HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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September 29, 2020

How Will IoT Help Me

Spatially Aware

I have heard a lot about the Internet of Things (IoT) over the years, but I have never really understood how it might help me. It might make street lights and vending machines operate more efficiently, but it didn’t really sound like a life changing proposition. However, I have recently discovered the concept of the spatial web, or Web 3.0, and things are starting to make much more sense. For the context, Web 1.0 was static information that was a downloadable document library with elementary searchability ( a distant memory for most). Web 2.0 became interactive and allowed for user generated content, social media, and ecommerce. The significant enhancements to our lives from both these web versions have become normalised and are now part of the furniture of everyday life. The new news is that Web 3.0 will enable the internet to move into our physical 3D world and to develop a proper sense of spatial awareness, with the potential to change our lives in a fundamental manner.

Life Changing

We are currently approaching the confluence of developments that include the myriad of connected devices in IoT, next generation mobile network capability (5G), enhanced and virtual reality (ER & AR), wearable technology, artificial intelligence (AI), decentralised edge computing, blockchain distributed verification, advanced robotics, digital health and personalised medicine. All these things will enable the internet to move from flat screens into our everyday three dimensional world. Everyday objects will be mapped, connected and verified, offering a new dimension of useful (and no doubt useless but compelling) applications. In addition to everyday things (like coffee machines) having marginal gains coached into them (which should aggregate to a big win in itself), we will also see the enablement of some genuinely life changing applications such as self navigating cars, robots and drones in the real world, but also a myriad of applications in virtual worlds and the prospect of using enhanced reality to move assets from virtual into real world settings. In addition to worrying about fake news, we will also have to contend with fake reality.

If Not Now, When?

As Matt Ridley points out in How Innovation Works, innovations like this don’t just require the knowledge, but critically require the purpose and locus of time, place and circumstance. Innovation is at its most potent at times of adversity and crisis. This was crucially demonstrated by the explosion of technological change the world went through from the end of the First World War to the end of the Second World War. This three decade period started with a world based around the horse and ended with nuclear fission and also included radar, plastics, computing, the jet engine, television and jazz music. There is nothing quite like an existential threat to humanity to illicit experimentation and innovation. I sense we are currently in just such a critical period, sufficient for certain industries that have largely remained unchanged by Web versions 1.0 and 2.0, to start being seriously disrupted (improved for consumers) in version 3.0.

Small Step or Giant Leap

As our brain tends to work linearly it underestimates technological change, which tends to operate on a geometric curve. For example we might like to think that the move from a 4G to a 5G mobile network is an incremental change of, let’s say, 5/4. So 25% better all round? This sounds good but maybe not life changing. Well, think again. 5G will improve latency (speed of data requests) by 200x over 4G and for the first time make network speeds significantly quicker than the reaction time of the human brain. At the same time network densities will improve by 250x, meaning that for any given mobile cell there will be capacity for about 1 million connected devices compared to just 4 000 with 4G. Finally, all this will happen with a network of devices consuming 90% less power and enhancing the battery life of low powered IoT devices by 10 years. Welcome to the entry point for the spatial internet. Applications such as autonomous vehicles, smart drones and clever robots as well as full spatial awareness in virtual and enhanced reality settings. We won’t quite have Star Trek level teletransportation, but it might begin to look and feel like we do.

And The Winner Is ...

Who are the likely players and potential winners in the spatial web? This of course is hard to know, but it’s pretty clear that Amazon, Alphabet, Microsoft and Facebook will all be able to join sufficient dots in their digital empires to position themselves sufficiently well (antitrust enforcements permitting). This also might be the point at which the computer games industry moves more into the mainstream of technological change. The chip manufacturers will also need to continue their never ending quest for re-invention as this space will demand even higher performance in key areas of capability, but these will also remain beyond my level of comprehension (Can it be right that Nvidia is on nearly 10x the revenue multiple of Intel)? Nearer to home, in terms of the UK market I see a handful of potential winners.

