Friday, 10 January 2014

The Internet of Things revolution is here

The Internet of Things revolution is upon us and that it is likely to affect all our lives, whether we are particularly aware of it or not. It will revolutionise consumer interaction with relatively docile devices such as washing machines and thermostats, as well as ‘enhance’ clothing through wearable tech, save lives through the use of smart implants and save energy with the use of ‘big data’ analytics.

There are varying definitions but the Internet of Things essentially encompasses any ‘smart’ device that is connected or connectable via a network, generally excluding ‘traditional’ mobile devices such as smartphones and tablets. Technology advisory firms have been giving wide-ranging estimates for the size of this market - around 30bn installed units by 2020 seems to be a rough consensus, compared to the 7bn mobile phones in use today.

Ahead of the Consumer Electronic Show (CES) this week in Las Vegas, we have been looking at the latest trends in mobile technology and the potential impact on the various companies exposed to the sector. Both Apple and Samsung have suffered of late on the back of poorer than expected mobile device profits and it looks to us that this trend is set to continue.

The inflexion point at the high-end of the mobile market is upon us and growth is now likely to come from the mid to low-end in emerging markets, resulting in continued volume growth but significantly lower incremental profits. On the consumer side, the Internet of Things is set to be the next big thing for chip makers. However, we do not think this will be quite as lucrative as the mobile device boom, in the near term at least.

Inventors are coming up with all sorts of ‘smart’ gadgets that may or may not help us in our everyday lives. Wearable tech, whether it be smartwatches or headphones in a headband, appears to be one of the biggest themes of CES. Household goods connectivity and ‘smart’ toys are also making a strong appearance. Whilst we see the benefit of a connected thermostat for consumer convenience, energy saving and ‘big data’ gathering that can help utility companies measure demand, we are not quite so sure that humanity will be saved by the invention of fridges that re-order your shopping automatically, although this could be useful.

The principle is that the chips necessary for a device to be connected become so small and cheap, that even if the benefit of the ‘thing’ being ‘smart’ or connected is relatively marginal, it may as well be connected. The benefit may not just be for the user. When data is gathered from all such devices and analysed, patterns can be identified and efficiencies or sales made. This of course brings up ever topical security and privacy issues.

The gathering of data is often regarded with suspicion by the public, particularly given recent revelations surrounding the US and other governments’ surveillance activities. Education and reassurance is one aspect required by companies. Another is a reasonably high level of sophistication at the chip level in order to combat hacking. ARM suggests chips need to be at least 32-bit in order to be successfully secured. These are available today but are more expensive than 8 or 16-bit.

The exact size of the opportunity in dollar terms for the chip companies, is unclear at this stage; however, we would suggest that this is not directly comparable to the start of the mobile device boom due to the significantly lower chip value necessary for the market’s success (below $1 compared to high-end mobile device chips of $20). On the other hand, the volume opportunity is much larger therefore this is not an insignificant opportunity either.

The issue for the chip designers and manufacturers is whether or not the IoT growth story will play out in time or be of the profit generating scale necessary to alleviate the fall off in mobile growth rates. Clearly with developed market smartphone saturation as high as it is (over 50% in developed markets), growth is likely to slow significantly at the high-end in particular and, whilst developing market growth rates are strong, smartphones being sold are generally at the mid to low-end of the smartphone price and component scale.

In addition, the IoT opportunity is most likely to be back-end loaded this decade and into the next, i.e. we are expecting the vast majority of the billions of devices to be installed from 2020 onwards rather than within the next couple of years. This potentially leaves a worrying ‘growth gap’ for the manufacturers and chip designers, unless the IoT revolution can ramp up much sooner than we expect.

It is too early to call the winners of IoT, in our opinion, as no current player has a comprehensive solution and a number of new companies will no doubt be created over the next decade to service this market. Watch this space.

Ruairidh Finlayson
Equity Analyst

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