Rivian: Why It Deserves My Attention.
Q1 2024 Update
No time to read the update? Watch/listen for free:
Edited by Brian Birnbaum.
1.0 Front-Running the Next Auto Consolidation Phase
Traditional manufacturer OEMs can’t keep up with the demands of digitally native customers. Rivian will contend for a number two position behind Tesla as the auto industry’s second major consolidation continues in earnest.
OEMs worldwide will soon be defaulting to Tesla’s operating system. The vertically integrated infrastructure required to yield autonomous driving (and other software-based features) is prohibitive for traditional OEMs. In this regard, Rivian is a strong contender for the number two position. At a market cap of $17.29B, the company is looking at considerable upside in the coming quarters.
The 20th century saw small OEMs (original equipment manufacturers) succumbing to the manufacturing expertise and, thus, superior unit economics of the larger OEMs. The small brands that survived ultimately did so because of the way they made customers feel, thus obtaining a prominent mindshare in the marketplace.
Notable examples of such smaller brands in the US include Cadillac, Jeep, Dodge, and others.
In effect, these large OEMs have acted as platforms that smaller brands have piggy-backed. As these platforms have compounded fandom with increasingly cost-effective manufacturing over the decades, it has become exponentially more difficult for non-affiliated brands to enter the marketplace. This is best evidenced by the number of new American car companies declining throughout the 20th century.
As a result, a number of large and profitable manufacturer OEMs have emerged across the world. Notice the graph below–Tesla’s cash from operations (red line) doesn’t quite yet stand out among the other large manufacturer OEMs, like Volkswagen (purple line), Toyota (blue line), Porsche (green line), and others. Nor does Tesla’s profitability stand out.
Despite the industry’s rapid evolution over the past decade, these OEMs are still great businesses. They prove that jumping into these platforms early can be quite lucrative–and thus why Rivian is worth studying closely, especially as its financials trend toward the waterline.
As we continue moving towards software-defined vehicles, we are likely to see a new set of platforms emerge. Such platforms help smaller brands stay apace with the ever-evolving needs and wants of digitally native customers. Yet, this new landscape will have fewer and more enduring winners because the software platforms will effectively be networks.
Tesla doesn’t explicitly tell its cars how to drive around. Rather, it lets their network of cars learn from real experience on the road. Those learnings are then retroactively etched into the software via neural networks that reprogram their parameters as the fleet of cars continues to accumulate miles driven. The more cars on the road, the better the AI and, by extension, the more appealing the operating system to other car brands.
Networks tend toward winner-takes-all scenarios, and Tesla has taken pole position. In such a scenario, Rivian would be as good a bet as Nikola–which is to say, not a very good one indeed. But I suspect the market may accommodate more than one platform. If so, Rivian is the most likely candidate to step up behind Tesla, with the former now seemingly tracking toward an inflection point.
2.0 What Makes Rivian Special
Rivian seems to be a few quarters away from gross profit.
Apart from Tesla, Rivian is the only company in the West that fully controls the perception stack: the vertically integrated infrastructure required to enable cars to pick up information on the road and turn it into insights, effectively unlocking autonomous driving and other software-based features. The stack subsumes everything from sensors to the datacenter, composed typically of large GPU clusters.
Without it, keeping up with Tesla is a lost cause.
The competitive dynamics at the perception stack level are like those of any other network’s: faster and better iteration leads to more participants in the network, yielding more data and thus value. Success is largely a function of iterating better and faster than competitors. Thus abstracting away physical constraints is paramount.
Getting physical constraints out of the way to iterate on the software as fast as possible is what makes this endeavor most difficult and is the primary reason for Rivian’s lack of profitability.
Our vertically integrated hardware and software capabilities enable continuous enhancements to the product.
-Rivian CEO, RJ Scaringe during the Q1 2024 earnings call.
However, Rivian’s gross margins continue to converge towards the positive domain. Management continues executing exactly as they’d said they would. During Q1, Rivian focused on updating the tooling in its ‘normal’ factory (the factory where they make all their cars at present), which according to management has negatively affected gross margins by 9.5%. In the below graph, we can see what gross margin evolution looks like if we normalize for this factor.