Aveva -

An interesting potential UK spatial web champion is emerging, in industrial software giant Aveva. Aveva is a long term survivor in the UK technology landscape whose origins go back to the mid-1960s government centre for computer aided design. It became a commercial entity in the 1980s and floated on the UK stockmarket in the 1990s ultimately changing its name to Aveva. Recently 60% shareholder Schneider Electric of France backed them to acquire US industrial data aggregator OSIsoft. A very interesting consolidation play in the space of digitised manufacturing assets and physical infrastructure management. It is also a very sensible combination of complementary businesses with adjacent strategic and geographic concentrations. The deal is due to complete towards the end of 2020. Having watched the development of Aveva from a small cap stock of years ago to a European regional champion, maybe, just maybe, this will be a global tech giant of the industrial spatial web in the not too distant future. It certainly has many of the characteristics I would look for: high margins, recurring revenues, and a platform technology with growing returns to scale. However, with the valuation of more than 9x revenue and a more than 40x PE suggests that I’m not the first to have had this thought.

Telit -

In the UK small cap space there is the Israeli based Telit which having been through a corporate and governance transformation in the last few years looks like it could be an interesting play. The revenue model is still dominated by hardware sales but the service and connectivity revenues are growing, and the balance sheet is solid following a disposal of its automotive arm during its clean up phase in 2018. The new clean slate of Board and senior management look capable and on a EV sales multiple of 0.5 and an old economy type PE in the high teens this definitely passes muster as a contender worthy of consideration.

Eleco -

Clocking in with a c £65m market cap, a company I have found fascinating for some time, is Eleco. Eleco boasts a very long corporate history and interesting journey into the BIM (Building Image Modelling) segment of the the BuildTech space, from its origins in 1895, evolving into an early pioneer of street lamp manufacture and formally becoming the Electric Light and Engineering Company by the early 1920s. The company moved into modular housing construction after the Second World War and further into building technology over the following decades. It has only been in the last decade that Eleco’s sole focus has been on IT aspects of the building and construction industry. Eleco supplies software and related services for all aspects of the lifecycle of a building from its design to its construction, operation, maintenance and facilities management. Like Aveva, Eleco has evolved its CAD knowledge into full spatial awareness. However, the building and construction industry is somee distance behind the process and mechanical engineering industries when it comes to the adoption of digital technology. But pressure is now fully on the building industry as tougher environmental, safety and quality controls are being implemented. This is particularly pertinent in the UK following the Grenfell Tower tragedy. Eleco has some highly attractive financial characteristics. The company achieves high margins, has a decent (c 55% of recurring revenue) with high level of customer retention and returns a very high percentage of operating profit into cash, while still managing to invest in R&D. Eleco also has a decent mix of revenues by product and geography. However, despite its long history Eleco’s current operational portfolio has largely been assembled via acquisition thus not really allowing for a clear picture of solid organic growth to emerge. This combined with the recent retirement of the long standing CEO adds an element of caution. Overall the EV/sales of this business at c 2.5x given the near 90% gross margins and mid teens RoE, probably justifies the c 20x PE. However, with Brexit uncertainty last year, COVID delays this year and new management regime going into 2021, Eleco probably needs to demonstrate some real organic growth to enjoy a re-rating.

Tern -

Heading further down the market cap scale is specialist IoT investment company Tern PLC. Tern is a list VC investor with about £16m (at cost) of investments in a small collection of privately held IoT companies. By far the largest and most mature of these investee companies is IoT security player Device Authority (DA). DA provides “headless” device security protection for industrial and medical devices. (Think of a 2 factor authentication for secure mobile apps, such as banking, without human intervention). DA has partnered with Intel, AWS and most recently become integrated into Microsoft’s Azure cloud offering. Microsoft has also recently undertaken a $5bn investment programme into industrial IoT which included the $165m purchase of IoT security company CyberX. Tern lacks liquidity, has a concentrated portfolio and is inevitably opaque regarding the detail of its investee companies. However, it is led by a veteran of the IT security industry with feet on the ground capability to add value to its investments and extend its portfolio into this growth segment.

I currently own none of these UK stocks, but I am keen to take some positions as the advent of 5G is likely to catalyse the potential beneficiaries of the spatial web.

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