Editing QuantumScape

== Summary ==
We initiate coverage of QuantumScape with a Hold rating and $20 price target. The company is taking a thoughtful approach to developing solid-state lithium metal battery technology, which offers significant advantages over current li-ion batteries for the automotive industry and could enable QS to disrupt the market if successful. It has also secured large investments from Volkswagen and partnerships with 3 other global automakers, providing a solid path to commercialization once the development is complete. At the same time, QuantumScape still needs to demonstrate it can scale up its technology and solve large technical challenges ahead, and even if all goes according to plan, the company is still several years away from mass manufacturing and even further from monetizing it.

'''Technology advantage'''

QuantumScape’s battery cell, which uses anode-less lithium metal battery technology and a solid-state separator, promises to offer superior performance than traditional lithium-ion batteries, including longer cycle life, better vehicle range, performance in wider temperature ranges, faster charging speed, and improved fire safety. We believe this should be of interest to automakers, which are under pressure to electrify their entire portfolio, and looking to improve performance and bring down cost of EV powertrains. While QuantumScape believes its batteries will also be cheaper to produce, with no anode, we believe the timeline to achieving it is more uncertain, using less commoditized separators and incurring larger manufacturing challenges.

'''Long path to validation and commercialization'''

We believe QuantumScape’s eventual success hinges upon its ability to validate the performance, safety, and most importantly, manufacturability of its battery technology. While performance demonstrated so far has been good, the company has only showcased cells with few layers. This year could be pivotal, as QuantumScape attempts to develop larger cells, produce an A-sample for testing by at least one customer, and take delivery of manufacturing equipment to be calibrated for manufacturing. If this year’s milestones are successfully completed, the company will look to start production of the next stage of prototype, B-sample, on its initial manufacturing line – a prerequisite for pilot commercialization in the 2024/2025 timeframe.

'''Ramping up scale'''

Assuming all tests and validations are successful, we expect a small amount of cell production during the pilot phase of 2024-25, and expansion to 4.5 GWh in 2026. With the addition of the QS-2 production line in 2027, we are modelling production of 26GWh and 56GWh for 2027/2028 and ramping to 91GWh eventually by 2030. This is more conservative than company’s plans to ramp up QS-2 line alone to 70GWh by 2028, to account for delays and uncertainties on the timeline of the manufacturing scale. We also don’t expect the company to reach positive gross margin until 2026, EBITDA until 2027, and free cash flow until 2028. If all milestones are reached, we forecast 2028 revenue of $4.1bn and Ebitda of $667m.

'''$20 price target based on probability of 2 scenarios'''

With an enterprise value above $6bn representing 1.4x EV/2028E revenue of $4.1bn, QS’ multiple is already almost in-line with the average of its well established li-ion battery peers such as Contemporary Amperex Technology (CATL) and LG Energy Solutions, and considerably above that of its pre-revenue startup battery peers. We believe QS' stock performance from here will reflect perceived likelihood of success with its technology validation and ramp up, and therefore be heavily influenced by results of testing and ability to hit technical milestones. If QuantumScape successfully delivers on those, we see room for its valuation to reach the high-end of established li-ion battery peers due to its potentially superior technology, at 2x 2028 EV/sales which would suggest upside to $24. Conversely, if the company’s development plans start facing complications, delays or loss of momentum, we see large downside risk towards just 0.65x 2028 revenue, more in line with its startup battery peers, suggesting downside to $10. We apply a 70%/30% likelihoods to these 2 scenarios to derive our $20 price target.

== Opportunity to disrupt massive market ==

'''Inflection point for EV adoption across the automotive industry'''

As a developer of next-generation electric vehicle batteries, QuantumScape is positioning itself to disrupt the battery technology landscape. With about 90m+ vehicle units produced by the industry in a normal year, total TAM for vehicle batteries represents at least $450bn annual sales opportunity, once EV penetration reaches 100% of light vehicle production. In the short term, the company’s SAM directly reflects that of BEV penetration of new vehicle production, which sits around 5-6% as of year-end 2021 (or ~$25bn in annual sales). Furthermore, QuantumScape is looking to commercially deploy its technology in the 2024 timeframe which should align with clear acceleration in EV penetration across the globe.

As we look forward to the rest of the decade, we expect BEV adoption to pick up considerably in the years ahead, forecasting about 20% penetration of full BEV vehicles on total light vehicle production by mid-decade. By 2030, the penetration rate could accelerate to >47% (43m units annually). We think this transition will largely be driven by China and Europe in particular, reaching 43%/25% penetration in 2025, respectively, and 81%/70% by 2030.

Of late, automakers have been pulling forward the timeline to eliminate new ICE vehicle production and transition toward full EV sales in accordance with increasing regulation. At the same time, consumer sentiment is quickly shifting toward electric vehicle alternatives as more compelling products come to the market, led by top nameplates including Tesla Model 3/Y, Ford’s Mustang Mach-E, and a slew of promising upcoming models. Notably, North American OEMs such as GM, Ford, Rivian and Tesla all plan to introduce industry-first BEV pickups to market which could serve to drive increased adoption in the US; the region has historically lagged others in EV adoption rates in past years.

To date, total commissioned battery capacity globally is about 800+ Gwh, with LG and CATL leading in planned production capacity. Based on our forecast of about 18m units of EV by 2025, with an average of 65Kwh battery pack, we estimate total battery demand of about 1,168Gwh, and as illustrated below, from now until 2025, we’ll need about 362Gwh in capacity addition to meet that EV production expectation.