In Q3 and Q4 2023 gross margins were negatively affected by a slowdown in deliveries (which has been widespread across the electric vehicle space) and the transition toward lower-priced models, such as the Rivian R1S and R1T. However, it seems that once again the company’s process power is shining through, as evidenced by the up-tick in gross margin evolution. Management now expects to achieve a positive gross profit in Q4 2024:
We expect to see meaningful improvement in our gross profit during the second half of this year and believe we will reach a positive gross profit for the fourth quarter.
-Rivian CFO Claire McDonough during the Q1 2024 earnings call.
My general impression having studied Rivian for just under a year now is that the organization’s culture rests on an obsession with continuously driving incremental efficiency. My perception can be gleaned tangible in the long term evolution of TTM (twelve trailing month) gross margins.
When I wrote my original Rivian deep dive, management promised a 60% reduction in ECUs (electronic control units). Together with the retooling of the normal facility, as of Q1 2024, Rivian has successfully transitioned toward said new ECU architecture, which removes ‘substantial costs.’ In turn, the tooling upgrades have enabled Rivian to transition from three to two shifts in R1 production, increasing the R1 line rate by 30% and have also improved the flow of materials and inventory across the facility.
Management seems to believe that the above three improvements will catalyze the move toward gross profit because of their outsized impact on variable costs. However, according to management, this won’t equate to a significant volume increase in H2 2024.
The largest driver for us in our path to positive gross profit remains the improvement in variable cost reduction.
-Rivian CFO Claire McDonough during the Q1 2024 earnings call.
When I first studied Rivian– circa from Q1 through Q2 2023–the company had just gone hit an inflection point in the cost per car delivered. This was due to the introduction of the new Enduro engine unit and the LFP (lithium iron phosphate) battery pack. In effect, the improvements in the normal facility are not a standalone event, but rather a continuation of a long string of optimizations.
The organization is genetically focused on what matters. But for abrupt cultural changes in the near future, Rivian is likely to hit positive gross margins soon.
And then beyond that, we're constantly driving incremental efficiency across the organization as a whole.
[…]
And so that, that intensity and focus is what's enabling our path to reduce our operating expenses overall for the year, but also importantly, seeing that second half 2024 step change reduction in OpEx.
-Rivian CEO, RJ Scaringe during the Q1 2024 earnings call.
3.0 Compounding Efficiencies
With the launch of the R2 and R3, Rivian is now positioned to further leverage the efficiency gains obtained on the R1 platform.
Per Scaringe’s remarks, the R2 and R3 enable Rivian to further leverage the efficiency learnings obtained by iterating the R1 platform. The R2 and R3 require fewer inputs. By enabling Rivian to essentially repackage and sell its perception stack across a much larger surface area, the R3 and R3 promise to enable Rivian to radically expand its TAM and at a marginal cost.
This paves the way for higher capital efficiency:
So as we wind that forward into R2, R2 is a fundamentally different architecture. It's built to a different set of requirements. R1 has a very extreme set of requirements in terms of on and off road capability, whereas the R2 product will still be very capable both on and off road, but not to the true extreme that the flagship product has.
-Rivian CEO, RJ Scaringe during the Q1 2024 earnings call.
According to RJ, the R2 was designed to ramp quickly, leveraging lessons learned from previous launches. Further, by starting R2 production in the normal facility, Rivian expects to reduce capital requirements by $2.25B between now and the start of production. Additionally, the aforementioned efficiency increases brought about by the latest update of the normal facility have led management to reduce FY2024 CapEx guidance from $1.2B to $500M.
The current cash balance is now expected to last until mid-2026, which is great news. However, it must be noted that liquidity is still an issue. Investors retain the risk of permanent loss of capital.
4.0 Conclusion
Worth watching closely over the coming year.
Car brands thrive by vibe and manufacturing efficiency–which is how they grow the top line and then drag an optimal percentage down to the bottom line, respectively. Rivian’s cars possess the necessary vibe and are making headway toward profits. Some companies falter along the way, but Rivian has continued making progress against all odds, including a period of rampant inflation and subsequent stretch of waning demand.
The long term progression of Rivian’s financials denote a culture that is obsessed with continuously optimizing processes and delighting end customers. It’s more likely than not that the bottom line will inflect into the positive domain. Although the risk of permanent loss of capital is considerable, I believe this company is worth watching closely going forward.
A number two position in the emerging auto operating system market is likely to be far more valuable than Rivian’s market cap at present of just $17B.
Until next time!
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