It’s getting real. Yes, pun intended. Virtual reality, as a concept, has enormous potential, and the world seems to be noticing. Apart from an increasing pace of media articles churned out daily on the subject, the recent CES in Las Vegas, Silicon-Valley-giant focus including Apple’s presence around Stanford’s VR labs, and Wall Street’s outlook have placed a significant spotlight on the subject. Is it warranted? And if yes, what’s next?
To begin with – yes, it’s warranted – and heavily undervalued, in my opinion. The concept may be well-known, but the application is still in its infancy – both from a consumer and enterprise perspective. Let’s take a step back. VR, in essence, is a computer-simulated reality that replicates physical locations for the user to immerse in; sight and hearing is a part of it, other sensorial experiences may soon follow. Good enough. Have you ever wanted to skydive, but were too terrified to do so? How about visiting a Brazilian rainforest immediately, or piloting a jetliner? VR can do all of it. Ok – none of these excursions add substantial value apart from some pleasure and cortisol…so take a step ahead. How about performing a procedure on an accident victim – with directions from a doctor unable to be present, but recreating the situation in a VR headset? Kids learning about space straight from the experts? The ability to train better for risky jobs, such as firefighting, or working in confined spaces? VR’s the answer. Enterprise applications are already being seen…Lowe’s now provides visitors views of potential home interiors; Ford, per Tech Republic, has ‘Immersion Labs’ to understand how customers experience their cars, and gaming, of course, leads the pack in obvious ways. Currently, Facebook’s Oculus Rift, HTC’s Vive, Sony’s Playstation VR, along with Samsung, Microsoft, and now Apple and Google dominate the hardware and software space; competition is escalating, but so is growth, given the enormous application potential.
The concept has existed for several decades. However, so has 3D printing and graphene – and none have achieved mainstream adoption despite supposedly tremendous potential. Why is now the time for VR? I outline three reasons.
1. A ready target market: Millennials are set to comprise over 75% of the world’s workforce in the next 5 years, with over $2.5T in purchasing power….this is demographic mentioned time and again in this column – one that is driven by sustainability, and has a preference on spending on experiences versus accumulating assets – criteria that VR can fulfill. Millennials also wants to make a positive impact on the world – carbon footprint reduction et al, and is an extremely social group…for example, 70% of them are more excited about decisions that their friends agree with, compared to 48% of non-millennials (Forbes data). Generation Z, of course, takes similar attributes to another level with tech immersion – and it wouldn’t be outlandish to say that the drivers of Snapchat and Instagram would prefer immediate experiences and spontaneity – again, up VR’s alley. Such a combination of attributes and behavior patterns among the population with spending power fits VR’s capability. Costs are a separate hurdle, but one that can be overcome; more on that below.
2. Capital spending changes: This is an interesting one. Per McKinsey data, I’ll reiterate that western corporations derived over 60% of the world’s profits over the past 30 years and tripled them in size, from 7.6% of GDP to 10% of total GDP over the span. Baby boomers entering the workforce around the 1970s, the unification of eastern and western Europe and China’s addition to the global economy – both in the early 1990’s – were all gamechangers with respect to the worker population and consumer needs. Consequently, the rise of cheap labor and global supply chains aided corporations which were large, and ones that could derive economies of scale and executional efficiency – think the DJIA components. Today, however, it’s a different era. Post-2008, the entrepreneurial drive of Silicon Valley, the ongoing information age, data-driven enterprises and the focus on ideas and asset utilization will define corporate behavior. With the rise of competition globally (in particular, Asia), McKinsey predicts corporate profits will erode back to the percentage levels seen in the 1980s. As a result, nimbler, more efficient corporations may shy away from traditional capex, training needs and perhaps even travel spending due to smaller sizes and an emphasis on lower overheads. VR will be able to substitute each of these activities extremely effectively – and therefore, the time may be right for a mainstream enterprise adoption.
3. A complementary ecosystem: Now, let’s think broader. VR doesn’t need to stay just VR. Other major structural trends taking off include the internet of things, artificial intelligence and robotics. Some stats? The IoT solutions market may be worth $7.1T (trillions, not billions), by 2020, per IDC. Per McKinsey, the US economy is only recognizing 18% of digitization’s potential. And today, robots perform roughly 10% of all manufacturing tasks, but the number may jump to 25% by 2025, per the BCG. There’s plenty more proof, but the point is that a convergence of advances in VR, the IoT, artificial intelligence and robotics may lead economic advances that are far beyond what each technology may contribute individually. VR could train machines to function by themselves, and sensors may monitor behavior and feedback, for example. The TAM, as a result, may be much larger than what current projections as a sum show. This concept requires a vision, but it certainly isn’t far fetched, and is in favor of VR’s adoption. Now, a look at the numbers.