'''Regulatory environment boosting EV adoption'''

In addition to growing consumer demand, the transition to electric vehicles has been further facilitated by increasingly stringent government regulations across the globe, particularly in Europe and China, leading to faster EV adoption in those regions. In the US, the Biden administration has laid out more aggressive targets to reach carbon neutrality and eliminate new ICE vehicle sales. Specifically, the President has outlined plans to reduce emissions by about 50%+ by 2030 on the road to carbon neutrality by 2050. In addition, the President has set a goal to have EVs account for roughly half of all new vehicle sale by 2030. The target is backed by leading US automakers including Ford, GM, and Stellantis, which have committed to reaching 40-50%+ by that timeframe. At a UN climate summit last November, GM and Ford doubled down on their commitment, by signing a declaration to phase out new ICE sales entirely by 2040 as well.

To support the rapid transition toward electric vehicles, the White House recently passed a new bipartisan $1tn infrastructure bill, which includes $7.5bn to build out the EV charging network further throughout the country. Considering the lack of infrastructure is a major inhibitor to accelerating EV growth in the coming years, the
plan could significantly improve adoption among consumers as recharging becomes more accessible. On the state level, 45 states and the District of Columbia all provide additional incentives for EVs either through a specific utility or state legislation ranging from tax credits/rebates to fleet acquisition targets, and more. While the US has been accelerating its emissions reduction initiatives of late, it still lags other regions noticeably, with the EU and Canada both outlining plans to eliminate the sale of new ICE vehicles altogether as soon as 2035. Nevertheless, the
emphasis on reducing emissions globally continues to gain momentum, facilitating the infrastructure build out and encouraging increased user adoption in the near term.

In China, the central government began requiring automakers producing >30k units annually to make or import at least 10% of the annual fleet using electric vehicles beginning in 2019 with a target for 20% NEV penetration by 2025 and 40% by 2030. At the same time, the government offers $3,600 subsidies for EVs with >400km of range and $2,600 for EVs with 250-400km of range (currently getting phased out however), considerably driving consumer and OE adoption as a result. Over in Europe, the EU recently proposed legislation that would require emissions cuts of 55% for cars from 2021 levels by 2030 (up from 37.5% currently) and 100% by 2035; to get there, the region would phase out the production of new ICE vehicles by 2035. As such, automakers continue to accelerate the transition toward NEVs to avoid paying hefty regulatory fines, and robust consumer demand continues to support a faster pace of adoption. The more forward-thinking regulations in the EU and China have dramatically driven adoption among corporates and consumers alike, giving the regions a solid lead in the transition on the US and supporting a budding global EV market.

'''Historical Li-ion dominance – time for a change?'''

A large driver of the accelerated adoption of EVs throughout the industry has been the reduction in cost of batteries. Of the roughly 4.6m BEVs sold globally in 2021, all are powered by traditional lithium-ion battery cells which have been in use for various consumer products since the early 1990s. Through ongoing technology advancements and the development of new battery chemistries, the traditional li-ion cell has made continued improvements in cost, size, and performance over the past 30 years. Now it is the dominant battery type used for automotive. Nevertheless, batteries remain costly, amounting to about $132/kWh at the pack level as of 2021 despite continued cost improvements for decades (down 89% since 2010). Many industry players have been targeting to take down the cost of batteries below the $100/kWh threshold at the pack level, which would enable EVs to reach cost parity with ICE comparable vehicles, leading to a meaningful inflection toward zero-emission vehicle adoption. While the industry seemed well on its way to reach this goal over the next few years, the recent spike in input cost prices has started pushing battery costs back up.

The traditional lithium-ion battery cell landscape for EVs is predominantly controlled by a select few manufacturers including CATL, Samsung SDI, Panasonic, and LG Energy Solutions. Over the coming years, the latest battery advancements and growing scale are expected to drive the cost closer to and below $100/kWh, with Ford targeting about $80/kWh by 2030 and Tesla around $50-60/kWh over the next few years. Unfortunately, ongoing supply constraints for numerous key raw materials (i.e. nickel, lithium, carbon, etc.) needed in the production processes for these batteries has disrupted the cost roadmap, leading to an increase in $/kWh for the first time in late 2021 and into 2022.

While the cost of traditional li-ion batteries has decreased materially, its trajectory appears to be plateauing, and the technology carries other shortcomings that QuantumScape’s solid-state batteries are looking to address. For instance, traditional lithium-ion batteries can only fast charge at the expense of the battery’s life. Perhaps most importantly, there appears to be a ceiling on the energy density provided by these cells of about 300Wh/kg, without improvements in anode composition. While enough to provide the desired range for an EV (>300 miles), increasing power density could allow for fewer cells (lower cost) and a simplified architecture if considerable advancements were made.

The use of a lithium-metal anode in the cell, as deployed in QS batteries, is expected to serve as a material step function toward reaching a higher density 400Wh/kg+. At the same time, the use of a solid-state separator (necessary for li-metal anodes) and no host material for the anode could allow for increased safety (fewer dendrites), and fewer materials in the cell could simplify the manufacturing process of the battery and deliver robust cost savings at scale. Altogether, the goal of solidstate batteries would be to offer improved performance from higher energy density, lower costs to produce at scale, and improved safety in the battery system, which could position the next-generation form factor to significantly disrupt the space typically dominated by traditional li-ion batteries.

'''Solid state battery efforts throughout the industry'''

Many automakers throughout the industry recognize the value-add opportunity that solid-state batteries could provide in terms of cost, performance, and safety, and have begun working on the development of proprietary SS configurations both alone and through collaborations with leading li-ion battery makers. The issue to date has been the ability to scale the technology to deliver the desired performance of the battery without degradation, in all environmental conditions, in a cost effective manner. As such, if a battery developer is able to deliver scalable solidstate batteries that meet OEM requirements, it could potentially capture a decent share of the overall battery market over time. Traditional battery suppliers have struggled to make any meaningful advancements considering their focus is largely on improving the existing li-ion battery performance. As a result, numerous dedicated SS-type battery developers have come to market in recent years to tackle the problem head-on.

