Business

Luminar Technologies is involved in the manufacturing, development and sale of light and range sensors, called ‘lidar’, which are an essential component in autonomous vehicles.

Luminar is currently developing software relating to their hardware products, although this is still in the development phase and is not it yet commercially available.

One recent development that may give investors concern when shorting Luminar is recent insider buying. Significant insider buying is one of the strongest signals that a security is underpriced, and there has been significant insider buying from the CEO.

"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." – Peter Lynch

In the case of Luminar, there are several reasons why this otherwise useful signal is not an accurate indication of future prospects. First, despite the recent insider buying, insider ownership has been down since Luminar’s IPO in 2020.

Insider owned 41% of Luminar in December of 2020, whereas they owned 29% in February 2023. Despite the decrease in insider ownership, the number of officers and directors has increased. This means that the insider ownership per director has decreased by an even more dramatic degree.

Looking to previous inside buying as a signal that Luminar’s stock price is due to rise has not produced reliable returns. With shares trading at $6.33 today, it is interesting to note that Austin Russell has purchased shares in Luminar for $16.49 in February 2022, which was followed by a drawdown of over 75% when Luminar shares closed at $3.95 on January 6th 2023, and is still more than twice what Luminar shares are trading for today.

There has been a significant turnover of higher ups since the company went public. Of the 8 executives and directors who served the company when it initially went public, only three remain. Austin Russell, Alec Gores, and Thomas Fennimore. As founder and CEO, Russell could not leave the company without causing an immediate drop in the stock price. Alec Gores has no significant operational or technical expertise. It was his blank cheque company, Gores Metropoulos, through which Luminar went public in 2020. Losing 62.5% of your senior management in 2.25 years corresponds to a 35.33% churn rate, hardly desirable.

Austin Russell’s life story is compelling and hits many of the Silicon Valley fairytale startup beats. Many VC firms take a ‘Founder focused’ approach to investing, focusing more on the qualities of CEO than more conventional factors, such as industry, strategy, and valuation. Austin Russell founded Luminar Technologies in 2012 at the age of 17. Russell then enrolled at Stanford University but dropped out to focus on Luminar Technologies full time after being awarded a Thiel Fellowship. Luminar Technologies operated in ‘stealth mode’ until 2017. Luminar then emerged from stealth mode, raising series A funding, launched a partnership with the Toyota Research Institute, announced a partnership to supply lidar technology for Volvo self-driving cars while also being a recipient of an investment by Volvo’s venture capital firm, Volvo Cars Tech Fund. Luminar Technologies merged with Gores Metropoulos and went public via SPAC. A frothy market environment combined with low interest rates pushed Luminar to $37.73 per share. Russell’s 32.5% stake in the company made him, briefly, the world’s youngest self-made billionaire.

An investor taking a ‘Jockey-not-horse’ approach to Luminar Technologies may also have reason for concern. I would question Austin Russell’s division of time between Luminar and his personal life going forward. Austin has acquired an 82% stake in Forbes in May and purchased an $83 million home in Palisades, California. The economic expectations implied by Luminar’s current stock price mean that anything less than extremely impressive financial results going forward will have a significant adverse effect on its stock.

Luminar Technologies has an unusually high, even extreme, degree of credit risk. Three customers accounted for 61% of Luminar Technologies accounts receivable. When you compare this credit risk to the companies Luminar Technologies has signed contracts with, Toyota Motor Corporation and Volvo, both of which are consistently cash flow positive and not in risk of breaching their debt covenants, it is not likely they will not default on their obligations to Luminar. It is worth nothing that Luminar Technologies has an unusually long Cash Conversion Cycle, one that will likely continue to persist as they attempt to prove out their technology.

Industry

Autonomous driving has long been hailed as a breakthrough technology. Any company that could fully free people’s concentration from driving would create a large amount of economic value. Rather than focusing on the road, individuals could work, watch television and movies, or browse the web. It would also make organising and attending social functions involving alcohol easier as there would no longer be the need to have a designated driver. Simply put, a vehicle capable of fully autonomous driving would be a huge advance and the company responsible for such a breakthrough would likely create a large amount of value for shareholders.

While autonomous driving is an exciting technology, it has proved elusive. Advancements have been made in self-driving technology but the holy grail, Full Self Driving, has still not materialised, even as some of the biggest companies in the world pour billions of dollars into Research and Development.

Elon Musk promised a Tesla would complete a fully autonomous, cross-country trip by 2017, which did not happen, and Tesla’s today are still not fully autonomous.

Waymo, a subsidiary of Google’s ‘Other Bets’ segment and another leader in FSD, has had better luck. The Waymo One has begun offering fully autonomous ride hailing in select locations, namely San Francisco, although human drivers will occasionally be present in the vehicle.

Luminar Technologies relationship with these two FSD leaders should not be a cause for celebration for shareholders.

Tesla experimented with lidar sensors in 2021, but has since pulled back on the technology and opted instead to pursue a radar based approach. Waymo uses their own internally developed lidar sensors but has stopped selling their own lidar sensors to other companies. In the same announcement, Waymo indicated they would continue building their own lidar sensors. This indicates that selling the lidar sensors is a difficult business to earn above average returns on capital on, a potentially foreboding sign for Luminar Technologies.

Competitive Advantages

Luminar Technologies biggest competitive advantage is intangible in nature, it’s Research and Development Intellectual Property. Luminar Technologies currently does not have any significant manufacturing capabilities, although management is optimistic that these facilities will be operational by the end of 2023.

