Automotive Economics

The Automotive Industry: A Challenging yet Promising Space

From the litany of failed car companies throughout history, it’s clear that making and selling a new car is exceptionally difficult. Wikipedia lists 81 defunct manufacturers in the UK alone. Historically, the capital intensity, razor-thin margins, and complexity of building a reliable, scalable automotive brand have overwhelmed many promising entrants.

However, the industry's dynamics shifted dramatically with the focus on climate change and carbon emissions. This change pushed the automotive sector toward alternatives to internal combustion engines, enabling new players to enter the market and capture significant market share. Tesla, the poster child of this transition, not only revolutionised the EV market but also created immense wealth for its shareholders.

Is Investing in Automotive Manufacturing Still a Good Return on Capital?

Over the past decade, capital has poured into the EV market, with investors searching for the next Tesla—a company that has so far successfully straddled the line between tech and automotive manufacturing. However, the switch to electric drivetrains hasn’t simplified the complexities of car design and production. In fact, it has introduced new challenges such as battery sourcing, software integration, and regulatory compliance.

The EV market is in a transient phase.; China remains the largest growth market, with numerous smaller manufacturers vying for a piece of the expanding pie. Meanwhile, in more established markets like Europe and the U.S., sales are growing, albeit at a slower pace, with incumbent OEMs catching up. Despite these challenges, investor enthusiasm remains high, as evidenced by Tesla's lofty valuation, which stems from its diversification into autonomous driving, AI, and robotics.

Valuation Dynamics and Market Positioning

The following P/E ratios illustrate how the market values EV and tech companies relative to legacy automakers:

This data underscores the premium the market places on companies that "blur the lines" between tech and automotive. Tesla, for instance, benefits from being seen as a tech company, driving higher valuations. In contrast, legacy OEMs like GM and VW struggle with low P/E ratios, reflecting market scepticism about their ability to adapt to the new automotive paradigm.

Strategic Positioning: Legacy OEMs vs. EV Startups

Some investors may see value in legacy OEMs, betting on their eventual adaptation to stricter regulations and electrification. However, this strategy echoes a key theme from Clayton Christensen's The Innovator's Dilemma: incumbent firms often struggle to adopt disruptive technologies effectively. Despite their resources, legacy OEMs are often entrenched in their existing business models and face internal resistance to change, which can slow their response to market shifts.

Challenger EV companies like NIO, on the other hand, represent the kind of disruptive innovation that Christensen describes. These firms are not burdened by legacy systems or traditional profit structures and can fully embrace new technologies and business models. Despite currently posting losses, NIO has attracted substantial investments, including $3.3 billion from Abu Dhabi’s CYVN Holdings in 2023. This capital allows them to focus on scaling their disruptive innovations, such as battery-swapping technology and advanced autonomous driving systems, without the constraints legacy OEMs face.

NIO's position illustrates Christensen's point that disruptive technologies often gain traction in niche markets (e.g., China’s rapidly expanding EV market) before scaling to challenge incumbents in broader, established markets like Europe NIO face challenges with potential regional tarriffs but these could be mitigated by locally sourcing commodities in a regionally diverse manufacturing footprint. See map below for current and planned sites:

The Role of Vertical Integration and Supply Chain Stability

A critical factor for NIO—and any EV manufacturer—is securing stable supplies of key components like batteries, motors, and semiconductors. CYVN’s backing provides NIO with resources to vertically integrate or acquire suppliers, reducing dependency on volatile markets. Additionally, NIO’s planned factory in Hungary would mitigate the impact of EU import tariffs (if they meet required conditions), which could rise as high as 45.3% for Chinese-built EVs by the end of 2024 over the typical 10% today. To qualify for tariff exemptions, vehicles must meet rules of origin requirements, with 40% EU sourced content until 2026 with this rising to 55% in 2027.

Regional flexibility is key to ensure the products remain price competitive whilst maintaining sustainable profit margins.

Leveraging Platforms and Expanding into Adjacent Markets: Enter Forseven & Onvo

To diversify and maximize profitability, manufacturers often use shared platforms across multiple models. NIO's next move includes an expansion into the budget and premium market with the launches of Onvo and Forseven.

Forseven is a new UK-based EV brand in the premium segment that promises higher margins but lower volumes, positioning the brand to compete with the likes of Bentley and Porsche.

Forseven’s leadership includes veterans from NIO, Gordon Murray Technologies, and Jaguar Land Rover, ensuring a wealth of industry expertise. Its partnership with NIO also allows it to license proven EV technology, accelerating time-to-market and reducing development risks. With the additional knowledge from Gordon Murray's iStream manufacturing process, Forseven has a foundation for potentially building innovative, premium electric vehicles.

Less information is known around the engineering leadership of Onvo, but with a car already available to order, partnerships and development could be tied very closely to the core NIO team.

The Future of NIO, Forseven and Onvo: A Potential Brand Strategy Win

With these strategic moves, the NIO portfolio stands poised to capitalise on a rapidly growing market. Key elements contributing to their potential success include:

• Proven, cost-competitive electric drivetrains licensed from NIO

• Potential platforms and manufacturing expertise from Gordon Murray

• Robust supply chain strategies backed by CYVN’s investment

• A diverse product portfolio catering to both mass-market and premium segments

Once approaching the market with their finished product, customer challenges remain, particularly around delivering superior customer-centric innovations and enhancing after-sales support, which are critical to building lasting brand loyalty. Whether through direct-to-consumer models or agency partnerships, both brands must ensure a positive and long-lasting customer experience to stand out.

What Does This Mean for Original Investors in NIO, CYVN?

Despite the challenges of automotive manufacturing, NIO (with Onvo and Forseven) have the ingredients needed to thrive. With the right execution, they could deliver significant returns, potentially reaching valuations comparable to BYD or even Tesla (after the frothiness of the market subsides), rewarding long-term investors like CYVN Holdings.

Some quick maths and comparisons against other automotive companies based on some simple ratios…

With the combination of NIO, Onvo and Forseven leveraging the same technical platforms and vertically integrated commodities (where possible to comply with ‘rules of origin’) for volume and revenue, this seems like a promising future for the company and it’s investors, but only time and the markets will tell.

I’m personally very interested in researching and subsequently writing about the intersection between engineering and business. I’ll be writing more regularly in future for any followers on the platform and welcome any feedback or questions on the post above.

Thanks!