== Solid state lithium-metal technology ==
'''Advantages versus conventional lithium-ion batteries'''

The current state of conventional lithium-ion batteries is known to pose limitations on range, density, life cycle, charging speed, and safety. For instance, today’s Panasonic 2170 NCA (nickel cobalt aluminium) cells are estimated to have a battery density of ~270Wh/kg to 300Wh/kg. Batteries with higher Wh/kg could store more energy (watt-hours) per unit of mass and helps address range anxiety which is known to be one of key challenges in EV adoption. Shown in the exhibit below, a conventional lithium-ion cell has a cathode layer (positive electrode), a porous separator usually made of polymers, and an anode (negative electrode) that’s usually composed of graphite or silicon, liquid electrolyte, as well as current collectors (foils, tabs) on both the anode and cathode ends. The liquid electrolyte saturates the cell, including in both the anode and cathode, and during charging and discharging, lithium ions become suspended in the electrolyte and move toward the opposite electrode through the polymer-based separator.

While the design, size, and use cases vary from one lithium-ion cell to another, a critical factor is the stability of the liquid electrolyte which are usually made of hydrocarbons. Lithium-ion batteries have specific temperature conditions under which they perform the best in cycle life and efficiency. When operating above a certain temperature, lithium can melt and react with the liquid electrolytes to cause a fire explosion. Even if the external environment might be cool enough, the battery can still heat up internally, leading to thermal runaway. On the contrary, when operating at extreme low temperatures, the ions move slower through the liquid electrolytes, resulting in a capacity reduction. Additionally, low temperatures can cause the velocity of the ion transfer to decrease, which can make it difficult to charge a battery. These specific challenges represent some of the problems QuantumScape is looking to solve, by using pure lithium-metal and solid-state separators without liquid in the composition.

While lithium-metal itself as an anode has been researched for several decades, it has also been known to react in unstable ways with liquid electrolyte. Thus, current technology needs to incorporate a solid separator which can help resist dendrite formation. QS is essentially looking to solve these limitations, by replacing the porous polymer separator with a solid ceramic separator and removing the anode. The cell is then left with a two-layer battery (only a cathode and a separator). The anode forms in-situ when the battery is charged for the first time in the factory; liions leave the cathode, through the separator, deposit themselves on the other side and creates a layer of solid lithium metal. Then it cycles back and forth. Such design would bring about benefits including higher energy density, faster charging, lower cost (about 15%-20% less thanks to the elimination of the anode material and manufacturing cost), increased battery life, and better safety. So far, QS’ data shows its testing cells’ ability to charge from 0% to 80% in 15 minutes and from 10% to 80% in 12 minutes. Typically, without solid lithium-metal anode, battery density typically doesn’t rise above low 300s in Wh/kg; QS expects development in this technology is to raise energy density by 50-80%, to +400Wh/kg or more, while costing 15% to 20% less to lithium-ion equivalents.

'''Development stages (single to multi-layers)'''

The immediate and mid-term challenge ahead for QuantumScape is forming multilayer cells and from there on, scaling up the manufacturing process. The company’s development approach is to build a single layer platform based on which QS validates the core chemistry capability and establish key performance parameters including charge rate, cycle life, temperature, and pressure. Post the single-layer validation, QS has moved on to a 4-layer then 10-layer, and now working towards 16-layer with ultimately dozens of layers in cell testing. In the next-gen battery technology space, unlike in the automotive, the fundamental chemistry has been the big problem. From a manufacturing perspective, no new laws of physics need to be invented. However, the chemistry is very much fundamental and serves as the building block, but completing a prototype is not as easy when compared to building a vehicle prototype (assembly), given the need to test in real-world and uncompromised conditions. Once QS progresses towards the 16-layer testing, the next step is several dozens of layers of testing which would then position them to provide A-sample prototype to its OEM customers (targeted for end of the year to at least one OEM customer).

'''Technology differentiation vs. other next-gen battery players'''

In the last couple of years, several startups focused on developing next generation batteries have become public, with notable ones being QuantumScape, SES, and Solid Power. Technology differentiation and viability is often difficult to assess from the outside, given the lack of actual mass-scale production and real-world performance data in EV fleets. These companies are taking different technical approaches in trying to improve batteries density, safety, cycle life, and cost.

QS’ approach is predicated on the elimination of anode layer and the introduction of a ceramic-based solid separator to replace the polymer-based separator. According to the company, the separator has two attributes that make it highly manufacturable; First, its components are earth-abundant commodities and are already being used at scale. Second, the separator manufacturing process itself should work with continuous flow; tape casting and heat treatment are the two steps required for making a ceramic and QS can do it continuously. Separately, QS is designing the cells to be cathode agnostic, thus the company can use NMC or LFP chemistries. In fact, QS states that the LFP version of its batteries should have near equal energy density as today’s NMC batteries, with lower cost and competitive performance.

On the other hand, SES has announced that it is dropping its efforts towards true solid state and pivoting to a hybrid lithium metal solution for faster manufacturability, which the company names via three developmental tracks: Hermes, Apollo, and Avatar. Hermes is a small battery roughly the size of an iPhone, and the difference from QuantumScape’s approach is that SES is introducing a proprietary solvent-in-salt liquid electrolyte and composite anode coating to help increase safety and cycle life vs. a conventional lithium-ion battery. The cathode stays the same; and an ultra-thin layer of li-metal anode is manufactured through SES’ proprietary process. Apollo is a version of Hermes that is about 25x bigger, designed specifically for automotive applications. SES has said it’s currently ramping up anode coating and cell manufacturing quality and testing capabilities for A-samples in its Shanghai and Korean factories. Lastly, through Avatar, an AIpower software that monitors battery health, the company hopes to predict 100% of potential safety incidents. Furthermore, the way SES looks to solve the dendrite challenge is to slow down dendrite growth and change the shape of its formation (from sharp spikes to round) and detects safety issues early, whereas QS is deploying a solid-state separator with high dendritic resistance.

