Why the NIO IPO is the ultimate test of market froth

Peter Garnry

Head of Equity Strategy

The electric vehicle and battery industry is one of the hottest investment themes today with massive government backing meant to kickstart a revolution in transportation away from the internal combustion engine (ICE). US-based battery electric vehicle producer (BEV) Tesla has so far pioneered the industry and remains dominant in the developed world in brand terms. However, China is already now the biggest BEV market in the world with many of its large carmakers producing electric cars for the masses.

China has to have everything that the US has, and now the Chinese company NIO, often called 'China’s Tesla', has announced plans to offer shares to US public markets. While the offering represents an opportunity to invest in this emerging new industry, it comes with great risks. The offering is aggressive and will be the ultimate test of market froth in the latter part of this economic cycle.

The offering and share capital

NIO states in its F-1 registration statement that it intends to offer 160,000,000 new Class A ordinary shares to the public in the $6.25-8.25 price range with a mid-price at $7.25 and an additional over-allotment option to the investment banks of 24,000,000 new shares. The shares will trade on the NYSE with the likely Saxo Bank ticker symbol of NIO:xnys. The expected pricing date is set to September 11 with the first day of trading on September 12.

Total outstanding shares immediately after the IPO, excluding the over-allotment option, are 1,011,041,978, translating into a free float of 15.8%. Based on the maximum offer price, NIO’s IPO proceeds will be $1.32 billion. If the over-allotment option is exercised, additional proceeds will be raised after the IPO.

The share capital structure is a triple-class ordinary share structure with the IPO comprised of Class A ordinary shares. Class C ordinary shares will represent 47.8% of the voting power immediately after the IPO, which means that public investors will exercise little control over NIO. Of all the IPO prospectuses we have analysed in the past, this one leaves us notably perplexed. The capital structure is complex and the overview of the share capital before and after the IPO is often confusing and unclear. We are thus cautious on the offering.

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Source: F-1 statement, Saxo Bank
As the shareholder structure table below shows, the founders and executive management sit on the majority of shares in addition to two large shareholders (Tencent and Hillhouse Capital Group) and will effectively dominate the voting power immediately after the IPO.
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Source: F-1 statement, Saxo Bank
The business

NIO was founded in late 2014 in Shanghai and has just started minimal production of its supercars and luxury cars. The company says its mission is “…[to] shape a joyful lifestyle by offering premium smart electric vehicles and being the best user enterprise”. The company’s EP 9 supercar was a clear marketing stunt to stir up excitement and interest in the company – the same PR strategy that Tesla pursued many years ago. Its first volume manufactured car is the ES8 (pictured below) which is a luxury SUV that the company started delivering to users on June 28 of this year.

As of August 30, the company has delivered 1,602 ES8s and has unfilled reservations for 15,778 ES8s with deposits. NIO plans to launch its second volume-manufactured BEV, the ES6, by the end of 2018 and start deliveries in first half of 2019. The ES6 is basically a more affordable version of the ES8.

In addition to physical EVs, the company is also engaged in autonomous driving with already commercial Level 2 autonomous driving capabilities. NIO’s system uses 23 sensors and the cars are equipped with Mobileye EyeQ®4 ADAS processor (Intel bought Mobileye in August 2017). Based on the low (so far) production numbers, the total miles driven by the NIO produced cars is likely very low and as a result the data available for training the deep neutral networks is minimal compared to Tesla and Waymo.

It’s our view that the boosting of autonomous capabilities is more for signaling value in the IPO than actual commercial value at this point.
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Source: insideevs.com
As noted, China is already the largest BEV market in the world. It's also growing faster than any other market as the Chinese government is determined to fight pollution in its major cities while building a strategic industry on par with its US and European counterparts. 

