QS: Valuation Exercise - Bear Case
As I see QS’s ( QS 0.00%↑ ) future, today, there are really 3 primary scenarios that can play out.
Bear Case - QS fails to deliver a product that can be a scalable/working product.
Base Case - QS delivers a competitive product into a saturated market.
Bull Case - QS delivers a product that stands above all other cell manufacturers.
I’ll cover each of these cases with separate articles. Today, I’ll cover the Bear Case.
Bear Case Overview
The downside case is important because, realistically, large scale commercialization still isn’t a guarantee at this point, and we’d like to define how much we stand to lose in the event that Quantumscape doesn’t succeed.
It’s also important because it helps us better define our expected value. I covered Expected Value in a previous article. Figure 3 from that post shows that when you don’t stand to lose everything, it actually lifts the expected value (i.e., intrinsic value) of our “bet”. So it’s extremely useful to know what the payout is for each branch of the probability tree…especially for the case where we lose. Again, this article covers the bear case.
Ultimate Downside
Obviously, the lower bound for how far the share price can fall is to $0, losing 100% of our investment. In this case, it doesn’t matter how much cash currently lives on the balance sheet because QS is going to burn through it all eventually. This, of course, assumes that they run into major roadblocks during scale up efforts or in testing. This scenario’s probability decreases with every milestone that QS reaches. Realistically, by the time the “demonstration phase” ends, this scenario’s likelihood falls to zero.
Note that I believe this type of downside scenario applies more to the Solid Power’s and SES’s of the world than it does to Quantumscape. Having a defined chemistry platform at this point not only puts QS ahead of the pack, it proves that the science aspect is more or less complete.
Scenario Value: $0
Scenario Return: -100%
Book Value
Assuming that a complete zero is off the table, we might assume that QS could be acquired simply for the assets on their books. I actually think this is the least likely of all the scenarios I’ll present today simply because Raptor and Cobra don’t really carry residual value as tangible assets. QS already has plans of scrapping Raptor. I would suspect Cobra eventually sees the same fate (assuming Cobra isn’t already in the 100 MWh range). Available cash also isn’t a great metric because they’ll burn through a good chunk of it in the next few years.
That said, it’s a useful benchmark to have. According to the latest shareholder letter (Q4, 2024), their tangible book value stands at $1.16 billion. If a company were to buy QS, today, for it’s tangible assets, that’s what they should expect to pay.
Scenario Value: $1.16 Billion ($2.20 per share)
Scenario Return: -56%
Intangible Book Value
This is where the analysis gets interesting. The true value of this company is in the Intellectual Property of the product. But, this IP value doesn’t actually show up anywhere in the Financial Statements.
GAAP accounting standards require that R&D spending is simply expensed. So even though it may have taken hundreds of employees several years and thousands of hours to develop Intellectual Property, the value of that IP isn’t recorded. For a pre-revenue company like Quantumscape, that IP (patents, trade secrets, etc) is essentially where all the value of the company lies. Here, I’ll try to quantify what QS’s intellectual property is worth, which should be a good indicator for what an acquirer might be willing to pay for it.
While determining intellectual property value may sound complicated, for a pre-revenue company, there’s actually a pretty straightforward way to estimate this. On the balance sheet, there’s a line item labeled “Retained Earnings”. For a typical company this would be the net of all income minus expenses and dividends paid to shareholder through the entire existence of the company (simply, how much historical earnings are kept for reinvestment by the company). Since Quantumscape has never had revenue, this line item basically quantifies all the expensed capital used to develop their product, and is a good proxy for the intangible book value of their IP.
Retained earnings as of Q4, 2024 is $-3.35 Billion.
There may be adjustments we’d like to do to this number to more directly reflect the capital used that went directly to IP.
C-Suite stock based compensation is probably something that wouldn’t be replicated at an internal division of Panasonic, for instance. Marketing expenses were needed to draw interest from the investing public, but don’t go directly toward IP development. The act of going public also incurs costs not directly in line with business activities (for instance, SPAC sponsors keep a small percentage of the company). Lawyer fees to battle lawsuits also falls under this umbrella.
Still, this number is, directionally, a good baseline. When combined with tangible book value, we get an “adjusted” book value of $4.51 Billion.
Today’s market cap ($2.57 Billion) is less than our estimated “adjusted” book value. We’re already starting to see that the downside risk could be very much overstated, and that even in an acquisition scenario, QS might be worth more than they are today.
Scenario Value: $4.51 Billion ($8.57)
Scenario Return: +70%
Time Value of R&D
We’ll continue to build off of the last couple of sections.
QS, founded in 2010, has been developing their product for 15 years, now. If a competitor wanted to develop their own solid state battery (akin to Quantumscape’s), there’s really two options:
Spend a decade and $3+ Billion in development. Or,
Acquire Quantumscape and skip a large chunk of the painstaking R&D process.
Figure 1 shows these two options. By going the acquisition route, a 3rd party would be able to skip all of the red bars.
We don’t know what QS’s value is today, but we could conservatively assume that the “present value” of all cash flows associated with R&D efforts (red bars) and QS’s Value (green bar) is equal to zero. Zero is the cutoff for what makes a capital project worth pursuing. If a company were to start from scratch, they’d want to see total present value greater than zero. Again, this is a highly conservative estimate, which makes it a good metric for our bear case valuation.
Without showing my work, we can solve for QS’s value (green bar) using the following equation.
where,
CF_R&D: Annual spend on R&D
d: discount rate
n: years of R&D to reach QS’s current position
As mentioned above, it took Quantumscape 15 years to get to this point. But, they basically started in a garage with no directional aim on a finish line (they originally started with advancements in cathode development). So let’s say that a motivated competitor on a mission can shrink this effort by half: n = 7 years.
If we assume that it would still take the same amount of total spend, we can take our Retained Earnings number from above, and divide it by the number of years of development to get annual R&D spend: CF_R&D = $478 million per year
The discount rate is less straightforward. We could use the overall market implied cost of capital (about 8%), but that wouldn’t reflect the additional risk that a competitor spends all this time and money and still can’t figure it out. So I think I’ll provide a range between 8% and 15%.
Value = $4.6 billion - $6.1 billion
Once we add back in the tangible book value of $1.16 billion, we get:
Scenario Value: $5.76 Billion - $7.26 Billion ($10.95 - $13.81 per share)
Median Scenario Return: +145%
Conclusion
Based on the scenarios provided above, we can already start to form the opinion that Quantumscape may offer an asymmetric opportunity for investors. Total book value, one that properly reflects the Intellectual Property that QS has developed over the years, could be in the low teen share price.
IP value is subjective, and just because a company burns capital doesn’t guarantee that value was created. If QS does hit major road blocks, then it may not be worth much at all.
That said, I can make a decent argument that today’s price trades at a discount to the bear scenario.
Also keep in mind that the upside scenario could yield a lower intrinsic value than any of the cases presented here. Again, just because you spent money doesn’t make the product worth what you spent. We’ll explore those upside scenarios in a later post.