Hobbyist computer company Raspberry – known for its small single board devices of the size of a credit card – will become a publicly traded company in a few weeks. In fact, Raspberry is more than just a hardware company for do-it-yourselfers. It’s targeted 500 mn. GBP IPO looks cheap on the surface with a (debt-free) PE of 20x and a growth story attached to it. I took a closer look into the prospectus – the stock will likely be way more expensive than you might think. Caution is advised.

Summary and key takeaways from today’s Weekly
– Raspberry is going public in a few weeks – the headline numbers look promising.
– The devil lies in the details. Before considering to chase a seemingly cheap valuation, better look closer at some other important numbers.
– It is likely that this IPO will be again a great success more for the sellers than the buyers – at least in the near- to mid-term.

After chip designer arm Holding‘s (ISIN: US0420682058, Ticker: ARM) stock has become publicly tradable for a second time after it was taken private in 2016 by the Japanese conglomerate Softbank Group (ISIN: JP3436100006, Ticker: 9984), Raspberry is now the second British computer-related company with a well-known name to enter the public stage in less than twelve months.

The difference is, Raspberry’s listing will be in London – not in New York.

This is insofar interesting, as several tech businesses recently preferred to go public in New York with the main argument being a potentially higher valuation.

Initially, started as a company with the mission to make computers accessible to everyone and eliminating costs as an excuse, today Raspberry is way more than just a hardware supplier for nerds. In fact, what the company is primarily associated with, today generates only less than 30% of its sales. The other ~70% come from industrial applications – a growth area.

Despite having had a period with experiments involving Linux, personally, I have never owned a Raspberry. But I have heard about its fanbase as well as its very favorable performance to cost ratio.

That’s why this coming IPO grabbed my interest.

In this weekly, I am doing a check-up of Raspberry with the aim to answer the question whether this 500 mn. GBP floatation could be worth a look.

If you add to the hardware growth story a (at first sight) 20x PE ratio and a debt-free balance sheet – this looks like a fair deal.

But, aren’t IPO’s usually done because they are good deals for the sellers?

After having gone through the registration document, I have become cautious as the numbers have to be taken with a grain of salt due to an aspect that is often easily overlooked. There’s a decent risk that investors who skip a closer look could be fooled.

In a nutshell, the true profitability and thus also valuation is a completely different one than the headline numbers suggest.

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The business of Raspberry

Raspberry is mainly known for its small and affordable devices (called Single Board Computers or SBCs) for enthusiastic or at least DIY-interested computer aficionados.

It started in 2008, when the Raspberry Pi foundation was created with the aim of promoting a higher interest in computer science, especially among young people.

The charity’s commercial activities – sales of its computer hardware – began in 2012 through the Raspberry Pi Trading Ltd which is still majority-owned by the charity with 72%. Other key strategic shareholders and also business partners, though with minor single-digit stakes only, are Sony (ISIN: JP3435000009, Ticker: 6758) with 1.7% and arm Holdings with 3.3%.

The charity’s founder and Raspberry’s CEO is Eben Upton who among others has worked for mobile game developer Ideaworks3D (see here) as well as semiconductor supplier Broadcom (ISIN: US11135F1012, Ticker: AVGO) with whom Raspberry until today has very close ties.

Raspberry’s business consists mainly of two pillars, Education and Enthusiasts (E&E) as well as Industrial and Embedded (I&E). The former is what the company is mainly known for, but it generates only slightly less than 30% of sales. The credit card sized computers are used by enthusiasts to make smart-home hubs, DIY computers and servers or even retro games consoles.

The latter, I&E, is the growth driver and it has a revenue share of > 70%.

In its Industrial and Embedded markets, areas of application among others are electric vehicle charging, elevators (see the Schindler (ISIN: CH0024638212, Ticker: SCHN) logo in the graphic above), escalators, industrial control and automation, sports performance tracking, smart buildings, energy management and more.

Many of those use cases are in growing industries or geographies.

There are mainly three key big names with whom Raspberry is collaborating which one should be aware of:

• Broadcom is the primary supplier of critical boards and compute modules
• Sony is the assembler / manufacturer of Raspberry’s computers
• The computing power comes from arm’s cortex CPUs which are co-developed with Raspberry

With the exception of hardware production (chips and end products), Raspberry is a fully vertically integrated entity which contains all design, development, engineering and testing processes of the value chain.

Software and an own operating system are also in-house products. Raspberry’s own operating system is called Raspberry Pi OS and it is open-source.

The small, yet powerful hardware allows to build a low-budget and small-effort computer setup. These machines offer among the highest, if not the highest, bang for the buck regarding performance to cost.

Until today, 60 mn. units have been sold in over 75 countries with current sales prices ranging from 4 USD (no typo!) to 80 USD.

In 2023 alone, Raspberry says to have sold 7.5 mn. of such computer devices.

Sales are growing with new and more potent hardware versions as well as application areas. The pace has accelerated recently after lockdown-related supply bottlenecks have been resolved to reach new all-time highs – just in time for an IPO and a great roadshow story.

What makes Raspberry so special?

