The Strategic Transformation of GM And Ford

Michael E. McGrath

Originally published in seeking Alpha on Aug. 9, 2018

Summary

Autonomous ride services (ARS) is the future of transportation, and it will cannibalize individual car ownership over time.
GM and Ford realize this and are making fundamental strategic transitions toward transportation as a service.
They each recently created major new business entities to exploit the ARS opportunity separate from their traditional businesses.
The ARS market will be an enormous opportunity with several very large companies expected to compete for it.
At some time in the future, their ARS businesses may be worth more than their car manufacturing businesses, and they know it.

GM (GM) and Ford (F) are in the early stages of a major transformation to transportation as a service. They will continue to design, manufacture, and sell cars, but are betting their future on autonomous ride services (ARS). Not only is a success in this new market a major opportunity for them, but it may be fundamentally necessary for them to continue as successful companies. In fact, the value of their new ARS business may well exceed the value of their car manufacturing business in the next 3-6 years. Long-term investors in these companies need to be aware of this transition because the company they own today may be very different in the future.

In this, the third of my Seeking Alpha articles on the profound impact of autonomous vehicles, I focus on how these two prominent car manufacturers are addressing this challenge.

Autonomous ride service is the future of transportation, and it will cannibalize individual car ownership over time. This is a technology-based transition like that faced historically by other companies such as Xerox (NYSE:XRX), Digital Equipment, IBM (NYSE:IBM), Polaroid, and others - only it is much larger. Both companies, as well as other car manufacturers, are very aware of the need for this transition and are managing it carefully but aggressively. They know what is at stake and know the risks of doing it correctly.

The advent of autonomous vehicles (AVs) has been discussed for a while, but AV strategies began to change significantly over the last two years as the technologies and opportunities became clearer. I’ve written about this in my previous research over the last two years. It has now become apparent to experts in the industry that autonomous ride services will be the first market for AVs, and that it will become an enormous market. The economic advantages and increased convenience of transportation as a service will displace individual car ownership for many people.

In the U.S. today, the average car sits idle 95% of the time, so ownership is very expensive. ARS vehicles are expected to be utilized 50-60% of the time, and without a driver, the cost of travel will be significantly reduced. Increased use of ARS creates an individually-owned car displacement ratio of 8-10 to 1, meaning that the purchase of new vehicles will be considerably reduced at some time in the future.

As I said, there have been some profound changes in ARS strategy. Initially, partnerships appeared to be the way to enter the ARS market, with each company providing different elements needed to be successful. However, behind the scenes, there was a battle over who would control the customer and get to decide how to allocate the customer's ARS dollar. Now, it appears likely that the partnership strategy is not going to prevail in most cases. So, each company is going on its own to control its own destiny.

Two recent announcements by GM and Ford provide some insight into changes in their strategies. Let’s look at their ARS strategies first, and then let’s look at the ARS market more broadly. The timelines in these strategies and the magnitude of investment illustrate how rapidly this market is expected to emerge.

GM’s ARS Strategy

Autonomous Vehicle (AV) strategies have been evolving rapidly over the last few years, and GM is no exception. GM bought Cruise Automation in 2016 for approximately $580 million with other investments bringing it to $1 billion. Cruise Automation was started only two years earlier.

In January 2016, GM also made a $500 million investment in Lyft (NASDAQ:LYFT). At the time, there were rumors that GM made an offer to acquire Lyft but was turned down. GM said at the time that it would work with Lyft to develop autonomous ride services. However, these intentions didn’t materialize because of differences, most likely that each wanted to control the customer and get the most significant share of the ARS revenue from each ride. GM president Dan Ammann joined the board of Lyft shortly after the investment was made, but he subsequently resigned from the board. In June 2018, GM stated that it had no active projects with Lyft. It currently appears that GM will develop its own autonomous ride services service to compete with Lyft.

Recently (in May), GM spun off Cruise Holdings LLC with Japan’s SoftBank (OTCPK:SFTBF) investing $2.25 billion for a 19.6% stake in the new company. GM will also invest another $1.1 billion. SoftBank’s initial investment will be $900 million with an additional $1.35 billion when the AVs are ready for commercial deployment. Cruise is expected to become GM’s business for autonomous ride services. The timing of these investments into the company is consistent with the significant capital needs to enter the ARS business.