Solid Power, for a while, has been working on lithium metal batteries but over the course of the last 6-9 months the company shifted focus to silicon anodes. While it’s not entirely abandoning lithium-metal, Solid Power cited one of the challenges it faced with lithium metal is delivery of high rates of charge given the tendency to form dendrites that could short circuit the cell. While the company aims to solve for this challenge as a second step, it is pursuing a high-content silicon anode solution in the nearest term with the use of its core technology: sulfide-based solid electrolyte, as well as solid anolyte and solid catholyte.

Other non solid-state battery companies pursing the high silicon anode strategy include Enovix and Sila Nanotechnologies. Currently about 99% of lithium-ion batteries in use have anode material made of carbon (in the form of graphite), but transitioning to silicon would be a better choice given that it holds 10x more lithium than graphite. Silicon-based materials also generally have a much larger specific capacity. For NCM/NCA cells, switching to silicon-dominant anodes could potentially boost energy density by 50%. However, one of the key disadvantages is that when silicon reacts with and absorbs lithium ions, it swells by 300% (vs. 7% for graphite), and this intense swelling eventually damages the silicon, causing its surface to crack and energy storage performance to drop rapidly. On the other hand, lithium-metal anodes don’t present an expansion problem, but they are expensive and present other technical challenges. Sila Nanotechnologies, for example, is looking for ways to resolve the aforementioned swelling problem in silicon anodes, and if successful it could represent significant opportunity to
improve the performance of existing li-ion batteries. Silicon is indeed among the world’s most abundant elements, and if cell makers eventually transition to silicon anodes, there will be meaningful benefit associated with exploring better cathodes given silicon anodes’ expanded ability to store.

== Development timeline ==
'''Testing and validation progress'''

QuantumScape has spent the last few months demonstrated that its battery works under conditions needed for automotive purposes and has taken to publish cell performance data under “gold-standard” test conditions: average charge/discharge rates of 1C or faster, temperatures of 25 degree Celsius, 100% depth of discharge, and externally applied pressure of no more than 3.4 atmospheres, simultaneously.

The 1C-1C charge/discharge rate which QS cells undergo testing essentially means the battery charges to the full capacity in one hour, and discharges in one hour; the entire cycle is two hours. For reference, C/3-C/5 is an 8-hour cycle (for normal automotive testing). If 800 cycles are conducted under 1C-1C tests, roughly only 200 cycles can be conducted under the C3-C5 test. In some ways, 1C-1C is also a more rigorous test on the material and QS cited getting good data this way in more stringent conditions. It also allows the company faster access to testing data which are important trackers for investors at this stage. In order to achieve testing for 800 cycles, it will still take about 3 months under the 1C-1C rate.

Separately, the battery needs to operate in a wide range of different temperatures for a long time, under high power rate, high cathode loading (high energy), unelevated temperature/pressure, and still achieve long cycle life and solid capacity retention. Figure 14 below shows results of 90% energy retention over 800 cycle life under the 1-layer, 4-layer, as well as 10-layer cell tests. QS also reported that initial testing on its 16-layer cell reflect similar results over 20 cycles. According to the company, these conditions are the best test for dendrite resistance, as cell failures tend to happen due to dendrites, or they experience capacity reduction due to chemical side reactions between lithium metal and electrolytes.

'''What investors are looking for'''

We believe investors are looking for data points to get comfortable with core technology of lithium-metal batteries, path to mass production, and probability of a revenue-generating future that happens in the second half of decade. Thus in the near term, consistent data publishing of new technical milestones will remain critical for QuantumScape stock performance.

Earlier this year, QS published a deep-dive into its cells’ fast-charging performance, with data showing its battery cells have completed 400 consecutive 15-minute fast charging (4C) cycles from 10% to 80% of cell capacity, while retaining 80% of the initial energy. QuantumScape believes this represents an industry-first for its kind of battery technology. We note that while SES has also demonstrated 80% charging in 15 minutes for its 25+ layer cell, the company is taking a non-solid state lithiummetal approach which then make it difficult to make an apples-to-apples
comparison. QS had conducted the test on single-layer prototype battery cells at both 25 °C and 45 °C temperatures, 3.4 atm of pressure and 100% depth of discharge (percentage of the battery that has been discharged relative to the overall capacity of the battery). In comparison, today’s leading lithium-ion EV battery typically need around 30 minutes to fast charge from 10% to 80%.

Just as importantly, we believe investors are looking to assess feasibility massscale production, path to getting there, and eventual timeline of revenue generation. The next 3 exhibits outline targeted commercialization timeline for QS, SES, and Solid Power, respectively. QS’s 20Gwh expansion plant is expected to start in 2026, vs. 2025 for SES’ 10Gwh production line, and 2026 for Solid Power’s high-content silicon anode cell (post 2026 for lithium-metal anode cell). Assuming QS is able to deliver on its technical and manufacturing milestones, we expect QS to start delivering more meaningful volume, at about 4.5GWh in 2026, with 1Gwh from the QS-1 Pilot line and 3.5Gwh from the QS-1 Expansion line.

== Strong partnerships with OEMs ==
'''Long-standing relationship with Volkswagen'''

QuantumScape maintains a longstanding relationship with VW that began back in 2012 focusing on testing and evaluation of QS’ prototype battery cell technology in close collaboration with VW’s global R&D team. Over time, QS began working more closely with VW’s Battery Center of Excellence, and the company has committed >$300m to the battery maker through multiple funding rounds in exchange for a 20% stake in the company and adding two senior executives to the company’s board (including two successive heads of group research for the VW Group). In 2018, VW announced that it had successfully tested certain single-layer battery cells from QS at automotive rates of power and has subsequently done the same with QS’ initial multi-layer cells. Together, the companies have formed the
QSV joint venture, through which the JV will supply OEMs with QuantumScape’s solid-state batteries beginning in 2024. Volkswagen is slated to become the first customer to receive delivery of the batteries once commercially available as well.