I believe the value the market places on Luminar Technologies intellectual property puts Luminar in a ‘damned-if-you-do-damned-if-you-don’t’ position. Luminar needs to cut spend on R&D to reduce their cash burn but cutting R&D would be damaging to the most valuable part of the company.

I am sceptical that Luminar, should they successfully build out their manufacturing base, will earn returns well above their cost of Capital. As was briefly touched upon earlier, Waymo previously used to sell their own sensors but ceased doing so. At the time of writing, Apple is currently the most profitable and highly valued company in the world. Apple earns ~30% gross margins on their hardware. Management has reaffirmed that they are on track to achieve prior guidance, and hopes to become gross margin positive by the end of 2023, but has couched this in their 10-K.

“We believe that we will continue to incur operating and net losses each quarter until at least the time we begin commercial deliveries of our lidar-based products, which are not expected to begin until late 2023 and may occur later or not at all as we face challenges setting up outsourced manufacturing.”- 2022 10-K

Investors may argue that Luminar Technologies is in the process of developing a strong network effect around their technology. As more cars adopt Luminar lidar sensors, they can collect more data, leading to better sensors, leading to more cars adopting lidar sensors and so on. If you are already familiar with Luminar Technologies and this is part of your long thesis on the company, I would recommend caution. There are already companies with sensors that have achieved partial FSD capabilities. These companies have already begun building their network and will enjoy a first mover advantage over Luminar.

Valuation

I estimate investors can earn a -31.46% IRR if shares are purchased and held for 4 years. The assumptions that I used for building my valuation are expanded upon below.

A link to the DCF and DCF notes in excel form can be found by clicking this link

The current valuation of Luminar Technologies is one of the strangest aspects of this thesis. Luminar Technologies currently trades at roughly 40x run rate revenue or 50x TTM revenue. This multiple is applied to a company that, in increasing order of concern, has never been profitable, never been free cash flow positive, never been operating income positive, never been EBITDA positive, never had positive cash flow, and has posted two quarters of positive gross profit since 2019, $540,000 of gross profit in Q3 2019 and $30,000 in Q1 2020.

It is difficult to attempt to value Luminar Technologies as most of the measures that are typically used to value companies, Net Profit, EBIT, EBITDA, Cash flow, and NOPAT, are all negative. I am therefore forced to use Revenue as a multiple, despite my misgiving about its usefulness as a measure of terminal value. Even assuming a 10x Revenue multiple in 2026, a very generous multiple that very few companies deserve to trade on, my model still generates a negative IRR.

Credit must be given where credit is due, and in December 2021, Luminar Technologies issued $625m aggregate principal amount of 1.25% Convertible Senior Notes due 2026 in a private placement. Securing such a large debt raise on such favourable terms was a shrewd deal, and without a doubt extended a lifeline to the company.

At the time of writing, Luminar has $89.9m in cash, $2.2m in restricted cash, and $332.3m in marketable securities, compared $613m in Convertible senior notes, coming due in 2026. Luminar’s cash flow from operations for its most recent quarter was -$64.674m, or on a run-rate basis -$258.7m. Even assuming marketable securities could be sold for 100c on the dollar, this gives Luminar 1.6 years, at best, before they are forced to return to debt or, more likely, equity markets for a capital raise, which will likely be much more punitive than their previous debt raise. This is assuming that the cash burn does not increase, which has not historically been the case.

Risks

Shorting based on valuation always has inherent risks. When a company’s stock becomes radically detached from its underlying financial performance, there is often no limit to how far it can go. A positive development can lead to a jump in stock price, which can draw the attention of momentum traders, pushing the stock higher through buying pressure. Luminar has a short float of roughly 25%, and the occurrence of a short squeeze is a possibility. I would strongly recommend any investor considering taking a short position in Luminar hedge their position by purchasing call options at a strike price that would protect them from incurring any losses they deem untenable.

While I believe my thesis in shorting the company is sound, one aspect that does concern me is a lack of a strong catalyst. I briefly touched on Luminar’s customer concentration risks, which may materialise, and may not. The inverse of this risk is that Luminar may sign another large contract with a customer. I believe cash flow issues will eventually cause issues for the company, but given a 7.15% cost to borrow, it is preferable (if you are short) that there be operational issues or negative outside events that adversely affect the company, and minimise the time you maintain an open short position. Management has recently reaffirmed guidance, including 100% revenue growth compared to 2022 and achieving positive gross margins by Q4 2023. Even achieving these goals is likely not enough to avoid cash flow issues, as I hope I illustrated in the ‘Valuation’ section of this thesis.

Closing thoughts

At the time of writing, it is the 25th of September 2023, and I am closing this blogs position on Luminar Technologies.

Luminar Technologies closed at $4.32 today, representing 31.8% decline in price since being posted to this blog. This has occurred over 90 days, which corresponds to an IRR of 206%. At a 7.15% cost to borrow, this corresponds to a 30% profit on the position and an IRR of 189.5% after paying borrowing costs.

Despite me believing it is likely that Luminar Technologies price may continue to fall from here, there are two primary reasons why I am closing this position.

While I am happy with the result of the position, and still believe my underlying thesis remains intact, I am growing increasingly uncomfortable with having an open short position from a portfolio management position. Luminar Technologies was the 6th company profiled on this blog and, as a result, represents 16.6% of the blogs positions. I am not comfortable having 16.6% of the blogs performance tied to a short position that can move against me quickly.

The second reason is that I am doubtful that the forward IRR from this position will be as attractive as it was in the past. There is not an investor alive who can consistently generate 190% IRRs. The drop is price is more attributable to flows than skill. I was lucky this time, I will be unlucky in the future.