Net Sales came in at SEK4.9m, -16% y/y, well below our estimate of SEK15.6m. EBITDA came in at -SEK16.1m. Same period last year, EBITDA was -SEK8.2m. Thus, well below our estimate of -SEK6.6m. The main reason for the deviation is lower sales than expected and higher OPEX. Part of the deviation in OPEX was due to a few “one-off” expenses. These include patent expenses, where Gapwaves reviewed its patent portfolio’s competitiveness and potential infringement from competitors. Our understanding is that management concluded that Gapwaves has a solid patent portfolio which is hard for competitors to bypass. We expect Gapwaves’ quarterly earnings to vary significantly between quarters before volume production commences. Thus, we view this as a bump in the road rather than a change in the long-term thesis.

From a semiconductor view, the semiconductor cycle at large has turned downwards. However, firms leveraged towards automotive have so far held up quite well. For example, Texas Instruments (TI) report it sees weakness in all its end markets except for Automotive. Gapwaves corroborated TI’s message, saying it continues to see demand for automotive radars, partly due to regulatory requirements on the Automotive original equipment manufacturers (OEMs). As Gapwaves is early in its commercialization, we expect it to be relatively immune to the semiconductor cycle. However, Gapwaves reported some weakness among its Mobility customers as some are restructuring to better align with the current economic environment. This has resulted in delays on projects that are otherwise close to commercialization.

Gapwaves received a new order from Hella during the quarter worth SEK3.8m with expected delivery during Q2’23. This order is for a second-generation 77 GHz automotive radar for ADAS systems. According to Hella, this radar will be introduced to the market from 2025 onwards. The radar is a 77 GHz radar sensor that will be used for environmental perception. Hella is also concentrating on devising a higher-resolution, cost-optimized radar sensor for vehicular corners to facilitate more advanced levels of autonomous driving. By leveraging Gapwaves antenna and chip technology, the detection ranges of Hella’s radar sensors can be considerably expanded, the field of view broadened, and close-range measurement capabilities enhanced.

Moreover, Gapwaves now has an approved production line for the first-generation Hella radar sensors. Thus, Hella’s production plans for a prestigious German manufacturer slated for 2024 are on track. Gapwaves’ agreement with Hella is licensed-based, and we expect Gapwaves to have a 10% penetration rate for Hella’s radars in 2024. We expect Gapwaves to earn SEK8m in royalties from Hella in 2024.

Gapwaves has a partnership with Bosch to develop waveguide antennas. This collaboration aims to create waveguide antennas optimized for high-resolution radar sensors at SAE level 4 (i.e., high automation driving capabilities), positioning Gapwaves as a high-volume supplier to Bosch. We expect Gapwaves to start earning hardware revenues from Bosch in 2026.

In 2022, Gapwaves successfully delivered the first antenna prototypes to Bosch. In 2023, Gapwaves will concentrate on determining material selection and manufacturing methods for the initial antenna to enter series production and initiating the development of the production line and facilities. Furthermore, Gapwaves will continue supplying increasingly mature prototypes to Bosch throughout 2023.

Lastly, for the automotive segment, Gapwaves secured a new tier-1 customer for its automotive segment, placing an order worth SEK0.5m. According to Gapwaves, this is in the early phases, and several steps are required before investors should expect any form of volume from this tier-1 customer. Typically, a customer goes through simulations, physical prototypes, and trials at testing facilities before contract negotiations can commence. The typical sales process is between three to five years. Thus, the earliest volume production from this customer would be in 2026, but we find it more conservative to expect 2028/2029. While this is positive, investors should also keep in mind that it is not certain Gapwaves would pass all the requirements set by the customer. However, it already has commercial agreements with three of about c20 tier-1 automotive suppliers in Europe. Gapwaves’ ambition is to be a supplier. Therefore, we expect Gapwaves’ potential commercial agreement with this tier-1 customer to have similar terms to Bosch.

