D-Wave: Reevaluating the Short Seller’s Case After the Downgrade

Key Points

• D-Wave Quantum has returned roughly 3,200% in the last year, as the quantum industry more broadly has skyrocketed.
• With investors having difficulty assessing the differences between companies in the space, successes across the industry tend to lead to gains for everyone.
• However, there is a short seller case to be made against QBTS shares, although the company's technological advances may undercut a key concern about D-Wave's prospects.

Like much of the quantum computing industry, D-Wave Quantum Inc. NYSE: QBTS has recently been on a high-flying ride. Shares have surged by more than 243% year-to-date (YTD) and nearly doubled in the last month alone. These gains pale compared to the stock's rally of almost 3,200% in the past year.

With an almost comically high price/sales ratio of 1,279.8, D-Wave could be among the most-hyped stocks currently available to investors.

The question across Wall Street and among retail investors, then, is to what extent D-Wave's fundamentals support this unbelievable performance. Earlier in the year, the prominent short-selling firm Kerrisdale Capital led a charge against D-Wave, giving short sellers everywhere fodder to argue against the company's commercial and technological potential.

Several months—and about 200% in returns—later, it's reasonable for investors to have concerns about D-Wave's commercial possibilities still even as the firm has solidified its technological case.

But the biggest issue for investors may be the massive rally itself, which has left analysts across Wall Street suggesting QBTS shares are likely to correct before too long, and may have also contributed to a recent downgrade by Zacks.

Answering the Question About Annealing's Potential Breadth

An argument that bears on D-Wave has made is that the firm's quantum annealing tech has limited potential due to its particular focus on optimization problems, rather than a more general problem-solving approach.

D-Wave has managed to ease some of those concerns with announcements of projects aiming to develop gate model technology, an alternative to annealing. It seems that D-Wave is adopting a technologically diversified approach to avoid developing itself into a corner that might put it at a disadvantage relative to peers focusing on other types of quantum technology.

At the same time, investors outside of the quantum industry likely often lack an appreciation for the potential of even a comparatively narrow technology like annealing, the benefits of which have started to play out in real-world examples.

In the last several months, D-Wave has announced successful partnerships, including with agricultural software company Verge Ag, Japan Tobacco, and the North Wales Police in the U.K. Each of these provides new evidence of the multitude of applications of quantum annealing and D-Wave's success in meeting client needs across a range of industries.

Commercialization Potential Remains Largely Untested

However, D-Wave's potential for commercialization remains murkier than the possibilities suggested by its technological achievements. In the last quarter, the company posted wider-than-expected losses per share as adjusted EBITDA losses rose 44% year-over-year (YOY) amid increasing operating expenses. A bright spot in the company's earnings was its revenue growth, largely thanks to a growing pipeline of projects and sales of its Advantage2 quantum system.

However, despite YOY revenue increases of about 42% for the quarter, revenue remains devastatingly low in absolute terms at just over $3 million.

The company has found some early success commercializing its quantum technology, although it falls far short of what most investors will seek to sustain its valuation and momentum. This is where the short seller case against QBTS gains strength: D-Wave is significantly overvalued by virtually any measure given its earnings and sales history. It's no wonder that analysts as a group predict shares to fall by nearly 40%.

D-Wave is hardly alone in having experienced a massive rally in the last year—rival Rigetti Computing NASDAQ: RGTI has climbed even more rapidly, with more than 5,100% returns during the same period.

But many participants in the quantum space can risk being overvalued while presenting a legitimate competition threat to D-Wave. Rigetti's recent announcement of a contract with the U.S. Air Force Research Laboratory is one of many developments for a D-Wave competitor that ratchets up the pressure on QBTS.

With most quantum-focused companies moving as a group while investors still have difficulty delineating them, successes across the industry contribute to what appears to be an ever-climbing group of stocks.

However, in time, one or more companies will likely emerge as leaders—investors must decide if D-Wave is likely to be in this category or if it might fall by the wayside.