I covered the first virtual reality pick hyped by Ray Blanco a few weeks ago, but I forgot to follow up and dig into the second and third picks he was teasing in that ad… so when I saw a new version of the ad circulating over the weekend, with the attention-getting “hook” changed from “Dinner with Shakespeare” and “Explore King Tut’s tomb” to the more prosaic (and perhaps more profitable) “Virtual Reality Pornography”, well, my memory was sparked and I dug back into the meat of the ad.
So… some more solutions for you today as we look at the continuing push to make you believe that virtual reality will be the next bit thing… and that there are a select few (top secret, naturally) companies who will profit the most from this next technological revolution.
Here’s how Ray Blanco pitches his second stock idea in the ad:
“The second virtual reality company I want you to know about today has best in class motion sensing technology that helps make moving through a virtual space smooth and lifelike.
“If experiencing virtual reality was like watching a DVD that kept skipping, for example, no one would ever use virtual reality a second time.
“That’s why Samsung and Facebook simply must rely on the first company I told you about for visual content rendering, and this second company for gyroscopic motion sensing.
“This company, based in California, is the leader in what’s called “sensor on a chip” technology – small, lightweight, powerful sensors that can pick up motion, images, and sound.
“Deloitte ranked this company as one of the fastest growing computing companies in the country…
“And Investor’s Business Daily reported in September that if you tear apart an iPhone 6s, you’ll find guts from this company.
“Right now, shares of this company trade for less than $14.00 each. That could be a distant memory when the virtual reality rocket really takes off in the weeks ahead.”Are you getting our free Daily Update
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So… who’s that? Here we’re almost certainly being told to buy Invensense (INVN), which is indeed an analog chip company specializing in “sensor on a chip” designs that combine things like gyroscopes and accelerometers to provide position and movement awareness. They also make other analog chips for helping small devices understand the physical world, like microphones, but it’s their 6-way and 8-way sensor chips that get most of the attention and are their leading products.
And so far, that hasn’t been enough to really make them stand out. They have gotten designed into the latest versions of the iPhone, but there’s not much certainty that they’re the sole supplier for iPhone sensors of that kind… and from what I can tell, their products are not differentiated enough that they can charge higher prices than folks like Bosch, STMicroelectronics (STM), NXP (NXPI) or the many other companies who make the “MEMS” and sensor chips that help mobile devices track motion.
I’ve suggested Invensense in the past, when it was beaten down because of the lull between their profits from selling Nintendo Wii controller chips and the expected boost from wearables and mobile phones that were going to increase sensor demand, and sold out to take profits after a little while… but Invensense has also been a cautionary tale about the semiconductor business. Their big victory in building on their sales to Samsung by getting designed into the iPhone 6 was short-lived in 2014, because even though it generated huge volume increases it became increasingly clear that Apple and Samsung were using their huge purchasing power to drive down prices, which, of course, drove down INVN’s margins and profits relative to what investors had been expecting. That’s largely why the stock was indeed at $14 last year, and was over $20 back in 2014 when they “won” some of that Apple business, and is now down to around $8… partly because Invensense didn’t “win” a slot in the Apple Watch, and because it’s not in the latest Samsung phone, either.
Technology in general is a hard sector in which to maintain dominance, because change can take away the advantages of even a large and powerful company quite quickly, but the semiconductor segment is perhaps the toughest neighborhood in a tough city — chip companies rarely have any brand power with consumers (which is why Intel worked so hard to promote their monopoly with Microsoft, and to turn themselves into a brand with their “Intel Inside” marketing), and they’re expected to both dramatically improve their products and slash their prices each year. And it is not necessarily easy for even those who work in the field to determine who has the “lead” in developing new technologies.
So yes, Invensense does indeed make sensors that are likely to be among those selected from when designers are putting together new virtual reality headsets — but virtual reality headsets also share a lot of their technology with high-end mobile phones (some of the cheaper VR solutions are just headsets into which you slip your smartphone, with the phone providing the display and the computing power). It bears repeating that lots of companies make these sensors, and I don’t know how “mission critical” it might be that some of them might be 5% better than competitors (or whatever) or have a slight lead in new generations of better/faster/stronger/smaller/more efficient iterations, as Invensense has sometimes seemed to. The Oculus Rift developers kit a couple years ago, for example, had an Invensense 6-axis sensor… but according to teardown reports I’ve seen, the new Oculus Rift that was released last month (the consumer version) has a Bosch 6-axis sensor. Google Glass had an Invensense inertia sensor as well. Probably neither of those sensors were uniquely designed for virtual reality purposes, and from what I’ve seen the competition among chip designers is not over whether the motion sensors work more seamlessly — it’s about how much power they use and how big they are, and the differences are small.