Gapwaves’ other verticals also made some progress with a new supplier agreement for developing and supplying high-resolution radar antennas with the existing Smartmicro customer. This agreement is worth SEK9m over three years. As we understand it, the SEK9m is based partly on contractual minimum purchase volumes. Thus, while the order is small, there is upside potential if Smartmicro surpasses its forecast. Moreover, this could lead to additional contracts and further expansion into the automotive and traffic management industries. Gapwaves also received a small follow-up order of SEK0.25m from a US Autotech customer that was delivered in Q1’23.

Gapwaves announced it will acquire 30% of Sensrad for SEK40m, with the option of receiving an additional 30% stake by June 30, 2024, for SEK40m or other agreed-upon terms. Sensrad is a spin-out venture from Qamcom’s radar division and specializes in offering a distinctive 4D imaging radar sensor. Imaging radar is a high-resolution radar that aims to bridge the gap between LIDAR and RF-based radar sensors.

The rationale behind the deal stems from several of Gapwaves Mobility’s customers designing their own imaging radar sensors instead of focusing on their core product, which may be a form of vehicle, such as a delivery robot. As a result, these customers spend valuable time integrating radar components instead of working on system integration, resulting in increased time to market and overall costs.

Acquiring part of Sensrad allows Gapwaves to move up the supply chain and develop prebuilt imaging radar sensors that its customers can purchase, thereby reducing time to market. By specializing in this area, Gapwaves is likely to improve the performance of the imaging radar sensors compared to those developed by its customers. This move not only allows Gapwaves to sell higher-value products, enter new verticals, and get closer to the end customer, but it also complements its automotive segment.

Distinguishing between a vehicle stopped on the roadside, a sign or an overpass is challenging for existing radars. For this reason, most current adaptive cruise control systems disregard stationary objects when moving at speeds exceeding approximately 64 km/h and only detect movement in the same or adjacent lane. While effective for adaptive cruise control and blindspot monitoring, these radars are inadequate for higher levels of driving automation. Therefore the automotive industry is expected to use imaging radars as the technology develops. Gapwaves will gain valuable know-how by acquiring part of Sensrad that it can apply to its customers as the automotive industry moves toward using imaging radars.

In our view, the acquisition is increasing Gapwaves’ long-term potential by first expanding to new verticals and gaining valuable know-how to improve its long-term prospects within automotive.

The content story in automotive is in its early inning. indie Semiconductors estimates that the current semiconductor content in cars is around USD500, which it expects to grow to over USD4.000 in the “future.” We believe the “future” refers to the 2030 timeframe. According to indie Semiconductors, Safety systems, and EVs will represent most of the TAM expansion. It expects the former to grow at a 25% CAGR and the latter at a 28% CAGR between 2021 and 2026. We believe Gapwaves radars would fall under the Safety system label.

Content growth will be a large part of the expansion in TAM; Gapwaves has presented at Redeye’s Smart Cities event, predicting that the number of sensors per car will grow from three in SAE Level 1 autonomous vehicles to seven to eleven for SAE Level 5 autonomous vehicles. Gapwaves says that current premium car uses five to seven radars. Moreover, the EU has implemented directives forcing all new cars to be equipped with AEB systems. This has pushed even lower-end vehicle models to be equipped with at least one radar.

Yole forecasted the TAM for radars modules in passenger cars (PCs) and light commercial vehicles (LCV) will grow at a 19% CAGR between 2020 and 2025, growing to USD9.1bn from USD3.8bn. Yole expects most of the growth to come from unit increases forecasted to increase two times over the same period, while the average selling price (ASP) is likely to fall by 20%.

Gapwaves offers 77GHz radars. Segmenting the radar market by frequency band, Yole predict that the W-band (75GHz–110GHz) will grow even faster at a 27% CAGR, reaching USD10.4bn from USD3.1bn between 2020–2025. While the two figures are not directly comparable, Yole expects the W-band to be the primary frequency brand for automotive. The standard has been 24 GHz radars and is used in legacy cars currently. However, due to interference with the telecom spectrum and other considerations, 24 GHz radars will be phased out, and the only allowed frequency band for automotive radars will be 76-81 GHz.

