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After the close, I was surprised that Enovix (NASDAQ:ENVX) was down 42%. I had to go deeper into the recent quarter to find out what was it that investors were selling off to, and whether this was actually an overreaction.
Investment thesis
I have written an initial article as well as a subsequent article that illustrates why I think Enovix will be a leader in the designing and manufacturing of silicon lithium-ion batteries. My investment thesis for Enovix remains intact after the recent quarter and are as follows:
- The key differentiator for Enovix is that the company is able overcome the challenges faces by silicon anode batteries in general and introduce a battery that has strong technological capabilities, high energy density and a solid safety profile.
- The company is in active engagements with 6 mega-cap technology companies, 2 of which have brought about design wins. This strong customer profile further illustrates the first point on the technological leadership that Enovix’s battery has, bringing superior performance to large customers.
- Asia is another region that Enovix is positioning itself for as it looks to attract large customers from the region.
- Progress continues with Enovix Mobility as fast-charging becomes a key differentiator for Enovix’s products in the mobility market.
Growing conviction on demand from the largest companies
Enovix currently as active engagements with 6 mega-cap technology companies and it has design wins with 2 of these mega-cap technology companies. The big announcement from the earnings was of course the non-binding Memorandum of Understanding (“MoU”) with one of these companies. This is one of the largest consumer electronics companies in world and this MoU sets up the framework for the 2 companies to have a long-term business relationship to use Enovix’s leading, next generation 3D silicon lithium-ion batteries for consumer electronics. The value add is clear as Enovix’s batteries are able to improve energy density and bring battery innovation required to be the catalyst for the new technologies of tomorrow.
This MoU is significant as it brings progress to the relationship with this customer and extends this relationship beyond the consumer smartwatch segment mentioned earlier and brings much more opportunities as Enovix and this customer will collaborate to bring their battery technology to this customer’s broader product portfolio, and also to discuss further on scaling up of manufacturing for large scale production. While there are still couple more milestones to be reached before product launch, this MoU is definitely a significant step forward for both parties, in my view.
The company is well positioned in the portable electronics market as it has more than 75 accounts in the market due to their strong technology capabilities, high energy density and safety profile.
In addition, the company is also trying to extend and grow its reach in Asia with its recent expansion there. As a result, management also disclosed that they have engagements with the leading smartphone OEMs in China as well as large consumer brands in Korea and Japan like Samsung (OTCPK:SSNLF). I like the progress I am seeing in the Asia region as Enovix is likely to attract the largest technology companies in the region, similar to what it has done in the US.
Enovix continues to have strong interest from auto manufacturers due to the fast-charging capabilities of Enovix’s batteries. Management shared that they shipped some products for testing to a Tier 1 electric vehicle battery supplier as well as a top 10 global auto OEM player. Management states that they are looking to identify auto OEM partners sometime next year to bring further progress to the segment and expand Enovix’s market opportunity.
With the scope of the recent MoU announced, it seems likely that the customer has a broad portfolio of products like laptops, smartphones and wearables. As such, some of the likely mega-cap candidates would be Apple (AAPL) and Samsung, in my view. With interest from 6 mega-cap technology companies that will drive large volumes, as well as interest from other smaller consumer electronics companies, there is a broad-based demand for Enovix’s products. With these large companies having large amounts of financial resources, it seems that there could be some financing mechanisms that could help Enovix ramp up volumes in the future, in my view. This could take the form of funding for the capital expenditures for lines at its customer’s existing facilities, or for dedicated lines at Enovix’s facility, for example.
I think that the option to do licensing agreements is also a smart move by management as large companies like Samsung will be interested in a license given that Samsung SDI (OTCPK:SSDIY) is already one of the largest battery producers in the world.
All in all, the demand landscape for Enovix is very promising and there is no shortage of interest from the largest companies in the world, which further proves the point that Enovix’s batteries bring strong value add in the form of battery innovation and technological leadership, strong safety profile and higher energy density.
Focused on scaling capacity of Gen2 to meet requirements of large customers
Enovix is building on the strategy that it outlined in the last quarter by ensuring that they focus on improving their manufacturing capabilities and performance as well as its cost instead of near-term revenues, which will help position the company nicely to produce in large quantities for its large customers from 2024 onwards. Therefore, their near-term task is to ensure that Gen2, which is the engine of growth for Enovix, is able to scale capacity to meet the demands of its large customers.
As a result, management is reiterating this in this quarter by stating that they will redirect resources to Gen2 even if this is at the expense of Gen1 given that they have strong confidence that Gen2’s performance will be superior. As such, the focus for management will not be to make Fab-1 run better but to make Gen2 to be as perfect as they can.