These sensors are relatively inexpensive, no one company owns the market or owns the capability to sense movement in six directions (up, down, left, right, front, back) or eight axes or nine (not sure what they’re adding with those), and though innovation obviously happens every day they are, at heart, the same basic sensors that are used in phones and all manner of other devices, including wearables that have to track movement and video game controllers and whatever else. Which is a long way of saying that selling a few million high-end virtual reality headsets this year is not going to drive the market, nor will selling 200 million headsets in a few years if the market gets dramatically larger… not when 6-axis sensors are in most smartphones. There are more than a billion smartphones sold every year, unless there’s something unique about virtual reality motion sensor chips, and some company invents a chip that’s so much stronger that they can charge twice as much for it and still get designed into every headset, it’s going to be the phone market and the wearables market that drives volume up and prices down for leading producers like Invensense, STMicro and Bosch.
Sound like I’m being a bit of a downer? That’s OK… I might be wrong, but I am skeptical that virtual reality will be a large enough business to create any huge winners in the chip space — which doesn’t mean Invensense (INVN) will be a bad investment, it just means that I don’t think the “hot” virtual reality story is going to provide enough revenue growth in the near future to rescue them from the two years of rapidly falling profit margins. I’d suggest, if you are interested in Invensense, that you make yourself enough of an expert on the industry that you can convince yourself that their products will be innovative or different enough to take market share from STM or Bosch without eroding their profit margins still further.
I have no such expertise, and the stock is not cheap based on current expectations (analysts think revenues will fall next year, and that the adjusted earnings will come in in the mid-40 cent range this year and next, which means the stock has a PE of about 18). They’re not necessarily in trouble, they have plenty of cash and they don’t lose much money in their bad quarters, but I’d probably have to know the inner workings of the company and the industry much better to see some specific reason for huge optimism because of virtual reality or anything else — and with the competition looking plenty strong and change continuing to happen at a rapid pace, I don’t see such a reason in their filings or their financials.
I’d guess that any real reason for optimism would have to be a design “win” (and after that, huge consumer demand) in some very small device like Google Glass, where an advantage of even a few percent in size or power consumption could establish at least a temporary competitive edge because of the weight challenge — but that’s just a guess, I don’t know if Invensense really has a technological advantage today and I’m skeptical that those kinds of high-end wearables will be real chip stories in the next year or two. I don’t think the volume in virtual reality will be big enough to drive profits for semiconductor companies in the near future.
What next? Blanco does have a third virtual reality company to hint at for us…
“Similarly, the third company I want you to know about today is the leader in what are known as ‘stacked 3D circuits.’ That’s a tech-lingo way of saying circuits that can do a lot in a little space.
“Also based in California, this company makes nano-precise, super-powerful circuits used in defense, medical, high-tech research, and advanced computing applications.
“It’s also poised to become a go-to solution for growing virtual reality companies that need reliable, top-shelf components to guarantee that the first time a customer comes in contact with their virtual reality device, they love it.
“Samsung and Facebook know just how important these ‘first experiences’ are with their virtual reality devices. That’s why they’re not leaving anything to chance.
“Barron’s, for example, wrote in October that three companies are key to Samsung’s future circuit needs… and this third company was the first one mentioned.
“In a nutshell, what you need to know about the three companies I’ve mentioned is that they’re the hidden suppliers of what’s going to make virtual reality take flight.
“While most of the crowd will buy Samsung, Facebook, and the other companies we’ve discussed, you could buy these three companies and make bigger gains as the rest of the mainstream catches on.”
This one, I think, is very likely even further removed from the direct influence of virtual reality — the Thinkolator says that Blanco is very likely talking here about Lam Research (LRCX), which is a semiconductor fabrication equipment company. Lam is in the process of acquiring KLA-Tencor (KLAC), a deal that has gotten through most of the necessary approvals and will probably close over the next couple months, so the company is close to doubling in size and becoming more diversified in terms of the products and services they provide to chipmakers (both firms have market caps a bit over $10 billion).
