Thesis

The electric vehicle market is arguably the most competitive industry today. Although it’s impossible to know how many players there are in the world, there is a lot of money to be won. However, it is not necessary to invest directly in electric vehicles to play this industry. Like cars that need gas, electric vehicles need energy to run. According Precedence search, the global electric vehicle charging market is expected to grow at a CAGR of 28% through 2030 to reach $66 billion. One company, ChargePoint Holdings, is trying to take advantage of this (NYSE: CHPT).

The company

Charging point operates the largest network of electric vehicle charging stations in the world. With over 188,000 ports activated, 12,000 direct connections, and another 320,000 ports accessible while roaming, ChargePoint’s penetration in the US and Europe is unmatched. The company makes money through a portfolio of hardware (charging stations) and software solutions.

On the software side, ChargePoint generates revenue through a number of insiders. The first is its subscription service, which offers many benefits to its commercial and fleet customers. One of these is ‘guest management’, a solution that offers business customers the ability to selectively bill individuals. For example, business customers can make charging free for the general public or for a select group of paying customers. “Host pricing” allows customers to change prices based on data collected from customers. Both of these features are enhanced by ChargePoint’s data analysis module. By collecting customer data, ChargePoint provides commercial customers and fleets with optimal customer pricing and fleet management (for fleet customers).

ChargePoint’s unique investment proposition is its penetration into every type of customer. While most cloud-based software solutions are enhanced to support commercial and fleet management, ChargePoint is also aggressively pursuing residential customers. With ChargePoint home charging, residential customers can get a lifetime subscription with different utility plans to manage their home usage. For multi-family properties, ChargePoint provides the ability for the software to charge tenants based on usage and for the property manager to set the price.

Performance

ChargePoint generated $241 million in revenue in FY22. This is a 65% increase over the previous year. 72.1% of this growth is attributable to the physical charging stations sold by ChargePoint. The remaining 22.1% came from subscription revenue. While the sales mix hasn’t changed much since fiscal 2020, ChargePoint aims for recurring software revenue to account for half of overall sales going forward. This is a great strategic goal as there is a clear indication that the software side will have a much better gross margin with scale. For example, in FY22, direct costs associated with software sales were 58% of sales in this segment while hardware costs were 84%.

Overall, gross margins don’t paint a pretty picture right now. Look at the two images below for quarterly revenue and gross margins.

The second image clearly shows the gross margin volatility here from quarter to quarter. This volatility is directly related to the company’s aggressive pursuit of customer acquisitions and an abundance of supply to realize its “land and expand” model. You can see this in action by seeing the rise in quarterly revenue in the first image. The problem here is that it relies on the growth in demand from the entire electric vehicle industry to reach a point of economies of scale. If this demand is never met or is at a much slower rate than expected, ChargePoint may reach a point of maximization, where it can no longer grow. While I don’t see that happening, it’s a realistic risk to consider.

ChargePoint’s operating expenses paint a similar picture. OPEX was 101% in FY22 and is currently 103% this year. Research and development contributes the most to this unprofitable activity, accounting for 60.2% of FY22 revenue. Sales, general and administration grew, accounting for approximately 30% of revenue each. Again, the story is the same. To engage in customer acquisitions and build a moat around its highly competitive business, these costs must continue to rise in the short term. However, in the long term, scale will allow the company to maintain relatively fixed operating costs over time.

Scalability

ChargePoint is not only unprofitable, but moving further and further away from profitability with each passing quarter. The biggest challenge for business is to reach a point of profitability. However, the image below shows that there is a positive correlation between EV penetration and ChargePoint sales. According to ChargePoint, sales of passenger electric vehicles are expected to grow at a CAGR of 41% through 2026. Therefore, the mass adoption of electric vehicles by the general market should well pose the scaling challenge for ChargePoint.

While the high operating costs in the last section are concerning, there is something to be said for the massive investment in initial customer acquisition costs; account expansion, something ChargePoint achieves. The company’s top 25 customers have spent 10.5 times their cumulative spend since their initial purchase. Similarly, the annual expenses of a Fortune 50 company reached a cumulative amount of 28.5 times. These multipliers grow quickly and reflect the ecosystem that ChargePoint creates by initially selling the hardware and keeping the customer engaged with the software to create a long-term value proposition for each customer.

One final thing that I believe will support ChargePoint’s large-scale growth is its focus on Level 2 charging. 2. Additionally, Level 2 chargers average 32 miles of range per hour of charge, significantly higher than the 4 miles delivered in a Level 1 charger. Therefore, I believe the mass adoption of Level 2 chargers will be more consistent with the growth in passenger electric vehicle sales.

Risks

Scaling will remain the biggest challenge for ChargePoint in the near future. While it appears to be aggressively pursuing its “land and expand” model, it is building on the sustained hyper growth in mass market adoption of electric vehicles globally. Unfortunately, electric vehicle charging cannot succeed without sufficient adoption of electric vehicles around the world. However, this seems highly unlikely. In addition to the countless new EV manufacturers around the world, many major automotive players like Ford are rapidly rolling out EV lines. While they may get into charging, ChargePoint’s aggressive expansion strategy coupled with first-mover advantage is expected to create very high barriers to entry even for big players in the mainstream space.

Another risk is related to its future leverage. While the company is comfortably seated with a healthy and positive working capital balance of $275 million and a moderate level of debt of $69 million, I believe that if it really evolves, it will eventually dry up its flows cash. Think about it, at a current revenue rate of around $80 million per quarter and an operating expense rate of 100%, growth is fueled by high costs. To truly penetrate the market, the company will need to spend hundreds of millions each quarter to maintain its execution rates. Also, while R&D expenditure is currently 60% of revenue, the competition it faces probably has hundreds of millions of dollars more to spend on R&D, which I’m sure is one of the biggest players will continue with its new ranges of electric vehicles. This means that its R&D spending will likely remain sustained at these levels for a long time.

Conclusion

ChargePoint’s stock is down 30% this year. While this may sound like a tempting buying opportunity, one has to balance the risks here with the greater challenges of the macro environment. With inflation at an all-time high and an inevitable recession approaching, household disposable income is eroding. This means that luxury goods like vehicles will see reduced demand. While many may argue that inflation-induced gasoline prices will cause many to buy electric vehicles, we must remember that the majority of the market is still using gasoline-powered vehicles and with reduced incomes, vehicles become unaffordable.

I believe that if sized correctly, ChargePoint can become a very successful and profitable business, but I’m waiting on the sidelines until I see a clear indication of where this business is headed.