If robotics aren’t inherently capital intensive, does management in robotics just suck? Yes. Here’s why…

Image: Fairchild Semiconductor Successor Companies
Source: Steve Blank’s Testimony to House Science Committee

I was harassing my asset management friends to get them to help me develop the synthetic short instrument I want to put into the robotic stock tracker and we started discussing capital use in robotics.    Their question, was, “Okay,  if robotics are not inherently capital intensive, why does it take more money to get a robotics company up and running?  Isn’t that initial expense an inherent characteristic of the robotics industry?”

In a word, no.  The fundamental problem with robotics companies is that management doesn’t have a well developed process for synchronizing customer and product development to use Steve Blank’s terminology.  Or put another way, a lot of robotics companies spend a fortune on unnecessary engineering when they frankly suck at discovering what customers want.  iRobot has a whole museum dedicated to their market failures.  I contend that much of this engineering effort is not necessary to development of viable robotic businesses–this same learning could be done with vastly less expense.

Much of this problem comes from the difficulty of porting over rapid-cycle software development best practices for discovery of true customer needs.  Most of our hardware development methodology comes from environments where customer needs are relatively well understood and engineering improvements require a lot of time.  Robotics companies still have engineering cycle times (the amount of time to go through the engineering build, test, analyze, decide cycle) that are much longer than pure software companies at least 3 times longer and often much more as best as I can estimate from anecdotal evidence.  Companies are very reluctant to reveal this information, so my estimate may be off by several factors, but it is clearly much longer for robotics companies.

I believe that we in the robotics industry need to tailor the customer and product development methodologies to the peculiar challenges of robotics.  We will need to reduce cycle times of engineering teams down closer to software levels.  3D printing and continuing improvements in supply chain should make this feasible.  Management should make it a priority and a reality, and be willing to incur some expenses to do so.  Even more, management needs to do a lot of work to reduce market risk much earlier in the product development cycle.

iRobot’s museum show that it is proceeding to engineering while far too much of what is required to make a viable commercial product remains unknown.  This isn’t to pick on iRobot, they may be among the  best in the industry, but it is just to show that even the most advanced practitioners in our industry are not very good at understanding customers compared to other industries.  Yes, for some customers, such as the government, just doing research can be a viable business model, but this won’t grow the industry.  We need to develop ways to reduce market risk and we need to get good enough that we’re showing the software industry how they could learn about customers more and code less.

I don’t propose to give a complete answer on how to do this here, but it is clear that there is more than one path to reduce market risk in a product.  Both Intuitive Surgical and Liquid Robotics seem to have taken the approach of building a robot that is so awesome and widely applicable that it will find a use even if it isn’t in the application that management originally intended.  Other robotics companies, like Kiva Systems and RedZone (since Eric Close took over), seem to have taken a more traditional minimally viable product approach and iterated upon the original product.  Both strategies appear to win in certain circumstances and companies that took the opposite approach in the same markets failed.   How do we distinguish which set of market and technical circumstances we find ourselves in?

This interplay between technical and market risk and how it applies to robotics management is only beginning to be understood.  Few people have proposed measurable distinctions that would allow management to make decisions about what risks to accept and what risks to mitigate before committing capital to a project.  This area of research more than any other will unlock the potential for robotics to become the next tech boom.

Is a dollar worth a dollar on a tech company’s balance sheet?

Previously, dear reader, you and I have discovered that robotics companies are firmly entrenched in the knowledge economy and their assets look like other knowledge economy companies’s assets.  Robotics companies only hold only a limited amount of real assets but lots of financial assets.

As a related question, what is the value of the cash (and financial assets) on the balance sheet to investors?  There might be several issues with holding so much cash.  Particularly, money in a company should be employed making more money, ‘earning or returning’ as the saying goes.   Are there valid reasons to hold so much cash?  And if so, how should we value the cash that knowledge economy companies hold?

Cash Is King! (Or at least a founding father)

Bottom line up-front:  Valuations are always wrong.  What’s interesting is how they are wrong.  Assuming a dollar is worth a dollar is as good a rule as any, but is almost always wrong.  Nobody is really sure which way (too much or too little) it is wrong.  Below, is an elaboration of some of the issues with valuing cash which may come into play when valuing particular companies.  (And you thought that at least cash of all things had a fixed value  —  don’t we all wish!)

There are various criticisms of excess cash on the balance sheet, below are some of the most common.

1)  Holding the extra cash reduces returns, i.e. to buy into the business you have to buy a pile of cash beyond what is ‘necessary’ to run the business.  Further, the rate of return on cash has been essentially zero and certainly below inflation lately, so holding the portfolio the stock represents of a highly profitable business, plus cash must necessarily produce a lower expected return than just the business.