The performance between Gapwaves and traditional antennas is insignificant at the current 24 GHz standard. However, At the new regulated frequency ranges, waveguide antennas are required. We believe this regulatory requirement will be a significant tailwind for Gapwaves. Compared to other waveguide antennas, Gapwaves Gapwaveguide antennas are easier to produce as they require less manufacturing precision and use simpler materials. Therefore, Gapwaves can offer cheaper antennas at the same or better performance as competitors while still earning a sufficient return. Thus, we believe Gapwaves is in pole position in the automotive radar market.

While the consumer market is significantly smaller than the automotive, Yole forecasts it will grow to USD0.2bn between 2019 and 2025 (70% CAGR). For consumer-related products, Gapwaves has one “tech giant” who has placed NRE orders worth cSEK20m, and another “tech giant” is trialing the products for autonomous last-mile delivery robots. The latter customer is buying the radars via Gapwaves’ Uhnder distributor. In our forecast, we have named these “new radar verticals.” We believe this segment offers much better pricing and a faster time to market as it does not have the same quality standards required for the automotive industry. However, we expect this segment to face more competition.

Semiconductors control key vehicle components and face high qualification standards to ensure the highest safety. However, adhering to industry standards such as ISO16949 and IAFT16949 poses a significant challenge for automotive suppliers seeking qualifications with OEMs. These standards outline strict quality management system requirements for the automotive industry, making it difficult for suppliers to meet the necessary criteria. As a result, the qualification process for automotive OEMs can be demanding and time-consuming.

According to US International Trade Commission (USITC), it can take up to six months for semiconductor chips to be qualified by an automotive OEM for vehicle use. During this six-month qualification period, the chips undergo rigorous stress tests lasting 2,000 hours, exposing them to higher voltages and temperatures than their rated specifications. Even after meeting these stringent performance requirements, the OEM subjects the chips to further testing at the system level, extending the entire process to well over one year. The long qualification period and the high-quality standards required for automotive chips make their demand more “sticky” than standard consumer electronic chips. Moreover, the automotive suppliers must achieve a “Zero fault rate,” i.e., less than 10 parts per billion defect rate for 15 years. Thus, the manufacturing requirements increase the entry barriers further.

In the automotive industry, OEMs typically maintain the same supplier for the entire model run of a car, which typically lasts around five years. They only consider a new supplier when launching new models. Because vehicles have an average lifespan of over 10 years, OEMs prioritize using suppliers they trust to support the product for the entire vehicle lifetime, up to 30 years. As a result, the product lifecycles of automotive chips tend to be lengthy. Once a supplier is qualified and trusted, OEMs often become repeat customers for existing and future models.

The high demands put on suppliers create significant barriers to entry. Coupled with long product lifecycles, Gapwaves is poised to enjoy a harvest period of 15 years or more once it qualifies at the automotive OEMs.

Gapwaves’ business model differs between customers. In Hella and Veoneer’s case, Gapwaves use a licensing model that earns a royalty for each radar sold, while with Bosch, Gapwaves is responsible for the production. Gapwaves could in-house part of the production in the production model, but it will likely outsource most of the production. We will call this model “fab-lite.” In the fab-lite model, Gapwaves owns the customer and is seen as a supplier rather than an IP provider.

It is easy to view the IP model as more attractive as it reduces the risk for customers uncertain that the technology will take off and comes with desirable margins and low capital requirements. However, we find the fab-lite model more achievable. Although the fab-lite comes with more risks, such as production and inventory risk, and requires more working capital, we see the economics generally better. For example, Gapwaves only earns a tiny fraction of the product value in royalties in an IP model. We estimate SEK1.5 per radar. Hence, the IP model requires enormous volumes to cover the fixed costs. Yole estimates 208m radar devices will be sold for automotive and mobility in 2025. At 1.5 per radar, Gapwaves TAM would be SEK315m. Meanwhile, we estimate Gapwaves could earn SEK210 per radar with the fab-lite model. Assuming a gross margin between 40-60%, common in the semiconductor industry, this would leave Gapwaves at a gross profit of SEK105 per radar at the mid-point to cover its fixed costs versus only SEK1.5 per radar in the license model. Moreover, the fab-lite model expands the TAM to cSEK44bn.