Note, selling less than 20% ownership has significant financial reporting consolidation and taxable income treatment for GM.

GM is quietly developing its own ridesharing app, called Cruise Anywhere, that its riders will use to request a ride from its ARS vehicles. It is also developing an ARS dispatch platform to be used to manage a fleet of AVs in each metropolitan area. The ARS dispatch platform will be necessary to control dispatching AVs to pick up passengers and then direct the vehicles to the next location. It will also monitor the status of each AV, respond to passenger requests, and even take control of the AV if needed.

GM Cruise is currently in its fourth iteration of AV. The AVs are based on the Chevrolet Bolt, but with significant AV renovations, and they are now referred to as Cruise AVs. GM acquired Strobe Inc., a three-year-old start-up, in October 2017 and is now using its technology to develop next-generation lidar technology for its AVs.

GM is currently testing a fleet of about 180 AVs in San Francisco, primarily with employees as passengers. Reportedly, GM has also installed 18 fast chargers in a garage in the Embarcadero waterfront.

Cruise is expected to launch its ARS as Cruise Anywhere sometime next year as a pilot. Initially, its ARS service will have very limited revenue, but my forecasted timing for the ARS market is that it will start to ramp up fast in two to three years. GM hasn’t disclosed the location for its initial ARS, but considering that it is testing and developing detailed maps in San Francisco, that will most likely be the location.

Ford’s ARS Strategy

Ford believes that the advent of autonomous vehicles will have a huge impact on everyday lives due to the centrality of transportation to both society and business, and that it is evolving quickly in both form and magnitude. Like GM's AV strategy, Ford's has also evolved quickly in form and magnitude. Initially, the company aggressively pursued external investments and acquisition opportunities in the latter half of 2016, backing or acquiring companies working in AI, lidar, and mapping. Its biggest autonomous technology investment came in February 2017, when it announced that it was investing $1B over the course of 5 years in AI startup Argo, and gaining majority ownership of the company. Ford then established its autonomous vehicle efforts around Argo.

Lidar is a critical technology that auto manufacturers lack, and in 2017, Ford acquired Princeton Lightwave to develop affordable lidar sensors. Previously, Ford invested $75 million in Velodyne.

Ford refocused its strategy on developing AVs for autonomous ride service vehicles first and then selling them later in retail markets. At the end of September 2017, Ford and Lyft announced a major joint initiative. The intent was that both companies would develop software that will allow Ford’s vehicles to operate with the Lyft mobile app. Lyft announced that Ford agreed to place its AVs on Lyft’s open platform, which enables partners to access its one million riders per day. Ford could use this opportunity to refine its ability to connect smoothly with a ride-hailing dispatch platform. This may be indicative that Ford could supply AVs to Lyft, or that it will provide the ARS vehicles and use Lyft as a service, but it is by no means certain since Lyft has other partnerships.

Then recently, on July 24th, Ford Motor Company made a significant strategic move, creating Ford Autonomous Vehicles LLC (AVLLC), indicating that Ford would use this new entity to launch its own ARS. Its intent is that the new business will be able to develop the right business and business model with less concern about Ford's legacy business. The new organization is charged with accelerating its AV business to capitalize on market opportunities. Ford Autonomous Vehicles LLC will include Ford’s self-driving systems integration, autonomous vehicle research and advanced engineering, AV transportation-as-a-service network development, user experience, business strategy and business development teams. Similar to GM Cruise, the new LLC is structured to take on third-party investment and will hold Ford’s ownership stake in Argo AI. Ford expects to invest $4 billion in its AV efforts through 2023, including its $1 billion investment in Argo AI.

The consolidation of all AV activities into a new business entity with a charter for developing a transportation-as-a-service network and with the expectation for outside investment clearly indicates that Ford will enter the ARS market using Ford Autonomous Vehicles LLC. While Ford may still do some partnership arrangement with Lyft, this is a clear indication that it intends to enter the ARS market on its own.