The partnership covers much of the volumes QS intends to produce from its QS-1/QS-1 Expansion phases, but at 21GWh annually, this would represent under 2.5% of VW’s annual production. As the automaker looks to scale its EV product suite, QS will work to ramp production to fulfill as much of this projected demand as possible in the years to come. We note that the agreement with VW is non-exclusive (although VW has first priority on volumes), allowing QS to pursue other commercial partners as it scales.

'''QSV joint venture'''

In 2018, QuantumScape and Volkswagen committed $3m to establish the 50-50 split joint venture “QSV.” The venture focuses on production of QS’ solid-state batteries leading to commercial launch and the construction of the QS-1 and QS-1 Expansion facilities. Over time as certain developmental milestones are reached, both parties have agreed to co-invest further capital to support the facility build-out and ramp volumes. In 2020, the JV agreement was amended to include an additional $200m investment; the first $100m came from VW in December of 2020, with the second $100m coming in April of 2021, allowing VW to elect two members to QuantumScape’s board of directors.

Under the agreement, the JV will ramp production toward commercial deployment in two phases; the first phase includes the construction of QS-1 to an annual capacity of 1GWh once QS reaches certain preliminary delivery and validation milestones for its battery technology. Phase two will include the QS-1 Expansion plan, which will expand the production capacity to an annual output of roughly 21GWh. Once the batteries are commercially available, VW will become the first customer with priority on initial volumes, having committed to purchase a certain portion of QS-1’s output at a price comparable to li-ion batteries plus a premium tied to the outperformance of the battery versus similar li-ion products. Operationally, QS will build the ceramic separators independently then sell those to QSV at cost+ (~$10-12 per unit), which will assemble the batteries for sale to OEM customers. All revenue and profits are then shared equally with VW. As such, QS owns 100% of the separator production facility, but 50% of the cell factory.

'''Other OEM partnerships'''

QuantumScape has also secured partnerships with three other unnamed automakers, including two additional top-10 global OEMs (in terms of 2020 sales) and a well-established luxury automaker. Management has indicated that the work it has done with the first undisclosed global OEM closely reflects the work done to date with VW, although no joint venture agreement has been reached yet. The two parties are jointly testing QS cells and validating the technology while simultaneously working on establishing a joint venture to ramp production through the legal and business development teams. The company has indicated that once secured, this partnership could represent about 2.5x the volumes tied to its VW partnership (or ~50GWh of capacity).

QuantumScape’s work with the other global automaker and the luxury OEM similarly includes testing and validation until production can scale further, but the volumes tied to these partnerships will roll off the QS-0 pre-pilot line. Operationally, these too follow a similar path as the relationship with VW in terms of testing and validation, but the company expects that these could carve a path toward future series production awards instead of shared JV volumes.

'''Other use cases'''

While electric vehicle is an obvious application for next-gen batteries, QuantumScape has recently announced a multi-year agreement with Fluence to introduce solid-state lithium-metal battery technology to energy storage applications. Fluence is a JV between Siemens and energy giant AES, and builds large battery storage systems on the grid to improve reliability and help match energy output from sustainable sources to the cycles of demand. Stationary energy storage installations are expected to grow by more than 2000% from 2020 to 2030, representing $300B+ global market opportunity. We believe QS’ solid-state lithium-metal technology has the potential to offer high energy battery cells that can store than energy in less space than today’s lithium-ion batteries. We think the narrative that battery mass and pack size are less important in non-automotive applications like stationary grid storage is likely changing; Fluence, for instance, cited that higher energy density will improve its grid-balancing systems.

Another tangential application for QS batteries could be in the eVTOL space.

Although electric aero-mobility is perhaps some time away from commercialization, but we believe that with the development of lighter batteries with higher density could potentially make the next-gen battery suppliers the go-to for eVTOL companies if/when technology matures and mass manufacturing happens in the future.

== Growth plans ==
QuantumScape is undertaking a multi-layered expansion plan to build manufacturing capacity in-line with its product development roadmap over the coming years. With one engineering assembly line in place already, the company intends to establish a larger pre-pilot line (QS-0) followed by an initial final production line (QS-1). Over time as QS’ battery progressed through A, B, and Csample testing and validation, the company will expand QS-1 to prepare for its
broader commercialization with top OEM customers.

'''Engineering line in San Jose, CA'''

Currently, QuantumScape conducts much of its research and development work out of its headquarters facility in San Jose, California, including an engineering production line where the company produces its initial sample cells for testing and validation. As QS continues to add layers and test the latest iteration of its battery product, all volumes to date have been produced on this line for both internal and external validation with OEM customers and third parties.

Over time, QS remains committed to improving the throughput and capability of the assembly line in San Jose, as well as building out additional capacity as in what the company calls “Phase 2” alongside the construction of its next pre-pilot line at QS-0 (set to be located near original engineering line). To do so, QS will be increasingly automating the processes on the pre-production lines in San Jose and preparing the line for larger form factor production as it furthers its multi-layer battery design and development. Management indicated that it is targeting to begin production on Asample cells on the Phase 2 line later this year.

'''QS-0 pre-pilot line'''

In 2021, QS announced plans to further its pre-pilot production capabilities with the addition of the new QS-0 line in San Jose. Together with the original engineering line in San Jose, QS will look to produce enough cells to support its customers’ testing needs and expected pre-series vehicle volumes over the coming years as it ramps toward broader commercialization. In addition to early volumes, the extra capacity that QS-0 provides will be used to begin exploring non-automotive applications of the technology, and de-risk the eventual ramp up of QS-1 as the company enters is commercialization stage. All in, QuantumScape expects the facility to have capacity for about 200k units of engineering sample cell production annually. In addition, about 10MWh of capacity has already been secured by QS’ second major (undisclosed) OEM partner to begin pre-series production on its vehicles ahead of commercial launch.

