April Update, 2018: Cars, Entertainment, And How We Stumbled Upon An Investment

About 3 years ago, we began investigating the evolution of the car. It started with our interest in Tesla. We wanted to figure out if this character—Elon Musk—made any sense. Self-driving electric cars? This seemed both possible and probable. We quickly dismissed the idea that any one company—Tesla—would control the market. This proves that you can make a good decision and still be wrong about the outcome of a stock’s success. Every major car company will have an electric car option by next year. Mr. Musk is struggling to make 2000 cars a week.  As of today, Tesla has sold at most 350,000 cars in its history but commands a market value of $50 billion and will lose $1.2 billion this year. In comparison, GM will make 825,000 cars this month, is worth $52 billion and will make about $10.5 billion this year. Tesla is up 33% in the past year and GM is unchanged. Ah, the power of a dream over cold hard cash.

At Davis Rea we were quick to embrace and invest in the advertising model of Google, and when Facebook went public we added that company to the portfolio too. We marveled as these two companies changed the media and entertainment businesses. The average U.S. adult spends more than 12 hours a day consuming media in one form or another (tv, mobile, desktop, radio). Spend some time working and sleeping and there isn’t much time to do anything else! That is a problem for those in the business of selling media and entertainment. U.S. consumers spend about 25 billion hours a month on media channels (according to ComScore) and that number has not changed much in the past 2 years. NOT GOOD! Said the Twitter-in-Chief.

But there’s one platform that may be poised to move the needle: the connected car. As time spent on digital devices stagnates, time spent in the car is increasing. In fact, the average U.S. commute has grown from about 25 minutes each way in 2009 to an average of 26.4 minutes in 2017. And BI Intelligence projects commuting time to rise to around 28.3 minutes by 2025. While such increases are minimal on their own, in aggregate, the impact could be huge. There were about 139 million people in the U.S. who commuted daily by car as of 2014 (the latest year for which data is available), which means there will be 900 million more minutes a day spent commuting by 2025. That equates to an additional 3.7 billion hours of people’s time up for grabs in the U.S. alone.

The traditional car ownership model is in the very early stages of a fundamental disruption. New methods of transportation like on-demand rides and car rental services are presenting consumers with alternatives to using personally-owned vehicles.

The growth of these services shows no signs of abating, presenting traditional automakers with both opportunities and challenges. Sixty-seven percent of consumer respondents said they plan to increase their use of mobility services over the next two years, according to McKinsey’s report from last year. The proliferation of new mobility players and services will only lead to greater price competition, giving consumers more options to get to a given destination without using their own car. Automakers have started to respond to this shift in consumer transportation habits by monetizing mobility services. This shift will have tremendous impacts on other services like insurance. Will car insurance be a function of your individual driving patterns (measured and monitored on-board the car) but also priced by the kilometer or just included in the cost of the ride? Will the car manufacturer also be the insurance company? Everything is up for grabs. Most importantly, your attention while in the car is a big money opportunity. If you don’t need to drive then you could be watching movies, sports, playing games, keeping up to date with the news or working and likely, it will all be supported and paid for by advertisements or subscription services.

The winners of this land grab for your attention will be Apple, Google, Facebook, Disney (all stocks in your portfolio) and others that may not even exist yet. As we thought about winners and losers during this change we thought of the innovators of the technology that would drive this evolution. One of those innovators is Aptiv PLC.

Aptiv is an automotive supplier specializing in outfitting cars with highly sophisticated electronic, safety, and mobility solutions. Aptiv is capitalizing on the fast growing smart-mobility and connectivity trends which are increasingly important components in the current (and future) state of the automotive industry. Aptiv is focusing its resources on developing and commercializing the vehicle ‘brain’ and ‘nervous system’ for global automotive customers. Its customers are the largest car manufacturers in the world. Aptiv is viewed as one of the most advanced leaders in state of the art technology and manufacturing providing the software, hardware, and manufacturing facilities to make automated and autonomous driving better. Its solutions are likely in your car today.

Smart-mobility is focused on addressing current urban transit issues; high costs, emissions, growing populations and extended travel time. Smart-mobility systems will allow fewer vehicles on the road to accomplish more, resulting in faster commutes, lower emissions and fewer accidents. These benefits will become increasingly noticeable as smart mobility options become more prevalent and sophisticated. Data processing and sensory systems are being developed along-side infotainment and active safety systems for today’s vehicles, forming what is referred to as the neural system; the ‘brain of the car’. In the future, artificial intelligence systems will create an autonomous vehicle ecosystem that not only safely accommodates and entertains the passenger, but communicates with all other vehicles and devices on the road creating a safe, efficient and more productive transit environment. For instance, KPMG believes autonomous mobility solutions will represent a $1 trillion revenue opportunity by 2030.

In 2017, Aptiv products were found in all the top 20 best-selling vehicle models in the U.S., 95% of the top 20 in Europe, and 65% of the top 20 sold in China. As automakers increasingly adopt Aptiv products into their vehicles, the use case for Aptiv technology becomes increasingly attractive for automakers, as these products are more effective at scale. On a more macro note, Aptiv has begun to collaborate with smart cities such as Boston and Singapore to help in their development of more modern mobility solutions, thus establishing their footprint outside of the car as well.

As electrification, ride sharing and later, autonomous driving continues to gain momentum, the demand for more innovative software and hardware solutions will continue to increase. As cars increasingly become computers on wheels, Aptiv will not only be able to provide the integration tools necessary to fuel this change, but has the potential to generate Software as a Service (SaaS) like revenue streams resulting in frequent updates and recurring revenues.

Strong sales growth and disciplined capital allocation programs allow for a mix of shareholder returns and accretive mergers and acquisitions, driving market share growth and sustainable margin expansion. Aptiv made $2.8 billion in profit last year and pays 38% of that in dividends to shareholders. The companies balance sheet is strong and its management is well regarded and seasoned.

We believe that companies like Aptiv have a long road ahead of profits and innovation. Many years ago, companies like Magna surged in profitability as they integrated themselves into the supply chains of the auto manufacturers through innovation and vertical integration. Even if car sales go down, Aptiv is selling more units into each car (thereby offsetting some potential weakness) and increasingly selling high margin and distinctive solutions. That makes for what we believe to be a strong long-term investment.

-John