2)  Because of agency problems, management may be incentivized to use the cash to reduce volatility or ‘save’ the business if it falls on hard times, even if the investors could get a markedly higher rate of return in the market.  From an investor’s point of view this would be systematically wasting money.  Employees, customers, management, and trading partners might have a very different view.

3)  Holding lots of cash is said to signal that the company does not have profitable investment opportunities commensurate with the cash that it is generating and the company’s growth may slow in the future.  Further, holding lots of cash signals that you don’t know, or are ignoring, the traditional Anglo-Saxon business administration.  English speaking investors generally expect management to maximize monetary returns over the forecasting horizon and put shareholder interests ahead of all others.

Some countervailing points that you will often hear are along the following lines. 

A)  Although holding cash reduces returns, for a volatile security like a fast growing knowledge economy company, having cash on the balance sheet dramatically reduces volatility.  If investors want more exposure to the underlying business for the same initial investment, lever-up.  Since we are talking about cash holdings, buying on margin is almost a perfect antidote to management’s lackadaisical cash management policies if you feel that way.  [But seriously, who is their right mind thinks you need to lever-up when buying tech stocks?]

B)  Although management might ‘burn’ cash saving a failing business, which would be better redistributed to investors, more likely, they are going to have the flexibility to engage in acquisitions and new ventures without having to deal with the whims of the security markets.  [Has anyone seen a rational market lately?  Please let me know.]

Or has anyone read the Wall Street Journal?  Tech companies are routinely attacked for having their fixed life fund investors exit—Groupon and Facebook each got front page hatchet jobs over the past two days with nary a mention that these funds had been planning to sell now for, oh say, 8-10 years!  Talk about journalistic malpractice.  Would you want to go to the public markets in that environment?  I sure wouldn’t.  If I was management, I’d say that if investors are that irrational, I’ll keep the cash and do what they should have done with the money.

C)  Finally, although cash on hand may sometimes signal that the companies are running out of investment opportunities, it certainly signals to would be competitors that the said company is in a position to stick around for a long time and bitterly contest any erosion of their market position.  This may greatly enhance the value of the underlying business asset.

D)  This is a successful tech company.  It is run by the founders, for the founders (i.e. management).  If you don’t want the privilege of investing and taking whatever returns the founders deign to give, please step aside and allow the next investor to purchase stock.  But this isn’t really a justification.  Founders are investors too, especially once the company goes public, with theoretically the same motivations as other investors since their stake is highly liquid.

Further research on technology companies and their cash management policies should address the following issues:

I)     Are there structural reasons beyond the creation of new businesses and defense of existing businesses for technology/knowledge companies to hold lots of cash?  It does not occur to me that there is anything about a maturing knowledge business that seems to require massive amounts of cash.  Law firms and accounting firms do not seem to hold too much cash, but they are also typically private and can make much more drastic changes than public companies.

II)   Are there frictions between the interests of various classes of investors?  Particularly when there is a founder controlled/managed company, cash on the balance sheet is probably as good to them from a control perspective as cash in the bank and better from a tax perspective.  Should investment banks or others creating the classes of stock have new mechanisms to deal with this?

III)  What are the true limits on investment opportunities?  My firsthand observation has been that the greatest constraint on growth of robotics companies is management attention.  It may be that most technology companies have massively profitable investment opportunities, but management attention is engaged on current projects and hiring into the management circle is not that easy.  What is the needed resource to change this?  How can cash be used to obtain this resource?  Can it?  Is passion required?

IV)  Are there ways that management could resolve some of the market frictions that require them to hold lots of cash?  The public markets seem to mercilessly abuse tech companies—no they don’t look like utilities, but the highs and lows that they are pushed to seems unjustified—there just doesn’t seem to be enough new information about their future prospects to justify either one.  Can management take steps to make access to public markets, particularly debt markets more reliable?  Could banks make money by providing massive, typically undrawn, lines of credit that would provide much of the same protections to management?

My reflections on #AUVSI North America 2012

I got to spend two days at the Association for Unmanned Vehicle Systems International (AUVSI) North America 2012 trade show last week.  As a first pass, the industry continues to grow even as defense cuts start to put a damper on things.  Other domains besides air are also starting to look like real possibilities though their manufacturers don’t always see fit to join AUVSI.  There is still tremendous excitement about the FAA’s recent moves that seem to indicate real progress in the last year.  Privacy concerns are being taken seriously, hopefully early enough to nip the issue in the bud, because the safety issues seem to be close to resolved.