In the future, the strategy will be to replicate these Gen2 lines for its large customers, either through direct means or indirectly through joint ventures of licensing. This will ensure that the Gen2 lines can be ramped up for large volumes quickly to meet the needs of Enovix’s key customers.
While I think that management made a tough decision that may not have been popular with short-term investors, this decision will reward long-term investors and is for the benefit for long-term shareholder value. This is because management has no choice but to ensure that Gen2 has the best performance it possibly can achieve to bring about large-scale manufacturing at a low cost for its large mega-cap customers to ensure that Enovix meets their requirements. While Enovix has attracted these large players through its technology leadership, safety profile and higher energy density, this will all be in vain if Enovix is unable to produce their products at the large quantities that these companies need, and for the production to be done efficiently and on time.
Progress on Gen2
Enovix has been learning from Gen1 and use these learnings for Gen2. As a result, the company has managed to bring 120 learnings from Gen1 to Gen2, resulting in advantages like producing more batteries with less space and less capital.
One such learning is the use of a laser patterned electrode form factor that helps Enovix bring innovations to its batteries. As laser patterning will be a key part of its technology, the company needs to build capabilities in this space. As a result, Enovix recently announced that they are collaborating with IPG Photonics (IPGP) to access the advanced laser technologies. This will result in Gen2 lasers having five times the power of those of Gen1, which according to management is ahead of its initial plan.
Other improvements include the improving the way batteries are transported and processed, by using a high speed and high accuracy linear motor that should improve throughput and reduce costs as this reduces the complexity of the equipment required.
For the Gen2 line, there has been significant progress made in the quarter, with the orders for key equipment needed for the assembly and packaging lines, including the laser patterning mentioned earlier. Management mentioned in the quarter that they continue to believe they are able to have their first Gen2 line by 2H23.
Financials
As a result of the focus on the Gen2 line over the near-term revenues, the current quarter revenues disappointed but the full year revenue guidance was reiterated. At the same time, due to capital expenditures being shifted to 2023 for the Gen2 line, there is a slower cash burn of $130 million to $150 million for the year, of which 40% pertains to capital expenditures. This is a result of a shift in the timing of payments for the equipment necessary for the Gen2 line in 2023. Management continued to reiterate their 50% gross margin and 30% EBIT margins long-term targets.
Valuation
Given that Enovix is an early-stage company, I have used a DCF model to value the company. Since I expect the ramp up in revenues to be significant from 2024, I have made a 5-year forecast for the financials for Enovix. I expect revenues to grow to $1.2 billion in 2027F from current levels, while EPS turns positive in 2025 with 2027F EPS being $1.30. I also assume terminal multiples of 15x and apply a discount rate of 15%.
My 1-year target price for Enovix is $31.10, representing 195% upside from current levels. This target price is justified given that Enovix is positioned for large design wins, providing strong tailwinds to revenues as it continues to accelerate. In addition, Enovix has strong technological advantages, and it is potentially still several years ahead of its competitors and is able to generate outperformance for the long-term.
Risks
Execution risk
For an early-stage company like Enovix, there is a risk that the company is unable to execute well to meet its targets and milestones. This is even more so given that there are high expectations for Enovix with the large customers that are interested in the company. The company needs to be able to show to customers that its Gen2 line is able to meet the tough requirements of large companies. In particular, these large companies need to know that Enovix is able to manufacture in large amounts, efficiently and on time before they are willing to be long-term customers of Enovix. If Enovix is unable to prove that it can execute well, then the company may risk losing the confidence of future potential customers.
Competition
The good thing about the Enovix story is that it seems that it is getting all the interest from the large companies and that its technology is well ahead of competitors. That said, there are startups and private companies that are developing and improving battery technologies that could compete with Enovix in the future. For example, another company looking to compete in the silicon anode lithium-ion battery space is Sila Nanotechnologies. As such, Enovix needs to move fast, execute well and continue to innovate and develop battery products with improved capabilities and performance.
Conclusion
I think that the sell-off we are seeing with Enovix is overdone. As I have elaborated earlier, the disappointment comes from the compromise of near-term revenues to focus on the company’s next generation production line to scale up capacity to meet the requirements of large companies. This is essential, in my view, given that the company is in active engagements with 5 mega-cap technology companies that will drive huge volumes. Given that these large potential customers are material to Enovix’s long-term growth potential, it makes sense for the company to prioritize its manufacturing capabilities to meet the requirements of these large companies.
In addition, Enovix has a strong demand profile continues to indicate to me that the company continues to bring strong value proposition to its customers in the form of strong technological leadership, safety profile and energy density. The company is looking to open up new opportunities in the auto market. All in all, I would recommend investors to buy the sell-off as it has provided long-term investors with a golden opportunity. My 1-year target price for Enovix is $31.10, representing 195% upside from current levels.
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