Is Virtual Reality All Hype, or the Real Deal?

 

The Window of Opportunity is Opening

Is Virtual Reality All Hype, or the Real Deal?

What to Expect in 2016

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It can be challenging to remain positive in the face of a market correction. But such events always open windows of opportunity. When the market turns, and it will, investors will once again flock to the most promising growth stories. So we need to be on our toes, always looking for the next big thing. For those of us who study stocks for a living, that means staying positive and hammering away at research, even while many stocks fall.

The Window of Opportunity is Opening

A couple of weeks ago, I published my Small-Cap Outlook for 2016. In it, I briefly described what I expect to be one of the most exciting trends in 2016—virtual reality (VR) and augmented reality (AR). For the record, I’m far from the only person with this view. And I think that’s a good thing—it means the profit potential is that much greater since interest is so widespread!

Goldman Sachs published a report outlining three scenarios for VR and AR hardware and software sales over the next decade. Its pessimistic case calls for $25 billion in revenue by 2025. The base case calls for $88 billion, while the optimistic case calls for $182 billion. To put those numbers in context, the current hardware market for desktop computers is just $62 billion.

In other words, this should be big.

There’s just something about this picture from VR/AR player Magic Leap’s website that I like.

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Is Virtual Reality All Hype, or the Real Deal?

This is what I wrote in my Small-Cap Outlook for 2016:

“Virtual Reality will be the most hyped theme of 2016, yet will still deliver the goods for best-of-breed stocks. The promise of full-immersion gaming, education, shopping and entertainment—from the comfort of home—is just too big a carrot not to nibble on. Especially when the who’s who of technology innovators, including Oculus (FB), Microsoft (MSFT), Alphabet (GOOGL), Sony (SNE) Samsung and HTC are releasing virtual reality (VR) and augmented reality (AR) headsets in the year ahead.”

Estimates for headset sales are expected to increase from around 10 million this year to roughly 100 million by 2020. Some are saying VR will be a bigger market than TV! With so much excitement surrounding the “next computing platform,” it’s little wonder the world is fascinated by what could very well be the biggest entertainment innovation since the high-definition flat screen TV.”

The hype around VR and AR has as much to do with excitement on the consumer end as it does with the number of companies making moves in this market. The latest development came last Thursday when news broke that Google is developing a stand-alone VR headset. This would be the first hand set that doesn’t require a PC, smartphone or gaming console to operate.

This is just a sampling of what else has happened over the last two years:

March 2014: Facebook buys Oculus for $2 billion

March 2014: Microsoft buys wearable IP from Osterhout Design Group for $150 million

October 2014: Google ponies up $542 million in funding for Magic Leap

June 2015: Samsung Ventures invests in FOVE VR

June 2015: Qualcomm and AMD invest $30 million in Matterport

September 2015: Disney invests $65 million in Jaunt

November 2015: Comcast and Time Warner invest $30.5 million in NextVR

February 2016: Magic Leap raises $800 million in “C” round funding, valuing the firm at $4.5 billion

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What to Expect in 2016

There are many markets that could be impacted by advances in VR/AR hardware, software and content; gaming, warehouse and inventory management, real estate, education/arts, sports training, medicine/surgery and energy top the list. Sotheby’s is already showing some luxury homes in VR. Volvo has a partnership with Microsoft to use HoloLens to sell cars.

Many of the beneficiaries are likely to be companies that we already know well: Sony, Google, Facebook and Microsoft. There are a number of other potential beneficiaries that are smaller. GoPro (GPRO) and Ambarella (AMBA) are somewhat obvious companies to pay attention to (even though the market hates GoPro at the moment, I wouldn’t be so quick to call the company dead and buried just yet).

Then there’s sleeper opportunities, such as Elbit Systems (ESLT), a $3.5 billion market cap defense company. It is the market leader in advanced fighter jet and rotary wing helmet-mounted display systems, not to mention the world’s largest manufacturer of drones. Some of these technologies are finding their way into more consumer goods. For instance, the company just spun out Everysight, who’s first product, Raptor, is a set of augmented display smart glasses designed for cyclists.

Everysight’s Beam technology projects real-time information (velocity, altitude, elapsed time and distance, grade and heart rate) on a see-through display in the wearer’s line of sight. The lens serves as the augmented display, and the data itself is see-through. A mapping app enables 2-D, 3-D and birds-eye views of trails and streets. The glasses, which are rumored to hit the market this year, also feature a camera and touchpad for capturing pictures and video.

There is also Himax (HIMX), an emerging VR/AR player that has a market cap of $1.4 billion and pays a 4% dividend. It’s estimated that Himax will generate around 18% of its 2016 revenue from AR and VR-related products, including display solutions that are likely to be used by HTC Vive, Microsoft HoloLens and Oculus Rift. The stock has traded in a range between 6 and 10 since April 2014.

Moving down the market-cap curve brings us to Kopin (KOPN), a floundering stock with a market cap of $118 million and a share price that has slid from 3 in late December 2015 to 1.77 on Friday. The Massachusetts-based company demonstrated its Solos smart eyewear, for use by cyclists, trainers and coaches, at CES 2016, and has been working on its Vista VR microdisplays for VR applications. It also has a binocular display module for use in competitive drone racing (they go over 60 mph!). Projections for average annual revenue growth of around 20% over each of the next two years justifies putting it on your watch list.

I think the real excitement in the AR/VR space will come when the new headsets start to hit the market. That’s when we will get teardown specs and find out who’s supplying what. It’s also when we’ll get consumer reviews of the units, and get a feel for available content.

Expect Oculus’ Rift to start shipping in March. The developer’s version of Microsoft’s HoloLens should be available any day now. Sony’s Playstation VR and the HTC Vive should be available by the end of June. Later in the year, Google’s updated cardboard VR viewer, complete with chips and sensors, should hit the market. And Magic Leap’s CEO just wrote a blog post suggesting they’ll have more information on their headset and platform in the near future.

It’s still early days for this market. But things are heating up, even as the broad market melts down. I expect that when the stock market turns around, investors will be scrambling to figure out which players are poised to win in the virtual reality and augmented reality markets. We’ll do our best here at Cabot to keep you in tune with the trend, and let you know who we think will be the big winners.

Your guide to small-cap onvesting,

Tyler Laundon
Chief Analyst of Cabot Small-Cap Cinfidential


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