See the graph below for forecasted new BEV sales globally:
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Source Bloomberg New Energy Finance (Electric Vehicle Outlook report, updated May 2018)
The graphic below shows NIO’s own strategy for positioning itself in the BEV SUV market by essentially offering the same premium features as the Tesla Model X – the best-selling BEV premium SUV – at a significantly lower price point. This is obviously a compelling offering, but the main question is whether it can be done at a high enough production volume to make it profitabile through economics of scale. 
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Source: F-1 statement, Saxo Bank
Immature and confusing numbers

NIO is likely one of the most aggressive IPOs seen in the US over the past 10 years. Based on the expected shares outstanding immediately after the IPO and using the mid-price, the estimated market value is $7.33bn and that’s for a car company with less than 2,000 deliveries.

Adding the substantial debt on the balance sheet, the enterprise value is estimated at $9.73bn compared to Tesla’s $61.6bn. Tesla is the only other publicly-listed pure BEV manufacturer in the world so it’s the only sensible yardstick for any comparison.

The market capitalisation figures have been calculated using an exchange rate on USDCNY of 6.8195.
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Source: F-1 statement, Saxo Bank
Another puzzling fact about NIO is its limited financial metrics. As the tables below show, revenue was just been recognised in H1'18 as the first cars have just been delivered. It is difficult to get any meaningful historical metrics as the group consolidated figures are only available for 2017. The 2016 group consolidated figures have been created, as well as is possible, from the parent company's figures for 2016. This leads to inconsistencies and a lack of transparency. We do not even have H1'17 balance sheet numbers for either the parent or the group.

As the figures are massively negative, no meaningful financial metrics make sense. The only meaningful metric we can compare to Tesla is the enterprise value to total assets as any measure of valuation. Tesla’s EV/Total assets ratio is 2.21x compared to NIO’s of 6.46x. So despite no revenue or meaningful production volume, the company wants the market to value its assets to Tesla's at a factor of three.

Some of the valuation premium obviously reflects that NIO has easier access to the Chinese market than Tesla and thus potentially has a bigger immediate addressable market, but it ultimately seems too excessive. In the last 12 months, NIO had a negative EBITDA of $916mcompared to Tesla’s EBITDA loss of $326.2m. The valuation and financial numbers warrant a very severe risk disclaimer. It will be exciting to see whether the company can successfully IPO without any significant headwinds prior to and after the offering. This might very well be the greatest test of equity market froth in this economic cycle.

Financial figures (income statement figures are consolidated to group numbers as best as possible):
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Source: F-1 statement, Saxo Bank
The table below shows some of the key VIE (variable interest entities) that NIO (the parent company) holds economic interest in, with NIO Technology Co., Ltd. being the most important entity:
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Source: F-1 statement, Saxo Bank
The risks are high

The opportunities in the emerging BEV market are large but they come with significant risks. Investors in NIO probably face the largest risk out of all the ways to play the BEV technology. Tesla is already an established and potentially soon profitable business, and the existing carmakers with large financial resources are ramping up R&D and production BEVs.

The biggest risk for NIO investors is that NIO cannot scale production fast enough while being profitable. As the production volume since inception is still small, there is massive uncertainty about the company’s ability to manufacture BEVs at scale. Tesla has demonstrated that producing cars at scale is a difficult task. NIO is also running large operating losses and carries significant debt on its balance sheet through preferred shares (convertible) which is likely to force NIO back for more financing in the future, diluting shareholders.

NIO is also fighting against a historically very low success rate for new car companies. Another key risk for NIO investors is its manufacturing partnership with state-owned car company Jianghuai Automobile Group, which increases the risks as NIO does not control the manufacturing process and cannot be sure of extending production capacity if needed.

As Tesla’s history shows, any delays in production and deliveries can negatively impact the balance sheet and the business. Lower oil prices are also a key risk to the whole BEV industry as it makes ICE cars more affordable on a relative basis. NIO will operate and sell the majority of its cars in China and thus continuous government support for BEVs is absolutely critical for future demand. Thus, investors in NIO face substantial regulatory risks.

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