More than 1,300 OEM customers are testament to an established and well-respected brand. On top, you have the loyal E&E community which is quasi (at least part of) an outsourced marketing department.

Raspberry’s main strengths and competitive advantages are superior performance to cost and hardware-software from a single source.

Another point in favor of Raspberry is its software support. Every single device, even the oldest from 2012 are still getting free software updates. We know how this is handled by cellphone and other computer names, especially in the pretend free and user-friendly Android world.

Regarding competition, of course Raspberry is not looking to push Apple (ISIN: US0378331005, Ticker: AAPL) aside. In their prospectus, they drop names most of whom I’ve personally never heard of like Beckhoff, Rockwell Automation, Advantech, Lanner, Toradex, Variscite, Kontron and Adlink in the I&E sector and Radxa, Arduino, Orange Pi, and Espressif in E&E.

There are also other names mentioned, however, Raspberry writes that barely anyone was ever able to reach Raspberry’s performance to cost ratio, not to mention the optimized and mature software-hardware interplay.

Now, let’s look at Raspberry’s financials and important IPO data.

The IPO won’t be as cheap as it looks – what you need to know!

This was the headline from the Telegraph daily newsletter in my mailbox which grabbed my attention instantly:

First a few things to know before we crack the numbers:

Raspberry is a British company with a coming listing in London and an estimated market valuation of 500 mn. GBP. But its accounting is in USD, so don’t overlook or forget to convert the numbers appropriately.

Besides, of the current shareholders the foundation intends to sell a certain (to me unknown) stake and the floating company on top plans to raise 40 mn. GBP for corporate purposes and to finance its further growth ambitions in the industrial sector.

This sounds plausible as there are no obligations to be repaid.

There seem to be quite a few concerns, though, that with the coming listing Raspberry is risking to abandon its dedicated enthusiasts and hobbyists community – its core and tradition – because commercial customers usually go for the more expensive devises on which Raspberry said it wants to focus more on.

Maybe there’ll be for the first time a 100 USD+ device on the market?

Whether this will be the case, we’ll have to wait and see. But it makes sense to go where the demand is.

When you only scan here or there a few key headline numbers and metrics, you will get the impression that Raspberry is a

• debt-free
• highly profitable
• strongly growing computer business
• that’s IPO-ing on the cheap with an estimated PE of only 20x

Regarding the first three points, it is true that the financials look great, as we have a snapshot here to examine / prove it:

Sales growth has been impressive as of late. In FY 2023, sales have risen by 41% (after already respectable +33% the year before) which is huge, especially for a computer company in a rather saturated sector.

Almost a double in two years with small computers?

However, if you remember the graphic with total devises sold from the first part, I wrote about supply bottlenecks.

2020–2022 was rather tough economic environment, so we better don’t assume 40% to be the underlying organic growth rate.

This has been more a catch-up situation, not real explosive demand-driven growth. On the positive, a new all-time high in units sold has been reached, surpassing the old pre-crisis top. There’s growth, but it is not 30–40%, if we smooth things out.

But more on the outlook below after we have checked some other numbers.

Below we see that gross margins as of late were 25%, operating margins 14% and net almost 12%. From very little finance costs, you can see that debt is not an issue.

A look into the balance sheet confirms this:

I have marked some lines. One by one, we see that

• intangible assets of 58 mn. USD (just keep this in the back of your head)
• sharply higher inventories, more than doubled compared to last year and being 40% of total assets – that’s very, very much
• 42 mn. USD in cash; as there are no financial obligations below (not marked as there are none), this is net cash
• also sharply higher payables, meaning outstanding and unpaid bills

What this means in a nutshell is that despite sharply higher sales, working capital was stretched massively by bloating inventories and receivables (which I didn’t highlight above). To not cause a huge cash outflow this was counterbalanced through also strongly higher payables, i.e. not paying own bills / customers on or before the date of the balance sheet.

Raspberry shipped lots of devices physically (great for sales and volumes), but it didn’t translate into appropriate cash flows. Plus on top, inventories skyrocketed – overproduction?

Assuming, Raspberry collects its receivables and pays its payables, there’s nothing to worry regarding the liquidity situation. This is normal accounting behavior in order to present the best possible numbers on the reporting date (just pay the bills two days later and you and your cash flow look great on year’s end!).

But drastically higher inventories are a first sign to be cautious, especially in such dimensions when they reach 40% of total assets – that’s an incredible number.

Going, further, here’s also the cash flow statement which confirms the working capital movements we’ve seen above:

The above are the reasons why despite massively higher sales and profit, operating cash flow has stayed comparatively unchanged with only +14%.

That’s why you always need to check profits AND cash flows – is the company able to convert its sales and profits into hard cash?

To round this up, let’s have a look at the recent trading statement from the management which can also be found in the prospectus (highlights by me):

Current Trading and Recent Developments

Since 1 January 2024, we have continued to trade in line with the Directors’expectations. Following significant purchases in the last part of 2023 by customers, notably our ARs and the Licensee, 2024 has seen expected volatility in their demand, and in the case of some channel participants and the Company, this has led to higher than usual levels of inventory.

