IONQ: Enormous Valuation And The Competition Is Big-Tech

Investment Thesis

While IonQ (NYSE:IONQ) is an exciting company in a next-generation industry, I think the company will struggle to keep up with the rapid pace of technological change. The company is competing with companies with more financial resources necessary to pay for the best talent. The company is losing money, and that will not change soon. Constant refinancing or dilution will be required. It’s also unclear how much value IONQ has added to its customers. It is difficult to find information and even more challenging to understand the technology behind quantum computing. Much of any potential future success is already priced into its enormous valuation. In addition, the cost of talent and energy is rising, and venture capital is becoming scarcer as interest rates rise. Therefore, I do not see an attractive risk/reward ratio.

About IonQ

IonQ was founded in 2015 by Dr. Christopher Monroe and Dr. Jungsang Kim, who already had decades of experience researching quantum computers. They had “the goal of taking trapped ion quantum computing out of the lab and into the market” (source).

Right now, it’s the only public company whose quantum computers are available in big-tech clouds – via Microsoft’s (MSFT) Azure and Amazon’s (AMZN) Web Services starting in 2019, and Google’s (GOOG) cloud starting in 2021. These can be booked by companies, which generates revenue for the company. The company has been listed on the stock exchange since October 2021.

The quantum computer market outlook

The quantum computing market size is predicted to rise from $89.6 million in 2019 to $1,866.8 million by 2030 (according to the market research report published by P&S Intelligence), equaling a CAGR of 33.1%. Furthermore, on page 3 of their investor presentation, IONQ mentions a $65B TAM by 2030.

Of course, these are all estimates, and I doubt any assessment that goes further than two years into the future. However, it is almost certain that when quantum computers exceed the computing power of today’s best classical supercomputers, the market will be there, and it will be huge. This assumes that the performance will also be practically usable without producing errors, which researchers have struggled with so far. There are already quantum computers that are faster than today’s supercomputers, but so far, these perform calculations tailored to them and cannot be used for “everything” in general.

According to IBM, how exactly quantum computers will be useful, we do not know yet. Among the early adaptors are Financial managers and banks. Pharmaceutical companies could also become significant beneficiaries, and finally, quantum computers will help elevate machine learning and AI to levels of complexity that are unimaginable for us today. And there will undoubtedly be many other areas of application, but from today’s point of view, this is only speculation.

IonQ vs. competing systems

Many technologies are used for quantum computing qubits, such as superconducting, photonics, silicon-based, spin qubits, trapped-ions, etc. IONQ’s quantum technology of choice is trapped-ion qubits created from an isotope of a rare-earth metal called ytterbium but will be switched to barium in the next generation. These barium-based systems are supposed to offer several benefits, such as lower error rates, systems that are easier to network, and increased uptime for customers.

Overall, IONQ is more focused on keeping errors low, as their systems are already commercially available. It could be a potential risk for the company to commit to a specific technology too early and thus be less free to research than the competition: a side effect of the IPO. From now on, the market expects sales to rise sharply.

The current system operates with 20 algorithmic qubits and is expected to multiply within the next few years. However, it is essential to remember that while these long-term projections are a goal for companies, they are never sure to happen.

Meanwhile, on November 15, IBM (IBM) introduced a chip with more than 100 qubits. The ‘Eagle’ chip is a step towards IBM’s goal of creating a 433-qubit quantum processor next year, followed by one with 1,121 qubits, named Condor, by 2023. Already in 2019, Google announced a 54 qubit processor with the goal to build a “useful quantum computer” by 2029.

Other competitors include Honeywell (HON) and several Chinese companies that are going their independent way in this area. As we can see, it’s a crowded business where we’ll see a lot of discoveries and research in the future. It’s impossible to predict who will build the most superior systems for years to come. But one thing is certain: This will require massive capital and talent. Currently, IONQ has only 97 employees (according to Seekings Alpha’s company profile), which sounds like almost nothing and makes me wonder how this small company can compete with multi-billion dollar companies. Sure, they have partners like the University of Maryland and South Korea’s Q Center. But will this be enough? I don’t know. But what I know is…

The future is already in the valuation

IONQ currently has a market capitalization of $2.5B with debt of $4.2M and “cash, cash equivalents, and investments” of $603M as of December 31, 2021, resulting in an enterprise value of approximately $1.9B. According to the latest press release, 2021 revenues were $2.1M ($1.6M in Q4), representing an EV/S ratio of 904. The company expects sales in 2022 to be between $10.2M and $10.7M, which would correspond to a price to sales ratio of about 180.

