citron has a pretty good track record when it comes to shorting stocks, and it’s hardly come as a surprise that the investment world listened when the company bashed Mobileye. The points the company raised on valuation, growing competition, and minimal R&D spend all carry some merit.

But the overall thesis is flawed due to a few things that the company missed. Let me start by discounting the premises that Mobileye is a mere chip company. This simply isn’t true. Mobileye is a proprietary technology at the forefront of a new and very promising technology. The company just happens to make its own ADAS chips. What truly sets Mobileye apart from its rivals is that it has accumulated 12 years of research data that its competitors have not. This is the reason why Mobileye is regarded as the true leader in the ADAS space. The company has won very significant design wins in the recent past. To be fair, some of its competitors are well-heeled and can afford to outspend Mobileye in R&D. But it’s highly doubtful they can manage to close the technology gap within 2, 3 or even 5 years.

Come to think of it, Intel (INTC) is the largest semiconductor chip manufacturer, yet has struggled mightily trying to get a proper foothold into the mobile chip business. Intel has, as a result been forced to book heavy losses as it tried to lure mobile phone manufacturer to use its chips by offering generous subsidies and contra revenue. All this has not helped the company's mobile ambitions much. Apple (AAPL) might not have had as much cash as Intel to spend on R&D when it launched its first iPhone. Yet the company has managed to crush its competition in the high-end segment of the market due to a definitive first-mover advantage and making great products. While having a first-mover advantage might not inure you from future competition, it does count for a lot. And Mobileye has a large first-mover advantage in ADAS. So it’s erroneous to assume that competition will kill it off so easily. Mobileye might well turn out to be the Apple of self-driving car technology.

Citron Research, either deliberately or through an oversight, chose to compare Mobileye’s R&D spend to its EV instead of sales as is the usual practice. Though it’s okay to use EV, the more common practice is to use R&D/Sales. Mobileye spent 25% of its revenue on R&D in 2014. That compares very well with the percentage of revenue spent on R&D by the other companies on Citron’s list, and even higher than that by companies such as Qualcomm (QCOM) which spent 20% of its 2014 revenue on R&D. Moreover, it misleading to compare pure-play chip companies, including analog chip companies such as Texas Instruments, with Mobileye since these companies spend their R&D cash on diverse fields of research whereas Mobileye dedicates all its R&D spending on ADAS.

Citron compared Mobileye to 3D printing systems ostensibly because driverless cars are little more than hype. But that again is misleading. Large tech companies such as and Google (GOOG) (GOOGL) and Apple, which have heavily invested in self driving cars  . This is not something that we saw with 3D printing. Although many auto companies won’t be launching their first fully autonomous vehicles before 7-8 years, a few like Audi plan to launch in about two years’ time.

But fully autonomous cars are just part of the market for ADAS. The NTSB has been pushing for collision-avoidance systems to become standard on all vehicles noting that just 4 out of 648 models in the U.S. sported full collision avoidance systems in 2014. So the market for ADAS systems could turn out to be much bigger than what many naysayers anticipate, thus giving Mobileye ample growth runways.

Takeaway

While Mobileeye shares still look overvalued, that is pretty normal for market leaders in high-growth industries. In the current choppy market, the shares could continue sliding. But, there is no good reason to believe that Mobileye will run out of growth runways any time soon. Investors should buy once the shares drop by another 10% or maybe 15% if the bear market continues taking a toll on the tech sector in general.