The internet of things (IoT)—a network of connected, intelligent everyday devices that includes everything from thermostats to assembly-line robots to cars—is poised to transform the way we live and work. The change is happening fast: The total number of IoT devices worldwide grew nearly 70% in both 2015 and 2016, now stands at about 6.4 billion—and will more than triple by 2020, according to technology research firm Gartner.
The connection of previously standalone devices is a dramatic change. Yet Fidelity portfolio managers Charlie Chai, of Fidelity Select Technology Portfolio (FSPTX) and Steve Barwikowski, of Fidelity Select Semiconductor (FSELX) point out that it hasn’t become a key driver of their investments, at least not yet. For one thing, there are few pure plays on the trend—many companies across many industries are trying to find opportunities with products and services related to IoT.
“The internet of things will have profound effects on things like factory automation and consumer services,” says Chai. “But in most cases it’s too early to identify the companies that will benefit. And it’s only a tiny part of the business for many of the companies involved—for example, the internet of things probably shouldn’t be the sole reason to buy or sell GE.”
That said, the managers say one area of IoT-related investment opportunities is coming into focus. And it’s emerging out of one of the market’s most traditional industries: automobiles.
The vehicle as networked device
Certain companies stand to benefit from the auto industry’s rapid adoption of ever-smarter technology. Most new cars today come equipped with an array of automated devices, such as turn-by-turn navigation, autonomous parallel parking, hands-free calling, and touchscreen interfaces with wifi. The next frontier is self-driving vehicles, networked to each other and to company servers that send them periodic software updates wirelessly. “I think it’s quite likely that we’ll see cars communicating with each other in the next five years,” says Chai.
One company that Chai’s Select Technology fund is invested in, Tesla (TSLA), may be poised to reap the benefits of the autonomous vehicle revolution. The company has yet to turn a profit, as it invests billions in production capacity and new technology. Indeed, it stands to lose about $1.6 billion dollars in 2016, according to Chai. Yet he thinks the future is bright. He notes that Tesla has been applying lessons learned from its Model S and Model X cars to the production of the new Model 3.
"Whether you think Tesla is a good investment or not probably depends mainly on your view of how fast it can ramp up production of the Model 3, and what the car’s gross margins will be,” says Chai. “I believe the market may be underestimating how quickly that ramp up will happen.”
Beyond cars: autonomous farm and industrial vehicles
The auto industry may be the most obvious player in the autonomous vehicle market, but industries that use heavy equipment are capitalizing on the new technology as well.
Take agriculture. Self-driving technology can be applied relatively easily to farm equipment, which moves across a well-defined grid without the dangers presented by other vehicles or pedestrians. Companies already produce devices that enable farmers to plant, water, fertilize, and harvest remotely, with greater precision and efficiency than ever before.
Several companies compete in this arena, including Hexagon AB (HXGBY), Topcon (TOPCF), and Trimble (TRMB). Chai has invested his fund in Trimble, an American manufacturer of GPS receivers, laser rangefinders, unmanned aerial vehicles, navigation systems, and a variety of software processing tools. The company makes devices that enable farmers, miners and builders to control and track tractors and other heavy equipment.
Trimble derives revenue from sales of hardware and software, as well as recurring software fees. “Software sales are about 45% of revenues now, and recurring fees account for maybe half of that—but I think these fees are the future,” says Chai. “Recurring software fees are growing 10% to 15% a year. Costs for those sales are relatively fixed, so margins on them are very strong.”
He notes that companies linked to agriculture have suffered in recent years from weakness in its end markets of agriculture and metals and mining. Yet those industries are cyclical; when the cycle turns up, the result could be a jump in high-margin software sales.
Growth for semiconductors
The internet of things will be powered by semiconductors. Chip companies with exposure to the auto market are benefiting from the first wave of IoT-related growth, says Barwikowski. "There's about $350 worth of semiconductor content in a new car,” he says. “That’s more than you'll find in the average personal computer, and it’s growing by about 5% to 6% a year.” He notes that Tesla already makes cars with more than $1,000 in semiconductor content, and the figure will increase as self-driving cars become more prevalent. Barwikowski sees the potential for 8% to 9% growth in automotive semiconductors in the near future. That’s roughly double the rate of growth in the chip market overall, which has slumped as growth in smartphones has leveled off.
Barwikowski’s fund has invested in Qualcomm (QCOM). “It trades at an attractive valuation,” he says, “and it will be the leading provider of 5G networking, which will be the key to autonomous driving. What’s more, it just bought NXP Semiconductors, the world’s largest provider of semiconductors to the auto industry.”
His fund also invests in ON Semiconductor (ON). "About 30% of its revenue comes from the auto market," says Barwikowski, "and that piece is expected to grow in the high single digits." The fastest-growing piece of ON's business is car cameras, where it has about 80% market share. Rear-view cameras are becoming ubiquitous on new models, but they’re just the beginning: New Teslas come with eight cameras distributed around the vehicle, and autonomous driving will depend on increased camera use. ON makes between $8 and 10 per auto camera, according to Barwikowski.
The future of the IoT
As the internet of things expands in coming years, applications will continue to shape a range of industries, including autos. Smart technology has begun to infiltrate factory floors, allowing manufacturers to optimize efficiency, troubleshoot in real time and track goods. Intelligent appliances will allow more consumers to connect devices like thermostats, security systems, washing machines, and refrigerators to their smartphones. Retailers will be able to track customers as they move through their stores. And farmers will be able not only to control their tractors remotely, but to monitor soil moisture, track livestock health and automatically regulate the heat of chicken houses and beehives. These changes could help provide competitive advantages, and potentially influence investment opportunities, down the road.
- Charlie Chai manages Fidelity Select Technology Portfolio and Steve Barwikowski manages Fidelity Select Semiconductor.
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