We have only been able to locate six publicly traded semiconductor IP companies globally, which we think speaks volumes of how complex this model is in practice, even if it looks desirable in theory. As such, we are encouraged by Gapwaves’ intention to bring production in-house for the Bosch agreement.

Moreover, we find Bosch, an ideal partner for establishing a fab-lite model as Bosch has extensive expertise in relevant production processes, industrialization, and preparations for series production. Gapwaves asserts that its collaboration with Bosch has accelerated its progress towards achieving certification as an antenna supplier by the IATF 16949 standard. This technical specification establishes a quality management system that encourages continuous improvement, prioritizes defect prevention, and reduces variation and waste within the automotive industry’s supply chain and assembly processes. Furthermore, the developments accomplished with Bosch will apply to product development and delivery for Gapwaves’ other clients, reinforcing Gapwaves’ position as a premier provider of high-performance waveguide antennas in the automotive industry. However, the challenges that come with controlling manufacturing should not be neglected.

In our opinion, Gapwaves has three commercial agreements with automotive suppliers that have the potential to generate revenues in the tens to hundreds of millions of SEK over the next few years. We expect Gapwaves’ near-term financials to fluctuate revenue and cash flow profiles until these agreements go into production. As a result, we do not place too much emphasis on quarterly financials.

Gapwaves has three main customers currently: Hella, Bosch, and Veoneer. Hella and Veoneer have licensing agreements where Gapwaves earns a royalty. With Bosch, Gapwaves will be responsible for the production. As discussed earlier, we view controlling the manufacturing process as more attractive as the potential earnings are significantly larger.

We expect sales towards Hella to ramp up in 2024, reaching 6m units in the same year. Production for Bosch is expected by 2026. Since Gapwaves is responsible for the production of Bosch, we expect significantly more revenue per sensor. We expect Gapwaves to deliver 0.06m units in the first year, worth SEK13m while reaching 0.25m units in 2027, worth SEK50m.

As discussed, Gapwaves added a new tier-1 customer. We expect to see volumes ramping for this customer towards 2028. Since the customer is undisclosed, it is tough to model the potential for this customer. According to Statista, Bosch is the largest automotive supplier in revenue. Therefore, we find it conservative to model half of our Bosch estimates.

According to Gapwaves, there is some weakness in the Mobility segment. The mobility segment includes heavy-duty trucks, vehicles used in harbors, mines, etc., and robotaxi and ride-hauling applications. The weakness is primarily related to robotaxi and ride-hauling applications, as these companies have a more challenging fundraising environment and must be more cost-conscious. As a result, we make slight downward revisions to our estimates for the mobility segment.

Magna is acquiring Veoneer, expected to close in mid-2023, subject to certain regulatory approvals and other customary closing conditions. Our understanding about Veoneer is that Gapwaves is well-positioned and has the potential to expand within the Magna group after it completes the acquisition of Veoneer. However, as discussed in our earlier update, corporate transactions have likely consumed Veoneer’s management. As such, we are not surprised if Veoneer starting production will take a bit longer than we initially expected. Therefore, we are pushing our Veoneer estimate to start ramping closer in 2024 instead of 2023.

The overall effect on net sales is a reduction in the 2023e-2026e between 1%-12%, while our 2027e-2030e estimates increase by 1%-12%. The net effect on our base case is negligible, and we keep our fair value range at SEK30-100 with a base case of SEK62 per share.

Compared to sizeable international semiconductor companies with automotive exposure, Gapwaves trades at a significant EV/S premium for 2023e–2025e. We find a premium justified as Gapwaves’ growth potential is much higher. However, we also note that Gapwaves is unproven, unlike most of this peer group. Our other peer group mainly includes Swedish companies with unproven products but high expected sales growth. Gapwaves still trade at a slight premium on EV/S for 2023e-2025e.

There is a considerable valuation gap between Gapwaves’ current share price and our base case. We expect progression on the Bosch agreement, and Hella is moving to volume production to be the main driver to close the valuation gap. Advancement on the new tier-1 or “New Radar verticals” could also catalyze the share.