Having just secured the lease for the facility in April of last year, QS is aiming to begin construction and tooling QS-0 this year in the “implementation phase.” True production of the engineering sample cells off of QS-0 is not expected until 2023, however, with pre-series vehicle testing set to commence soon after. Management expects to commence B-sample cells on the line once it is operational. Volumes will continue to ramp over the duration of the year, accelerating the validation process and allowing the company to further optimize its manufacturing processes before it begins work on QS-1. Altogether, the company plans to spend about $215m in capex on the construction and ramp of QS-0 in 2022.

'''QS-1 phased build-out'''

QuantumScape’s primary production facility will be QS-1, which will be built out in two phases and represent the company’s first commercial-scale manufacturing facility for its solid-state batteries. Phase one will incorporate the construction of the facility with about 1GWh of capacity annually, or enough to support 10k vehicles assuming 100kWh battery packs. Site selection, design, and construction on the plant is slated to begin this year, followed by equipment installation next year. As the company continues to develop its product, the official start of production is set for late 2023 and will scale volumes through 2024 as it furthers its work alongside OEM partners. QS estimates that the total cost (capex + startup expenses) for the facility will be about $1.6bn.

The true inflection point for QS in terms of scale will take place as it builds out the second phase of QS-1, which adds another 20GWh of annual capacity (or enough to support 200k vehicles assuming 100kWh battery packs). Phase two site selection will take place in late 2023, with design and constructing extending through the end of 2024. By 2025, the company will begin installing the necessary equipment at the facility and look to start production by the end of that year before ramping into 2026 as it enters the true commercialization stage of its expansion plan.

About 70% of the facility will be used for cell manufacturing, while the remaining 30% will be for the company’s proprietary separator production. Importantly, the QS-1 facility will be owned and operated by QS’ QSV 50/50 joint venture with Volkswagen, with the two parties sharing all revenues and profits from the site’s operations. Similarly, VW will share the capex responsibility to construct and operate the facility as it scales. Alternatively, separator facility will be entirely owned by QS, which will then sell those parts to QSV for integration into the full cell.

'''Eventually QS-2'''

Once the company has completed the scaling of its initial production line, management intends to begin work on QS-2, which will be its first fully owned production line, with the goal to begin operation in the 2027 timeframe. While exact targets have not yet been disclosed, the new line would serve to meaningfully expand volumes, while allowing the company to capture more value over the process. We expect the introduction of QS-2 to be a considerable step forward toward the company breaching breakeven profitability in the 2027/2028 timeframe.

== Near term objectives ==
'''Key milestones'''

During its 4Q earnings call, QuantumScape announced that it had met all 2021 milestones on schedule, including meeting the technical milestone jointly set with Volkswagen which helped unlocked a $100m investment from the OEM. In addition, QS had sought to demonstrate the ability to make multi-layer cells with similar cycling performance as its single-layer cell; the firm completed its 10-layer cell test in November of 2021. Furthermore, QuantumScape secured the manufacturing space and began construction of its QS-0 pre-pilot facility. Looking ahead to 2022, QuantumScape has set the following targets:

# Continue to demonstrate the viability and manufacturability of its proprietary cell format, in preparation for large-scale customer sampling.
# Deliver A samples using its proprietary cell format to at least one prospective customer for validation and testing. A-sample represents an important step to finalizing the design and performance specification of its cells. Then looking to 2023, the company plans to produce the next stage of prototype, B-sample, on its QS-0 line – a prerequisite for commercialization in the 2024/2025 timeframe.
# Scale up film starts to 8,000 per week (from an average of ~1,800 films per week in 4Q21). This will help demonstrate QS’ ability to scale up testing and pave the path to several dozen layers in its cell format.
# Take delivery of QS-0 equipment and stay on track to the start of QS-0 prepilot production in 2023. As part of the mass-manufacturing process, QS plans to deploy a scalable digital architecture throughout its pre-pilot line which will allow the company to record and track individual parts with high precision, develop a data pipeline to use in AI and machine learning for quality control.

'''Near term hurdles'''

Equipment installation represents a key bottleneck QS is experiencing at present. Receiving the equipment usually doesn’t mark the immediate start of its usage, as the QuantumScape would need to install, test and reengineer them to address shortcomings. As it stands currently, the manufacturing process is very manual and creates inconsistency in output. Once the equipment installation is complete, the company will be able to substantially increase film output, a stepping stone to producing multi-layer cells for testing and ultimately the A-sample for at least one prospective customer by end of this year.

'''Opex and capex spending expectations'''

QuantumScape’s 2022 capex plan makes significant investment into cell development and scalable production, including continuous flow manufacturing processes featuring increased level of automation, high throughput metrology systems, and scalable digital architecture. The company expects to spend $325m-$375m in capex this year, of which $215m will be planned for the QS-0 and expanded QS-0 campus. Construction of the additional QS-0 campus space will begin in mid-2022. $85m will be spent on the phase 2 engineering line, and $52m will flow into phase 1 of the engineering line and additional projects including the R&D centre in Japan. By 2023, QS expects capital spending related to engineering and QS-0 line to decline significantly, as they will have received majority of equipment for the production line and tracking to 2023 goal of cell sample for that line for use in test vehicles. Capex should ramp again in 2024/2025 as QuantumScape prepares for the QS-1 production line. We are modelling about $350m in 2022 capex, followed by moderation to $133m in 2023 capex, before this metric rises back up to $300m+ level in spending.

QuantumScape also guided to cash operating expenses of $225m-$275m to support growth in hiring and expected volume associated with 2022 product development, customer sampling, and manufacturing process development goals. Looking ahead to 2023, opex spending should grow in-line with headcount growth, approximately in the range of 10%-20% annually. We expect opex to grow to $370m + next year, while modelling this metric to be in-line with management expectation for this year.