  • The show is bigger than ever with more and more companies in attendance.  Based on my entirely unscientific method of walking around the show and looking at the booths at random, it seems to me that there are more companies offering services and software, about the same number offering components and hardware, and many fewer trying a hawk new platforms.  I think this reflects the reality of customer budgets and also the maturity of the industry.  The show didn’t have quite the same clubby feel that I used to remember, but maybe that’s good as well.
  • There was real concern and real awareness of the image problems that our industry has.  AUVSI is still definitely focused on the air side of things, but ground and maritime are definitely on their radar.  There is real determination on the part of the association leadership, both professional and volunteer, to counteract the negative press that the industry has been getting.
  • The Brookings Institution and the American Civil Liberties Association (ACLU) were both in attendance to participate in a privacy forum.  The Brookings and ACLU seem to have a great deal of common ground with the AUVSI membership at large on at least the law enforcement uses of unmanned aircraft.  That is the fourth amendment is still in effect and the same sorts of procedures that govern manned aircraft data collection ought to govern unmanned aircraft data collection.  Further, most people here on both sides of the panel were far more personally concerned about being tracked by cellphone data than unmanned aircraft.
  • The show is still definitely defense centered.  However, there is a feeling in the air that the FAA will actually do something and get unmanned aircraft out in the airspace soon.  Lots more booths are starting to have material that touts civilian use and more thinking is going into what will happen after the FAA starts allowing unmanned aircraft in the airspace.  Personally, I’m still skeptical that FAA is going to meet its deadlines, but I am certainly hoping that they will.
  • Robotics is starting to be used more in the same breath with unmanned systems.  Most of the AUVSI education outreach efforts don’t talk about unmanned systems at all (except maybe in an acronym) but do talk about robotics education.  I think this is a really positive development.  I would like to see AUVSI, the RIA, SAE robotics, and the robotic medical device companies operate under some kind of shared banner.  We all have the same workforce concerns, similar regulatory concerns, and face the same kind of backlash whenever we try to introduce new applications.  I believe that there is strength in numbers and it is always great to get the back-up that the fallacious counter arguments being trotted out against your robotic application are the same ones trotted out against other robotic applications that have gone on to be successful.  Particularly when we go to Capitol Hill to try and get rules changed so that we can compete on level playing field with legacy systems I think that there is value in having the Boeings (NYSE:BA), Intuitives (NASDAQ:ISRG), and Schillings (acquired by FMC NYSE:FTI) of the world support each other.

 

Robotics capital intensive?! What are you smoking? Don’t believe it.

Robotic manufacturing is not capital intensive, contrary to the popular wisdom.  (Looking at you HBS.)

Unless someone can bring data to the contrary, we should treat this issue as thoroughly decided against the  conventional wisdom.  As we saw previously, robotics companies do not need a lot of fixed assets.  Now, we will see why people who blithely repeat the conventional wisdom that robotics companies are capital intensive are wrong–even if they claim robotics companies are hiding their true use of capital.

First off, robotics companies’ balance sheets look like technology companies’–the internet kind, not the aerospace/industrial kind.  Robotics companies have lots of cash and relatively little else.

Second, robotics companies have gross margins that even companies that don’t make stuff would envy.  The robotics gross margin would probably be even higher if iRobot and Aerovironment were not defense contractors.   There is a lot of pressure to bury as much expense as allowed into the cost of goods due to defense contract rules.   Intuitive and Cognex’s margins are around 75%.  They are even beating Google on gross margin!

Although, it does appear that robotics companies have a bit longer cash conversion cycle than the basket chosen for comparison here, their cash cycle appears to be in line with other complex manufacturers.  Plus, the robotics companies are holding so much cash their management may just not really care to push the conversion cycle down.

Look at the cash required to sell aircraft though!  Manned or unmanned it looks like it takes forever to get paid for making planes.

Although robotics companies have physical products, the value of a robot is in the knowledge and information used to create it and operate it.  The materials are nothing special.  Consequently, these companies look like part of the knowledge economy–few real assets, lots of cash, and huge attention to their workforce.   Next time someone tells you robotics companies are capital intensive, ask them to share what they’re smoking–it’s probably the good stuff–because they aren’t using data.

One thing that a venture capitalist may mean when he says that robotics is capital intensive is that it generally takes a long time and lots of money to develop a viable product in robotics.  This may be true, but it is not really the same thing as being capital intensive.   This observation should cause a lot of soul-searching within our industry.  What the venture capitalist is telling us is that we–as an industry–cannot reliably manage our engineering, product development, and business structures to produce financial results.

This is why the conventional wisdom is dangerous.  It suggests that the lack of investors, money, and talent flowing into our industry isn’t our fault and there’s not much we can do about it.  That is what needs to change in robotics.  We need to get better at management.  We need to start building companies quicker and producing returns for our investors.  If we do that the money, talent, and creativity will start pouring into industry.  Then robotics can change the world.

Notes on Data and Method
Data Source: Last 10-k

Method:

Accounts Receivable = All balance sheet accounts that seem to be related to a past sale and future cash, so accounts receivable plus things like LinkedIn’s deferred commissions.

Cash + Investments = All balance sheets I could identify as being financial investments not required to operate.   Assume all companies require zero cash to operate.

Did not account for advances in cash conversion cycle.

