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Morningstar | TomTom’s Strong 3Q Results Overshadowed by Fear of Google and Loss of Volvo Account; Maintaining FVE

TomTom’s third-quarter results beat on the top and bottom lines. During the quarter, the automotive, enterprise, and telematics segments posted year-over-year revenue growth. In addition, though the consumer segment continued to decline, TomTom generated operating income for the third consecutive quarter. However, the bad news outweighed the good: While TomTom beat expectations and had announced BMW and Peugeot account wins in early October, the firm said on the earnings call that its contract with Volvo has ended. In addition, questions regarding TomTom’s ability to compete with Google and its decision to possibly sell its telematics business remain. While management upped its full-year 2018 guidance, we did not make any significant adjustments to our projections and are maintaining our EUR 8 per share fair value estimate on TomTom.

The stock has experienced significant volatility in the past four weeks, sinking 24% and hitting 4-star territory after the Google announcement, only to recover and re-enter 3-star territory after news about some account wins and its intention to sell telematics. In reaction to third-quarter results, this no-moat and high uncertainty name is now down more than 15% and has returned to 4-star territory.

We continue to expect Google’s increasing traction in TomTom’s space to pressure the firm’s revenue growth after 2021. On Sept. 18, the Renault-Nissan-Mitsubishi Alliance said that it will use Google’s Android operating system for its cars’ infotainment starting in 2021, affecting TomTom’s automotive segment revenue. While Google’s Android car infotainment operating system can include non-Google navigation systems, the deal does create opportunities for Google to take away connected navigation system market share from companies such as TomTom. According to the Renault-Nissan-Mitsubishi press release, the new agreement does include Google Maps, which could eliminate any possibility of TomTom’s navigation system remaining part of the Alliance’s default infotainment offering.

This could also affect TomTom’s chances of playing a meaningful role in the advanced driver-assistance market as a part of autonomous vehicles. As we had noted in our initiation report, companies such as Alphabet, with its Waymo self-driving operating system, are more likely to work closely with a variety of OEMs and possibly prevent TomTom’s ADAS offerings from gaining traction.

The announced deal between Google and Renault-Nissan-Mitsubishi Alliance also supports our no-moat rating of TomTom. In our view, while TomTom’s navigation system and data offerings allow it to provide various components of infotainment systems to OEMs and/or dashboard technology vendors, the firm faces stiff competition, as demonstrated by the Google and Alliance news. In addition, in the short term, TomTom continues to face threats from Apple’s CarPlay and Google’s Android Auto, which basically connect car infotainment systems with drivers’ mobile devices and provide user interfaces very similar to what the drivers are more accustomed on their smartphones.

On a slightly brighter note, on Sept. 27, TomTom announced its intention to sell the telematics segment, which we think can earn the firm around EUR 1 billion, as we described in our Sept. 27 note. However, we are not yet certain how TomTom may use the cash. Some options include further investments in the firm’s automotive segment to compete a bit more effectively against Google, or distributing the cash as a one-time dividend to shareholders.

Regarding third-quarter numbers, total revenue grew year over year for the first time in eight quarters, up around half a percent to EUR 220 million. Automotive revenue grew 25% from last year due partially to a current client’s upward contract adjustment in the previous quarter. We expect this segment to grow at only around 7% annually through 2022 mainly due to the loss of the Volvo contract, along with the Alliance and Google decision, which may lower the probability of TomTom account wins in the future. We note the firm did announce account wins and agreement extensions with BMW and Peugeot. There was a turnaround in the enterprise (or licensing) segment as it posted its first year-over-year growth (0.6%) since the first quarter of 2016.

TomTom posted 6% growth in telematics, driven mainly by continuing double-digit year-over-year growth in subscribers, partially offset by slightly lower revenue per subscriber, as the firm continues to bring in larger fleets as clients. With further volume discount pricing, we expect telematics' revenue to grow at a five-year 5% CAGR. However, given this segment's 35%-plus EBITDA margin, we believe TomTom will attract interest from potential buyers that may be willing to pay around EUR 1 billion (or 20 times 2019 EBITDA) for the segment, as mentioned in our Sept. 27 note.

Growth in software-based automotive and telematics revenue pushed gross margin higher by 700 and 110 basis points year over year and sequentially to 73%. Cost control in marketing and selling, general, and administrative expenses helped TomTom post its third consecutive profitable quarter, with operating margin of around 11%. While we expect operating loss in the fourth quarter, due to seasonality in the consumer segment as the firm’s declining personal navigation devices face more pricing pressure, we think TomTom will be profitable in 2018.