Tech bloggers and reporters have written so much about the “internet of things” (IoT) that the phrase is beginning to get tired. However, we believe the IoT is one of the most significant investment-related technology themes. We also believe that investors’ instincts, when looking for ways to approach this theme, may be unduly skewed towards new technologies, when in fact, a vast building-out with older technologies may be one of the most notable characteristics of the IoT.
The IoT’s Multi-Trillion-Dollar Opportunity
As we’ve written in this letter before, the IoT refers to an internet that connects not just people but the devices they use.
Back in 2011, old-line IT giant Cisco (CSCO) defined the arrival of the IoT as the time when there were more networked devices on the planet than people. By that metric, it arrived sometime in 2009, and by 2010, there were 6.8 billion people and 12.5 billion networked devices. If you counted only those people who had internet access, there would have been 6.25 networked devices per person. And with trillions of devices that could be profitably networked to generate data and increase efficiency in virtually every sphere of human activity, all the growth so far is just a drop in the bucket compared to the potential expansion.
The Internet vs the Web
According to Cisco’s thinking, the “Internet” refers to the actual technological skeleton of our connected world — the physical switches and routers and other equipment. The “Web,” on the other hand, is the layer of programs and applications that add flesh to that skeleton and through which we do our communicating.
From that viewpoint, the Web has seen radical changes, from the basic information-exchange of military analysts and academics in the 1960s ARPANET era, to the simple “web presence” of companies offering descriptions of their business in the early 90s, to the burgeoning of e-commerce transactions in the late 90s and early 2000s, to the growth of the social web which now serves as an indispensable tool for personal and professional networking.
On the other hand, the Internet itself, the physical, technological foundation of the rapidly evolving Web, has not experienced comparable evolutionary changes. It has grown exponentially in size, but it is still largely doing the same things it was initially designed to do.
The IoT represents the Internet’s first evolutionary shift.
Connecting the World, Not Just the People
The IoT expands connected devices beyond the infrastructure needed for humans to exchange data with one another. Essentially anything — from your home thermostat to a cow in a farmer’s herd — is a potential element in the IoT. (Yes, there are networked cows, and the company that pioneered it estimates that each cow generates 200 MB of data annually.)
Of course, the huge and rapid expansion of connected, data-generating devices (and cattle) has drawn attention mostly to the potential for the analysis and use of such data. With ubiquitous connected devices in your home monitoring your diet and your health, for example, all connected to a data-crunching super-doctor in the cloud, medical interventions to nip problems in the bud could become much more efficient and effective. (We noted this specific application recently in our description of the new Google Baseline project.)
Investment Opportunities Beyond Big Data
Looking at big data analytics is an obvious response to the IoT for thematically minded long-term investors — those with the patience and conviction to watch trends they’ve identified come to fruition. However, investing directly in themes such as big data can be difficult, since new entrants in this space often attract excessive valuations — trading at multiples that make them highly vulnerable to market fluctuations.
Often, it seems to us, decades’ worth of optimistic forecasts are already priced in… when that rosy outcome is really just too distant to gauge with any confidence.
Fortunately, such new, expensive stocks are not the only way investors can gain exposure to the IoT.
Old Tech in the Midst of the New
For example, as transformative as the IoT will be, it relies fundamentally on a technology that was probably more familiar to average Americans in the 1960s: RF (radio frequency) communications. In short, the trillions of networked devices that will be joining the IoT in the next decade or two will be talking to each other by radio.
This will represent a tremendous, possibly unparalleled opportunity for the developers and manufacturers of RF semiconductors, which will be needed by the trillions for the data generated by the IoT to make it from device to cloud.
(We note that the SPDR Semiconductor ETF (XSD) has given investors a better-than-26-percent return this year, well above the performance of the S&P 500.)
Semiconductors have long been a mature and notoriously difficult cyclical industry. In our own thinking about RF semiconductors as a way to gain exposure to the IoT, we try to focus on companies with several characteristics:
1. Companies with a track record of technological innovation, especially in producing smaller-footprint, cooler running, and more energy-efficient chips;
2. Companies with existing contracts or potential contracts to provide hardware for large, established device manufacturers; and
3. Companies that may be attractive takeover targets.
Investment implications: The Internet of Things will likely be even bigger than analysts believe. However, it isn’t necessary to look at excessively valued big data analytics firms as a way to approach this theme.
Study the designers and manufacturers of innovative RF semiconductors, which may enjoy the same growth trajectory at a fraction of the multiple.
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