== Longer term financials ==
'''Proprietary design could help with BoM reduction'''

In a battery cell, cathode is typically about 40% of the cost, possibly reaching 50% with the recent raw materials inflation. QuantumScape’s anode-less design could enable it to deploy the same cathode materials as a standard lithium-ion battery cell, without the material price and manufacturing cost of the anode. The incremental raw material and manufacturing cost of the solid-state separator would be a critical determinant of whether QS is able to achieve BoM reduction for its batteries, and where their eventual cost settles compared with traditional li-ion batteries. Just a few tens of micrometers thick, the ceramic separator is expected to prevent the formation of dendrites while still allowing lithium ions to travel back and forth. Currently, QuantumScape expects the cost of the separator to be roughly $10-$12 per Kwh. But large questions remain regarding manufacturability of the cells using this separator at scale. Below we illustrate our expectations of COGS composition for QS’ battery cells from 2025 onwards. Overall, we expect total cost of goods sold to decline by ~23% starting 2026, followed by 14% and 14% decline in 2027/2028, respectively.

'''Volume growth and forecasts'''

We expect QuantumScape to remain largely on target for the QS-1 Pilot and QS-1 Expansion in terms of both capacity and pace of ramp. However, we are being more cautious about the ramp to 30Gwh of capacity targeted for 2027 initially for the QS-2 line. Instead, we are modeling more conservatively only half of production, at 15Gwh and 35Gwh for 2027/2028, and ramping to 70Gwh eventually by 2030. For reference, QS plans to ramp the QS-2 line to 70Gwh by 2028. Given that the company is still in a testing and validation stage, we feel a level of conservatism is needed in the model to account for delays and uncertainties on the timeline of the manufacturing scale.

In the initial two years of the QS-1 pilot, we expect minimum revenue contribution, at around $17m and $46m for 2024/2025, respectively. The addition of QS-1 Expansion will help ramp revenue, to $383m in 2026. Larger scale revenue ramp, however, won’t materialize until QS adds the QS-2 line to its production capacity, by which then we forecast $2B+ in 2027 and $4B+ for 2028. We anticipate that QS will yield positive gross margin in the low-teens once the QS-1 Expansion line starts to ramp, with a more dramatic improvement in margin with the addition of the QS-2 line starting in 2027, at an aggregate gross margin of 20.5% and increasing steadily to the outyear as manufacturing efficiency scales with capacity expansion. We also don’t expect FCF to turn positive until 2028, when total volume ramps to 56Gwh in capacity, with more substantial contribution from the QS-2 line. As such, we anticipate that FCF will remain in -$400m to -$600m range from 2024-2027.

In the table above, we’ve outlined QS’ initial expectations for revenue and profit (based on our estimate of the figures on a consolidated basis). In comparison, we are generally on the more cautious end and model closer to 50% of QS’ revenue expectation in the outyears, starting 2027 and beyond. In particular, we are modeling for revenue to reach $2B in 2027, while QS’ estimate suggests $4B+ on a consolidated basis starting in the same year. Consensus revenue for 2027 is in-line with our forecast. Heading into 2028 and beyond, we remain on the conservative side vs. consensus on the top-line but also note that estimate comparability might be less meaningful given scarcity in the number of estimates contributing to consensus. On the profitability end, we expect both gross margin and EBITDA margin to remain below QS’ initial expectations, modeling for EBITDA margin to reach ~6% and 16%+ for 2027/2028 vs. 25% anticipated by the company in both years. Meanwhile, we’re modeling more in-line with consensus for EBITDA, in single-digit margin for 2027, mid-teens margin for 2028.

'''Industry-wide trends in battery costs'''

Considerably higher raw material and component prices are impacting li-ion battery costs negatively in 2022 and this could continue into next year. According to BNEF, the volume-weighted average battery price will increase for the first time this year in nominal terms, to $135/kWh. The higher prices expected in 2022 and 2023 could potentially delay the point at which pack prices of traditional batteries reach $100/kWh. At the cell level, per kwh price had declined by 62% since 2015. The trajectory is likely to continue over the longer term, and this expectation directionally coincides with our forecasts for Quantumscape. However, given the likely higher performance metrics of QS batteries, we believe the company will likely price its offering at a premium on a per Kwh basis relative to the price trajectory of conventional lithium-ion batteries.

'''Pricing expectations for QS'''

On a per kWh basis, we expect initial revenue to be higher than the outyears, at $112/kWh but steadily declining to $71 by 2030, representing -5% CAGR starting 2026 onwards. With COGS declining over time, QuantumScape will have to price down in order to remain competitive both with its next-gen battery peers as well as the price/cost trajectory of the existing lithium-ion batteries. Even then, we feel there is a real possibility for the cost curve of conventional lithium-ion batteries to reach close to or even below solid-state prices. But again, the performance metrics for QS batteries should stay superior to conventional lithium-ion batteries which could justify its higher level of pricing power. Longer term, it will be important for QuantumScape to provide a flexible pricing structure based on performance metrics, targeting different segments of the EV market.

== Challenges ahead ==
'''Manufacturability'''

While the value solid-state batteries could provide to future mobility is potentially high, there are numerous uncertainties regarding QuantumScape’s ability to deliver on its plans, including challenges to ramp production and eventually reach profitability.

First and foremost, the company is working to scale up production of a technology that has never been mass produced before. QuantumScape has begun testing and validation of some multi-layer cells with about 16 layers in total, but a production-ready cell would need to work with 100+ layers altogether. Indeed, the 16-layer development continues to make progress, but it appears that QS still has a long road ahead to ensure that the cells continue to deliver optimal performance once the company reaches its 100+ layering target.