Ford is taking an interesting strategy in developing a new autonomous ride services vehicle. First-generation ARS vehicles are versions of production vehicles that are retrofit with autonomous capabilities. For example, the Cruise AV just mentioned is an adaptation of the Chevrolet Bolt, and Waymo (NASDAQ:GOOG) (NASDAQ:GOOGL) is retrofitting the Fiat Chrysler (NYSE:FCAU) Pacifica Hybrid minivan and Jaguar I-Pace. In contrast, Ford is developing an entirely new AV from the ground up, instead of retrofitting an existing model. This will most likely delay Ford's entry into the ARS market, but probably not too late. In addition to being a vehicle designed specifically for ARS, and possibly what will become a "second-generation" vehicle instead of a retrofit first generation, it will be a hybrid, where most experts expect second-generation ARS vehicles to be electric. Ford's reason for a hybrid is quite compelling: it wants to make this vehicle more profitable for ARS providers. A hybrid can drive much longer without refueling than electric AVs, and this can be very important to ARS providers where utilization is critical. Having a major portion of its fleet down for an hour of recharging during peak periods could become a big problem. This design consideration illustrates that Ford is serious about the ARS market as its initial AV opportunity.

Ford intends to launch its AVs, most likely as autonomous ride services, in 2021. This is a little later than others, but not too late because it's when I forecast the rapid ramp-up of the ARS market. Ford is already testing AVs in Miami, as well as in other areas. Ford is also developing a strategy around autonomous delivery, which could provide another source of revenue.

The Autonomous Ride Services Market Opportunity

In my recent Seeking Alpha articles: Google Tips Its Hand on Its Autonomous Vehicle Strategy, And It Will Be Big and Deciphering Apple's Autonomous Vehicle Strategy, I described my thoughts on the emerging market for autonomous ride services. I won’t repeat all the details of my market estimates; instead, I will summarize some of the highlights.

ARS is ridesharing without a driver. The economic advantages of eliminating the cost of a driver and achieving much higher utilization of ARS vehicles will reduce the cost of transportation significantly. I estimate that the price of a typical ARS trip will be less than half of a typical Uber (NYSE:UBER) trip today, and it might be even much lower than that. Even at this much lower price, ARS will be very profitable compared to the typical loses in ridesharing. ARS will be even more convenient than ride-sharing, and ARS vehicles will provide a more comfortable interior.

ARS will be the first market for autonomous vehicles (AVs). People will be more comfortable trying out a trip in an autonomous vehicle than taking the risk of purchasing one. ARS will be initially provided in selected municipal areas, most likely in the South and areas with favorable weather conditions. ARS vehicles only need to be sufficiently autonomous, by which I mean that they just need to be able to travel on specific routes, not every back road or alley. Geo-fencing will define the suitable roads for ARS vehicles.

I expect that ARS will be fleet-based. For example, 500-1,000 ARS vehicles will be placed into a typical municipal area by an ARS company (such as GM, Waymo, or Uber) with potentially 2-3 ARS companies eventually competing in each primary market. Because they are fleet-based, the ARS vehicles can be more easily serviced, maintained, and cleaned. An ARS will use specifically defined routes within each metropolitan area that its vehicles can maneuver with proven reliability. When a passenger requests a ride from one location to another, the ARS app will validate that it is a route it can manage, and if not, then it will not offer that ride.

ARS will be such a potentially large and profitable market that I expect several large companies will enter this market aggressively. The nature of this market will also motivate competitors to open new municipal markets quickly. I compare it to a land rush. If Waymo and Uber each put 1,000 vehicle fleets into a specific municipal market, then GM may bypass this market and go into another. Once ARS is accepted as a viable and attractive service, then aggressive competition will drive rapid growth.

I estimate the size of the ARS market in the United States to be approximately $150 billion by 2025. I get there with my assumptions that each ARS vehicle will make 50 trips per day, which is the same assumption that Waymo subsequently made, and that each trip will average $8.75 with vehicle utilization of 350 days per year. This equates to approximately $150,000 of revenue per vehicle annually. With 1 million ARS vehicles operational by the end of 2025, total ARS revenue in the U.S. would be $150 billion; however, it would still only account for approximately 3% to 3.5% of total miles traveled. This estimated ARS revenue of $150 billion by 2025 may be understated since Waymo has already stated plans for more than 80,000 ARS vehicles by 2021, which almost all of the 100,000 ARS vehicles I predict for 2021.