Lam Research doesn’t really make circuits… but their equipment does, and they sell that equipment to folks like Intel or NXP. So it’s an odd selection, but it could make sense in some ways — if you think that chipmakers are going to continue to push the envelope in order to provide a more seamless virtual reality experience (faster chips, faster memory, more robust graphics, etc.), then those chipmakers will need more and more advanced equipment, which will benefit Lam… as well as Applied Materials (AMAT) and all the other providers in that sector.
Why is this the match? Well, Samsung’s reliance on other folks for chips is becoming more limited, given their continuing push to make more of their own chips, but they do rely on equipment providers as they continue to ramp up new chip designs and capacity — and Barron’s did indeed publish an analyst note stating that Lam was the first of three likely beneficiaries of Samsung’s increased capital spending in the memory chip business last year. I should note that at the time (this was about six months ago now) the suggestion was that this was a short-term move, as the big push for new memory chip capabilities was pushing some expected 2016 CapEx into 2015… which, of course, could mean that expectations for 2016 might be moderated.
And Lam says it’s a leader in providing equipment and process technologies for stacked 3D circuits, though I don’t know if they are genuinely a “clear leader” or not. 3D NAND memory is a big push for large memory chip makers like Micron (MU) and Samsung, and Lam has been releasing new equipment over the past couple years that enables better process control in that fabrication process. I don’t know whether their process control equipment is unique, or is better than their competitors.
Analysts have Lam penciled in for pretty strong earnings growth over the next year or so — they are currently wrapping up their fiscal year (ends in June) with what’s expected to be roughly 20% earnings growth over the previous year, and analysts are predicting that they’ll grow earnings per share by another 10% or so in FY 2017, which would give them earnings of close to $7 a share and a PE of about 11. That seems abundantly reasonable for a large and growing chip equipment company, though I imagine the KLAC acquisition will bring some potential volatility to results as the integrate things next year. JP Morgan analysts also call out Lam as their favorite pick in that sector, and they’re looking for the stock to reach $95 by the end of December — which would be close to a 20% return from the current $80 share price.
So… sure, I have nothing against Lam Research. I don’t think their success or failure has anything meaningfully to do with the rise of virtual reality, specifically, but that doesn’t mean it’s a bad stock. As chipmakers continue to innovate and develop new technologies, equipment makers will do well — handicapping the prospects for a firm like LRCX is much more about analyzing what the capital expenditures will be for big chipmakers like Intel, Taiwan Semi, Broadcom, NXP, etc. than it is about predicting the next hot trends in technology. Competition among chipmakers is good for semiconductor equipment makers, so I suppose you might argue that virtual reality is the tip of the spear in pushing more advanced chip technologies and forcing the chipmakers to invest in better equipment… but that’s quite a stretch. Lam is reasonably priced, and cyclical, and driven by the investment cycle in chipmakers, and it might be a fine investment… but it’s not going to double in six months because your children or grandchildren all want Oculus Rifts.
Which brings us to our close for today, dear friends — I’m obviously not an expert on these technologies, but I’m quite certain that Blanco is hinting at Lam Research and Invensense to close out his Virtual Reality pitch (the first pick, covered earlier, was NVIDIA (NVDA)). If you know more about Lam, Invesnsense, Nvidia or anything else in this segment, feel free to shout out and share your wisdom with a comment below.
Disclosure: I own long-dated call options on NVIDIA, and am long call options and/or shares of Alphabet/Google, Facebook and Apple. I don’t own any other stocks mentioned above, and won’t trade any stocks covered for at least three days per Stock Gumshoe’s trading rules.
P.S. The list of virtual reality teaser pitches is getting long — NVIDIA has been touted more than other stocks, getting the attention of Ray Blanco, Michael Robinson, and the Motley Fool, but we’ve also seen Jason Stutman pitch HiMax, Louis Basenese hint at Kopin and Spectra7, and you can almost feel the desperate urge of investing pundits everywhere to find the next hot (or, at least, unique) virtual reality stock pick. With most of the consumer attention drawn to virtual reality projects from massive corporations like Facebook and Samsung and Sony, and with virtual reality dependent on technology that’s very similar to that in high-end mobile phones, and so far lacking any “killer app” or mass-hit game, we lack that small cap “name” that could be the huge breakout performer because of VR… to me, it still seems like most of the virtual reality recommendations use logic that’s a bit stretched.