The 2021 net loss was $106.2 million, and the adjusted EBITDA loss was $28.3 million. For 2022, adjusted EBITDA loss is expected to be approximately $55 million. So the cash burn rate continues to accelerate, but at least the cash reserves are sufficient for a few more years. Nevertheless, there is no indication if and when the company will ever be cash flow positive. In the current monetary and geopolitical environment, energy is becoming more expensive, and salaries are higher, especially for the highly educated talent that IONQ needs. They are permanently competing with rivals who can comfortably pay any compensation.

Insider selling and other risks

One thing I always check when stock prices appear high is whether there has been insider selling. I interpret that as a sign that those sellers think their price is overvalued. So there’s not much to see here, especially since the stock price was double in December. Nevertheless, I mention it anyway because it is always valuable to check insider selling.

I could not find out the price for bookings of the quantum computers. Then I realized that there is very little information:

• Who is booking and why?
• Does that benefit IONQ’s customers at all?
• Are these possibly mere tests of individual companies?
• Are these bookings one-time or recurring revenue?

Or in other words: I find it extremely difficult to assess whether this is a sticky business with high added value for IONQ’s customers or not. Without knowing that, how should private investors like us evaluate our investments? The technical descriptions and developments are hard to understand for private investors. For example, how is anyone supposed to understand whether barium-based systems will be better than those made of ytterbium? So you always have to rely on the information provided by the company. At the same time, we don’t know what the competition is currently researching and how far they are already behind closed doors. It will be the same as in every area of the economy: whoever offers the best product at the best price will prevail.

So there is a lot of uncertainty. Nevertheless, the valuation is so high that years of strong growth are already priced in. It is not an appealing risk-reward ratio. There is a lot of downside potential at this valuation, and I can hardly think of a trigger that would send this enormously high valuation even higher now.

But there’s also a bright side

But of course, there are also many positive things about the company. They have proven their concept and already have quantum computing systems in the clouds and successfully monetize them. This could well indicate that the company is technically further ahead than the competition, especially regarding a lower error rate, which research struggles with a lot.

Furthermore, the management team consists of high-caliber and highly educated people. Some have been researching the subject for decades and have previously done fundamental quantum research at universities. Furthermore, there is now a joint R&D with Hyundai to create the next generation EV batteries. The company also has high-profile investors (Amazon, Google) and customers (Goldman Sachs, Accenture).

The company may be a takeover candidate. While they are not generating much revenue, the intellectual property could be precious. Moreover, their system is already running on the clouds of Microsoft, Amazon, and Google. Therefore, it would not be far-fetched if one of these three companies were interested in a takeover. IONQ’s technology and employees would most likely complement their research. At the moment, of course, this is just pure speculation, but it should be kept in mind, especially if you want to short the stock because of its valuation.

It is a tempting stock to short. However, there is also risk: The hype around the share and quantum computers may continue or intensify. Furthermore, the company could be a takeover candidate. If you want to short, be sure to place a stop order so that the risk is limited. If you don’t want to do that, I think this company is an excellent candidate to wait and see. It is likely that at some point, the company will not reach its quarterly targets, and on that day, the share price will fall sharply. There will be a better time for an entry if you ever want to enter.

Conclusion

For all these reasons, an investment is out of the question for me. So far, there is only meager revenue, a lot of research to do, a high valuation, and a business model that I can’t assess. Moreover, a competitor could make a breakthrough any day, causing the company to fall behind technologically. Nevertheless, it is a stock I want to keep on my watchlist since it could possibly be a potential winner of one of the next megatrends.