Expected Structure of the ARS Industry

In order to anticipate what is required to compete successfully in the ARS market, you first need to understand the expected structure of this new industry. Like any other industry, the ARS industry is best viewed as the “layers” required to provide ARS services. Different competitors will compete in different groups of layers. Here is my view of these layers from top to bottom:

Ride-Hailing App – ARS starts with the ability for a passenger to request an autonomous ride, similar to the way it works with Uber and Lyft.
AV Dispatch and Management System – This is the software system that dispatches vehicles to riders, controls travel between rides, manages ride billing, communicates with passengers as needed, and possibly takes control of the AV if necessary.
Municipal Fleet Operations Management – Encompasses the management of the physical fleet – including maintenance, cleaning, software updates, local variations – in each municipal fleet.
Fleet Ownership – The investment ARS fleets will require very significant financial resources so third-party investors could own fleets.
Autonomous Vehicle Technology – This consists of the platform of sensors, computing processing, and software that runs the vehicle autonomously.
“Dumb” vehicle – Not intended as a criticism, but some competitors in this market will purchase a high volume of customized vehicles without any intelligence to fit their AV technology.

Within these layers, I expect various ARS companies to compete differently, depending on the strengths and experience they bring to this new industry. The ride-hailing app will be the primary point in the ARS system controlling the customer. Whoever “owns” the most popular ARS apps will control the customer and will probably take a larger share of the profit because of this. The autonomous vehicle technology is what I refer to as the “defining technology” of the ARS platform. It is what truly enables an ARS vehicle and will be most critical to success.

Expected ARS Competitors

The ARS market doesn’t exist yet, but it is close enough in time (only a year or two away now) to identify the most likely competitors to enter the market. As I wrote in my previous SA article, I see Waymo with a lead over others in the market, as it will enter the market early and aggressively, but there will be other strong competitors in the United States as well.

Large technology companies will be attracted to this enormous market opportunity, and they bring critical software technology and computer experience to it. In addition to Waymo, as I discussed in my SA article on Deciphering Apple's Autonomous Vehicle Strategy, I also see Apple (AAPL) coming into this market, even though it hasn’t declared its intentions yet. In addition to the technical expertise to develop AV technologies, these two companies have two other advantages. They have the smartphone platform to introduce an ARS app rapidly. They also have the deep financial resources needed to invest the billions of dollars required for ARS fleets. I don’t expect them to build the basic vehicles. Instead, they will initially modify current production vehicles with their own autonomous vehicle technology. Then later, they will design their own ARS vehicles and subcontract the manufacturing.

The current ridesharing companies, particularly Uber and Lyft, must compete in the ARS market, as it will cannibalize their entire business eventually. They can use their dominant position with an existing customer base and prominent ridesharing apps to enter the ARS market. They will also be able to provide a mixture of ride services. In the Uber app, for example, a passenger could choose between UberX, UberXL, or UberAV, and the app would identify if UberAV is available for that route and provide the lower price for it. However, the ridesharing companies lack the remaining layers necessary for ARS, especially the AV technology, basic vehicle manufacturing, and the capital necessary to create AV fleets. Uber has been developing its own AV technology, but it has had some well-publicized setbacks recently. Lyft does not appear to have invested substantially enough in developing its own AV technology and will probably depend on others. This makes Lyft a very attractive acquisition candidate to others entering the ARS market.

Outside of a group of interesting start-ups, car manufacturers are the other potential competitors. GM and Ford will be the primary initial competitors in the United States, but I expect other car manufacturers will also enter the market. Mercedes, for example, is currently in a process of spinning off its potential ARS business as a subsidiary similar to GM and Ford. These car manufacturers come to the market with skills in vehicle design and manufacturing. GM and Ford are aggressively developing their own AV technology. They will be new to the top layers of the ARS platform, especially the ride-hailing app, but they appear to be developing their own. It still needs to be determined if that will grab sufficient customer attention. They also lack the capital required to create ARS fleets. That is what makes the spin-off of the potential ARS business so interesting. They are planning in advance to have a separate entity that can raise the capital needed.

ARS Market Share

While the size of the ARS market can be anticipated and even roughly projected, it is still too early to predict who will garner the largest shares of this market. It's important to note that the ARS market has an important distinction: it will be a local-services market, unlike smartphones and search engines that are global markets. So, competition will be by region or by municipal area, and competitors will initially be more disbursed.

For example, Waymo may be the first to provide ARS in the Scottsdale Arizona area, and possibly others. But GM may be the first to enter the San Francisco market, and Ford might be the first to enter the Miami market. ARS customers in San Francisco will only be able to use GM Cruise initially since there won't be any other ARS available. The primary (largest) and secondary ARS markets won't be fully populated with competitors until the later part of the 2020s. So, the ARS market will be disbursed to some extent until it finally consolidates.