The Directors expect this to normalise over the course of 2024, resulting in stronger results in the second half of the year than in the first half. Our ongoing investment in product development, driven by our growing team of experienced in-house engineers, complemented by third party consultants and the purchase of intellectual property, as well as a number of new product releases planned for the second half of 2024 and beyond, gives us confidence in our future.

^{Raspberry IPO prospectus, p. 33 (see here)}

Even higher inventories after 01 January 2024? Not so great…

To sum it up until here, Raspberry increased sales almost 2x over the last two years, but receivables doubled, too, and inventories almost tripled.

Somethings in the bush… Better don’t get too euphoric about this story and the recent growth rates!

On the positive and on a different page, they also wrote that average selling prices have again risen during 2023, this time from 38 USD to 41 USD or almost 10%.

For me, this means that growth rates should come in dramatically lower compared to 2023. Also, I’ve heard phrases like “will normalize during the year” and the likes several times over the last couple of years. Often, those improvements were postponed, so I would not expect too much or at least be prepared that the expected strong trading won’t be as strong as portrayed.

The more so in the wake of a definitely not-booming-anymore economy.

Next, here’s the cash flow statement again, because it contains an important row which I am sure most people will overlook and ignore.

The row “capitalized internally developed assets” is important.

In layman’s terms, these are real costs where cash has left the company, but the company does not recognize them as costs in their P&L through full and immediate depreciation (respectively amortization which is a different term for write-downs, however, in accounting hard assets are being depreciated, while intangibles are being amortized).

This has the effect that certain costs where real money was paid for are suddenly being shown as assets on the balance sheet. Remember the 58 mn. USD of intangible assets? Don’t get me wrong, this is not illegal, but it inflates the balance sheet and is contrary to defensive accounting.

These 58 mn. USD represent almsot a quarter of the balance sheet (or total assets).

While it might be true that what has been created through these expenditures has some value, it is intangible and hard to quantify, even though they write on p. 123–124 that the costs must be precisely determinable. The usual write-down period in their accounting is three to six years for those “internally developed intangible assets”.

They will be writing it down over the years. So fine so good.

The problem is that due to lower amortization expenses, operating and net income look higher than they should.

That’s also the reason there’s such a high discrepancy between income and cash flow.

Let’s now have a look on how this affects the valuation.

When you use the net income of 31.5 mn. USD (~25 mn. GBP) from the income statement, we get a PE ratio of 20x, assuming the IPO will be valued at 500 mn. GBP (and neglecting the net cash position for simplicity).

If you now take what I view as the true earnings power, the cash flow, we have operating cash flow of 16.5 mn. USD (~13 mn. GBP) – which is almost only half of net income due to the aforementioned working capital inflation.

That already roughly doubles the valuation closer to 40x.

Operating cash flow has its limitations, though, if we assume working capital to normalize (increasing operating cash flow), but especially as it is before investments.

This makes the whole picture even worse, because we are dealing with negative free cash flow of about –7 n. USD (~5.5 mn. GBP) after investments in property, plant and equipment and the capitalized (put on the balance sheet instead of written down) intangibles.

So, in essence, with negative free cash flow, this is not seriously valuable.

More forward looking, let’s assume that working capital shrinks and normalizes again as inventory gets sold as expected in the trading statement.

This could lead to operating cash flows of around 30–40 mn. USD (~23–32 mn. GBP).

I think this is a realistic number to use as a starting point.

After subtracting all investments of ~23 mn. USD (~18 mn. GBP), expected free cash flow could be estimated at 5–15 mn. GBP.

Put against the targeted 500 mn. GBP IPO valuation, this is by no means a fair deal, not to mention a bargain – even if we assume on top some growth.

I do not know how investments will evolve. Currently, Raspberry is launching its next generation computer, so some higher expenses are justified. But how much? With higher targeted growth, these investments will likely grow too.

As said, this is not illegal what they’re doing. Other companies are doing the same.

But one should be aware that such intangible assets are hard to value and can be suddenly written off with the effect that huge operating and / or net losses show up.

Using earnings related valuation multiples, the result is a way too low valuation due to inflated earnings.

Before closing, here are some other risks at least to keep in mind:

• having such a huge key supplier with Broadcom is good and bad; good due to access to its technology, but a huge risk should they cease their collaboration
• the same for Sony as the sole manufacturer
• the strategy of low-cost and high-volume selling has worked for now, but it is prone to a competitor with deeper pockets entering and selling even at lower costs and thus pushing Raspberry into losses
• Raspberry itself writes on p. 13 in its prospectus that its products have “low barriers to entry”. This might be a bit overstated as they seem to be doing the right things, but yes, let’s take it into account as they are not focussing on being a technological leader

With this, it is clear for me to stay absolutely away from this IPO.

I will be watching the company and have a look into its earnings announcements in the future. But the rule of thumb that IPO’s are good deals for the sellers will likely prove to be true in this case.

Conclusion

Raspberry is going public in a few weeks – the headline numbers look promising.

The devil lies in the details. Before considering to chase a seemingly cheap valuation, better look closer at some other important numbers.

It is likely that this IPO will be again a great success more for the sellers than the buyers – at least in the near- to mid-term.

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