U.S. Robotic Stocks: Speculators Wanted (the real kind, not the financial kind)

The first part of the robotic stock tracker is up.  The index is coming!

First observation:  It is amazing how volatile robotic stocks are and how much idiosyncratic behavior each stock has exhibited since the start of the year.   With this much volatility, one would expect robotic stocks to produce market beating performance over the long run, but they certainly haven’t done it so far this year.  In the short run, it is very difficult to value real assets that have uncertain financial prospects.  In the long run, I’m banking on an extremely bright future, powered by robots.

What cluster does a company with HQ in Boston but more offices in Silicon Valley belong to?

I’ve got more comprehensive data on public robotics companies due to some updates suggested over at hizook.  However, I’m at a loss as to how to classify Brooks Automation and Cognex.  They both make automation components for various kinds of industrial applications and they both have corporate HQ outside of Boston with two offices each (probably the legacy of acquisitions) in Silicon Valley.

At a loss as to how to classify them, I’ve made a new category for them on my charts.  If you have thoughts about how to get good acquisition data–especially as a lot robotics companies can be acquired in a transaction that is ‘immaterial’ to a 10-K/Q for public company–I’d love to hear them.

And here is the raw data.  Not all market caps were taken on the same day.

Surprise! Robotics Companies Are NOT Capital Intensive

Please allow me to blow your mind and overturn the common sense notion that robotics companies are capital intensive.  Comparing profitable, public, U.S. based robotics companies to a diverse basket of prominent public companies shows that robotics companies do not require a lot equipment and property to make successful businesses.

In fact, robotics companies have the least property plant and equipment of any of the companies I selected for comparison–which deliberately included such tech giants as a chip maker, an operating system maker, and a search engine giant.  Looking at capital expenditure and depreciation, the robotics companies are again among the leanest of the companies on the list.

The only companies that had such low numbers for CAPEX and depreciation had their assets tied up in very long term investments like real estate and aircraft manufacturing facilities.  Also, most of the robotics companies are still growing and may have their capital expenditures boosted as a percentage of revenues by their anticipated growth.  Take a look at the trend line.

Now what people may mean when they say that robotics is ‘capital intensive’ is that the marginal cost of goods sold for a robotics company is greater than $0/per unit that consumer web applications have–but if that’s what they mean they should come out and say it and not be sloppy in their reasoning.

Angels, VCs, and other investors are you paying attention?  Big plays are going to be made on relatively small bets.

As a Percentage of Revenue
Ticker

Company

PPE Depreciation

CAPEX

Robotics

IRBT

iRobot

6.81%

2.42%

3.05%

ISRG

Intuitive Surgical

11.31%

1.68%

6.79%

AVAV

Aerovironment

7.24%

2.76%

4.61%

CGNX

Cognex

9.86%

1.72%

2.43%

Robotics Median

8.55%

2.07%

3.83%

Robotics Average

8.80%

2.14%

4.22%

Diversified

GOOG

Google

25.33%

3.68%

9.07%

MSFT

Microsoft

11.67%

3.95%

3.37%

T

AT&T

84.50%

14.50%

15.87%

INTC

Intel

43.75%

9.52%

19.93%

XOM

ExxonMobil

45.96%

3.34%

6.63%

BA

Boeing

13.55%

2.12%

2.36%

D

Dominion Resources

206.34%

8.96%

25.40%

AA

Alcoa

77.82%

5.94%

5.16%

DIS

Disney

38.99%

4.50%

7.32%

HD

Home Depot

34.54%

2.39%

1.65%

Diversified Median

41.37%

4.23%

6.98%

Diversified Average

58.25%

5.89%

9.68%

Some notes on the analysis:

-Data comes from the companies last 10-K filing.  Some companies include different things in revenue (where possible I tried to exclude revenue from a financing arm), in deprecation (some include amortization of intangible assets), and capital expenditure (Intuitive, for example, includes the acquisition of intangible assets).

-I wanted to look at a diverse basket of public companies and tried to pick companies that might be similar in some ways to robotics companies but whose earnings would not be unduly influenced by robotic related income.  For example, I excluded offshore oil field services companies because they were too close to being robotics companies, but still not pure enough to get a good view of the diversified company.  I did include Disney (which does anamatronics), Boeing (which has a UAV making subsidiary), and Google (which has a robotic car division) because I thought the revenues contributed to the these companies by robotics related activities had no material impact on the financial metrics.  However, their tangential involvement in robotics speaks to their similarity to robotics businesses.

-Future analysis should look at some other places where capital use can be buried.  For example, Cost of Goods Sold can hide capital that is employed on the companies behalf further up the supply chain.  It is possible that current assets like inventory may also need to be higher for robotics companies.  Also, we should compare total assets and liabilities to the revenue generated to similarly sized public companies to see if there is a substantial difference.