The potential: Show me the money, right? The range of estimates for the VR market is pretty wide – but the lower limit is around $5B in 2016. Recode estimates a market size of nearly $70B by 2020 – over 10x that of today, so a ~15% CAGR for both VR hardware and software. TechCrunch goes further, estimating the augmented and virtual reality space at ~$150B by 2020, with VR around $30B. I believe that in the short term, hardware will dominate, but a few years out, the market will focus on the software, with ecosystems evolving to include more apps, open-sourced platforms, and significant indirect, yet tangible benefits – say, a reduction in workplace injuries due to better training. According to Goldman Sachs, major hardware devices have experienced pricing declines in the range of 5-10% annually over the past 20 years. So, while the headlines may be around the Rift today, the real innovation is just beginning.
In any case, the CAGR for VR and absolute size potential resembles that of the IoT, big data or the cloud – and yet, the VR space is hardly ‘proliferated’, in comparison with the numerous cloud firms riding the market coaster at the moment. Even though the life cycle stage may be considered embryonic (usually characterized with new entrants, no profits, explosive growth stories and some implosions), VR is different, given the major players are established mega caps, with billions in cash at hand; the leaderboard is hardly counting on VR for free cash flow – and as a result, can focus on longer-term innovation and large client relationships. At the same time, according to CB Insights, there were 91 investments totaling ~$1.1B in the VR field in the 18 months after Facebook bought Oculus, compared with 50 investments of $316 million in the previous span. So, it’s game on.
The Players in VR: OK – everyone and their investing mother knows about Facebook (FB), Apple (AAPL), Microsoft (MSFT), Samsung and Alphabet (GOOG). A Lynch-style-10-bagger due to VR isn’t happening with this list – but their leadership is certainly worth some rewards. Sophic Capital estimates that Samsung’s Gear VR may conquer the mobile gaming space, since 78% of the world’s 1.2B gamers are mobile; Oculus Rift is expected to ship 3.6M headsets this year, per Piper Jaffray.
The details, then – the breakdown of the OculusRift, courtesy iFixit, shows an involvement with Toshiba, STMicroelectronics (STM), Samsung, Spectra7, and InvenSense (INVN). Invensense has a market cap of about $640M, trading at 14.7x forward P/E. Relationships with Apple cause the stock to lurch up and down, but the motion sensing technology is something to watch in this space. Equally intriguing are smaller firms, including Leap Motion and Sixense, both private currently, with leading forays in hand motion and motion tracking across both virtual and augmented reality. Intel (INTC) has been making graphic processing units for headsets as well, and has RealSense, its depth-sensing camera technology; it has outperformed the NASDAQ over the past 2 years. Nvidia (NVDA), meanwhile, with a $4.8B revenue, 5.4% 3-yr growth rate and a manageable forward P/E of 19x, was recommended by Oculus to consumers for an ‘optimal experience’ due to its GPU technology. In fact, the firm has smartly positioned itself for artificial intelligence, virtual reality, and driverless cars – all phenomenal structural trends with serious tailwinds. Another interesting firm is Sony (SNE). Sony has underperformed the NASDAQ by 95% over the past 5 years, but Piper Jaffray estimates it will be shipping 1.4M Playstation VR headsets this year – as an established gaming firm, there’s more to come here. To summarize, going all in on these stocks may not be too wise – but these are definitely some of the firms to watch. Software, meanwhile, is a whole untapped story, barely starting. VR is an incredibly interesting and unchartered public territory, and the disruption potential across sectors is likely to become extremely attractive for Wall Street in the coming months.
What it means for you: In a market where growth remains elusive, oil continues to coat stocks and emotions run high, fascinating ideas may be getting covered up behind the gloomy forecasts and bears running around. Virtual reality is one of them. In the next post, we’ll look at another subject with enormous potential: space, involving satellites, reusable rockets, and the players involved. Investors should stay strong – there’s plenty of innovation all over the place, and a whole lot of brightness to look forward to after the storm recedes on Wall Street.