Based on my research, I currently see 3-5 major competitors gaining approximately two-thirds of the U.S. market by 2025 with another 5-10 competitors sharing the remainder. Based on my estimates of a $150 billion U.S. market in 2025 and a $750 billion in 2030, this is a significant revenue opportunity for these 3-5 companies to achieve $15-30 billion in revenue in 2025 and $100-200 billion by 2030 in the United States ARS market alone.

Based on what appears to be more aggressive ARS strategies backed by billions in investment, GM and Ford will be in the mix as significant competitors for the ARS market, along with Waymo, Apple, Uber, and Lyft. Although AV investment data is not available for Uber and Lyft, it is very possible that GM and Ford are investing much more than either of these two companies. Whether they will be in the top five or in the second tier depends on how well they execute their strategies, but they certainly have a good chance.

Impact on Valuation

Looking at GM and Ford, what is the potential impact on their valuations from entering the ARS market?

The starting point for future valuations, however, is not simply measuring an increase in their current valuations because ARS will significantly cannibalize the retail car manufacturing business. While I have modeled this out in some of my research, the model is too complex for this article and unnecessary to make the point. In simple terms, as ARS becomes more popular, car ownership will decline. This impact is already being seen with ridesharing services. Even though ridesharing drivers still purchase their vehicles at retail, they do have higher utilization than individual owners. The average individually-owned car is utilized only 5% of the time and sits idle the rest of the time. Ridesharing vehicles are utilized more, which is why ridesharing is already impacting car sales volumes. ARS will have a much more dramatic impact on retail car sales. ARS utilization will be 50-60%, meaning that approximately one ARS vehicle will eventually displace 8-10 or more individually-owned vehicles. Once more, these ARS vehicles will be fleet-based and not purchased at retail. It’s premature to forecast the full extent and timing of this impact and whether it will come first from new cars or used car sales, but it’s safe to say that the success of ARS will eventually reduce new car sales. GM and Ford know this, which is why they are heavily investing in ARS. It’s not just a new market opportunity; it’s a major transition of their fundamental business of providing transportation.

With this transition, I expect that GM’s and Ford’s ARS subsidiaries eventually will be worth more than their current car manufacturing businesses. Morgan Stanley analyst Brian Nowak said recently that Alphabet's Waymo may be worth $175 billion instead of his prior estimate of $75 billion, and much of this comes from autonomous ride services.

GM’s market cap is currently about $53 billion, including its share of its Cruise subsidiary that was valued at $9 billion with SoftBank’s investment of $2.25 billion for less than 20% ownership. This then assumes that the basic car manufacturing business is worth approximately $44 billion. The ARS business is expected to be very profitable, and it will have extremely high growth rates for many years. This will most likely provide very favorable valuations for ARS businesses. For example, if GM is successful in the ARS market (and that's still a big IF), then Cruise could increase in value from $9 billion (GM’s 80% share) to potentially something as large as $40 billion to as much as $80 billion (assuming $10-$20 billion in ARS revenue, a 20% profit margin, a growth-based PE of 25X, and continued 80% ownership share). This would more than offset the decline in the valuation of its current car manufacturing business. If GM, is not successful in the ARS business, then it might be reduced to a subcontract manufacturer for other ARS companies, and its future valuation could be significantly reduced from today.

The story is similar for Ford. It has a current market cap of approximately $40 billion. Since there is no outside investment yet in its Ford Autonomous Vehicle LLC subsidiary, there is no way to value it. Success in the ARS business could more than double its market value by the mid-2020s. Failure could significantly decrease its current market value.

In summary, autonomous ride services is not just a potential opportunity for GM and Ford, it’s a fundamental strategic transition of the way transportation is provided, and it will determine their future values. It’s Digital Equipment, Polaroid, IBM, and Xerox all over again – but only much bigger. And both of these companies know this, which is why they are betting their future on AVs in general and ARS in particular. They don’t intend to stand by and just watch it happen.

If you are a current investor in GM or Ford, you need to be aware that you may own an ARS business in the future. If you want to invest in a future ARS business, then GM and Ford may be a way to get there. But all of this depends on how successful they can be in executing this strategic transition.