Once the tests on cells with 100+ layers is completed to satisfaction, QS will face the larger obstacle of ramping production toward its initial capacity of 21GWh. Getting initial volumes to operate on par with OEM standards is one thing, but being able to maintain the same level of quality on thousands of cells at a time in a brand new manufacturing process could prove to be a more difficult challenge. The solidstate batteries developed by the company share many of the same manufacturing processes as typical li-ion cells even without the need for normal anode production, but its unique separator and different assembly process could lead to unforeseen complications and expenses mounting ahead of commercial launch. At the same time, complications associated with scaling production on an industry-first product could very well force the company to push back its timeline to launch as well, delaying its path toward profitability. Investors will continue to monitor datapoints and development progress to better understand its ability to meet stated targets for launch.

'''Capital needs'''

In addition, QS will likely need to turn back to the capital markets in order to raise additional funding to expand its volumes beyond the initial QS-1 Expansion and QS-2 lines, even barring any delays in the ramping process. Management has stated that the company has enough capital with its partners to support its initial capacity build out, but as it looks to capture a meaningful share in the EV market over the course of the decade, it will need to significantly expand its output in outer years to support VW and other OEMs’ volume goals.

Moreover, this all assumes that QS is able to ramp manufacturing on its batteries efficiently without any setbacks as discussed above. Should the company delay its timeline to launch, its near-term cash burn could force the company to look to raise additional capital simply to meet its initial targets and further pushing back its expansion opportunity and limiting its ability to capture meaningful share as competition races to catch up.

'''Competition remains stark'''

At the same time, QuantumScape will need to maintain its first-mover advantage in order to capture share in the future mobility market. Many traditional li-ion players are working on proprietary SS battery designs (including CATL and Samsung), which could come to market sooner than anticipated given the established manufacturing footprint and battery production expertise maintained by incumbents. Meanwhile, QS is also racing numerous new entrants similarly developing solid-state batteries from the ground up, including Solid Power and SES in particular. Indeed, these competitors are developing “solid-state” batteries much like QS, but with some unique differences that could simplify the road to mass production. We highlight SES’ approach, which is a “hybrid” SS battery, allowing the company to rely more heavily on the traditional li-ion manufacturing process with little required retooling necessary to produce its proprietary systems. SES also remains in the early development stages, but its unique manufacturing process could prove to be a smoother road to mass volumes allowing it to reach the market sooner than QS despite the latter’s development lead to date. In this instance, QS could sacrifice considerable share in the EV pace in the short-term following launch. Nevertheless, QS will still maintain its all-important OEM partnerships which guarantee certain volumes and could allow the company to regain its footing in a more mature EV/SS market.

Lastly, traditional li-ion batteries are not simply going to disappear with the introduction of next-generation battery technologies. The traditional incumbents continue to make incremental improvements on the li-ion design, driving gains in terms of energy density and cost in particular. These advancements could allow li-ion batteries to remain particularly competitive with initial SS cells in terms of performance in the first few years while offering better pricing, minimizing the disruption that SS batteries are expected to have on the market. In this case, QS and other SS battery makers could see a slower ramp on volumes in the first few years and further delay the timeline to reach true profitability.

== Initiating with a Hold and $20 price target ==
When evaluating QuantumScape, we look to two peer groups as close representations of the company’s potential: established li-ion battery manufacturers, and pre-revenue battery startup peers.

Considering QS’ business model is built around the deployment of an entirely newto-market technology, we value the company much like a prospective BioTech firm based on two scenarios focused on the likelihood that the core product successfully (or unsuccessfully) progresses toward the point of commercialization; Scenario #1 would see the company accomplish its goal of bringing an automotive-ready solidstate battery to market in a reasonable timeframe, which we believe would warrant a multiple in-line with or above that of the more established li-ion players (including LG Energy Solutions, CATL, SK Innovation, Samsung SDI, and Panasonic, among others). We believe a valuation on 2028 EV/Sales around 2.0x (at the high end of incumbent range) is justifiable given the product’s opportunity to disrupt the battery space in terms of improved energy density, safety, charging capabilities, and potentially cost longer term, albeit at lower initial volumes. In this scenario, the company would reach an EV of $8.3bn, representing a $24 per share value.

Alternatively, we note that there remains considerable operational risk for QuantumScape on the road ahead as it scales from ~16-layer cells to mass production of 100+ layer cells, namely ramping an untested manufacturing process; This leads to scenario #2, which would represent the case where QS is unable to meet its timeline to commercial launch, leading to significant cash burn (and increased capital need) and a dissolved first mover advantage. In this case, we see downside risk to a valuation of about 0.65x 2028 EV/sales, trading down toward the average of its battery start-up peers. This would correspond to an enterprise value of ~$2.7bn, and a per-share value of just $10.

Given the company’s solid operational progress to date, we see about a 70% chance that the company successfully meets its stated targets for launch under scenario #1 and just 30% for scenario #2. Together, this leads to a blended EV of $6.6bn, justifying our price target of $20. Ultimately, we think QuantumScape’s value could be determined by its testing/validation progress, manufacturability, and timing relative to some of its next-gen peers. If successful, the company could dethrone the traditional li-ion incumbents that have dominated the battery space
for decades. We therefore initiate coverage of QuantumScape with a Hold rating, as we believe the company offers a compelling product with a strong opportunity to disrupt the incumbent battery market if proven successful. Nevertheless, the company is faced with considerable operational challenges ahead as it works to progress through its prototype sample phases and eventually move to mass production on a relatively tight timeline. Its partnerships with VW and numerous other global/luxury automakers should guarantee solid volumes once deployed, so the key lever for the stock’s potential rests in the validation and ramping stages leading up to launch. Our $20 price target is based on a 70/30 blend of 2.0x 2028 EV/Sales and 0.65x EV/sales based on our perceived likelihood of the company’s
timely commercial launch and scaling efforts.
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