How To Think About Recent Volatility in Tech

Market decline does not change the mega growth opportunities. The heart rate of the market increased the past week because of fears of a trade war, Facebook data privacy, and broken market technicals, but the health of the market is unchanged and the health is good. Core underlying tech trends including artificial intelligence, robotics, big data, and autonomous transportation, will support continued growth.

Hold tech for the long-term. We believe that tech is essentially taking over the rest of the economy; therefore, investors should hold tech long term. Just as every company is now an internet company to some degree, we believe that eventually every company will be an AI company.

Market undervalued. From a valuation perspective, our view is undervalued. The market has rallied back to the old highs, but the S&P is up only 3% per year over the past 17 years, compared to the previous 17 years (1983-2000) when it was up 17% per year.

Putting the size of tech into perspective. The tech sector’s growing clout is not just a U.S. story. Tech stocks have become so dominant in emerging markets that for the first time since 2004, the industry last year overtook finance as the biggest sector in the MSCI Emerging Markets Index. Tech had a 28% weighting near the end of 2017, more than double its level six years ago, according to data provided by MSCI. Facebook, Amazon, Netflix Inc. and Alphabet together account for a 7.8% weighting in the S&P 500, more than double from five years ago.

Company Updates:

Tesla. We remain positive on TSLA. Shares are down 20% in the past month mostly due to fears of another miss in Model 3 production. The recent stock dive is due to a combination of a Model X accident that is being investigated, Waymo’s partnership with Jaguar, which legitimizes a key competitor (the I-Pace electric SUV), growing concern among all companies testing self-driving vehicles amid the Uber fatality, and news that Moody’s has downgraded Tesla’s bonds to B3 from B2, citing significant shortfall in the Model 3 production rate and a tight financial situation. We continue to believe the Tesla story has the best risk-reward among tech companies over the next 5 years.

  • Model 3 production. We’re expecting another miss in Model 3 production in the March quarter but that does not change the story. There is more demand than supply for the Model 3 (about 400k preorders which is unheard of in automotive). It might take a year, but eventually, Tesla will get the Model 3 production right, and ramp output.
  • Model X accident. We see the recent Model X accident the same as accidents with gas cars. It is unlikely that the battery or Tesla’s advanced cruise control “autopilot” were to blame. Tesla disclosed that the autopilot feature properly functions 200 times a day on the same stretch of road where the accident happened.

Facebook. Limited upside to FB. Given the privacy issues, for the first-time advertisers have to think about Facebook as a liability. Separately, it’s unclear about how the recent privacy changes will impact Facebook’s ability to make money.

Nvidia. We remain positive on NVDA. Shares of NVDA dropped 11% in the past week following the announcement that they temporarily stopped autonomous testing, and in part because of the broader market sell off. While the company did not comment on timing, we expect testing to resume in the next 3 months. The big picture is the company is well positioned to capitalize on four mega trends, AI, autonomous cars, gaming, and blockchain through their dominance of GPU processors.

Apple. We remain positive on AAPL. Concern is emerging that iPhone demand in June will fall below Street expectations. We think iPhone demand over the next two quarters is not important to the story. What’s important is the share buyback, services, and the next iPhone.

  • Share buyback. Apple can add 4% per year to the stock price (assuming they use $40B of the $55B they generate in cash each year to buy back stock). Apple will give an update on the share buyback when they report the March quarter, likely late in April.
  • Bigger screen iPhone this fall. We expect Apple will announce a 25% bigger phone in the fall. This will be a positive for unit demand and average selling price.
  • Services. Services account for about 15% of revenue and are growing at 15-20% year over year. We believe this segment will continue to grow at a 15% or better rate over the next five years. This is important because the earnings multiple on shares of AAPL will likely increase as investors view the predictability of services are more attractive.

Google. We remain positive on GOOG. We expect the next six months to be rough for shares of GOOG as questions emerge about how the company uses data. Despite that negative potential, Google is too tightly woven into the fabric of the internet. The company is one of the best ways to invest in AI, given the company has a stated their intention to move from a mobile-first company to an AI-first company over the next several years. Lastly, the company has a stake in Waymo, the leading autonomous car company. We expect years of positive news to come from Waymo.

Amazon. We remain positive on AMZN. The company is best positioned for the future of retail. We see that future as a combination of both online and offline retail. Online sales account for about 15% of global retail, and in the future, we believe it will eventually reach 55% of sales. We also expect Amazon to do more with physical retail locations and we continue to believe the company will eventually acquire Target (TGT). The company’s AWS web hosting business is only 15% of revenue, but it is growing at greater than 30% for the next several years.

Twitter. Limited upside to TWTR. About 14% of Twitters 2017 revenue came from selling data, growing at 18% y/y, compared to Twitter’s ad business that declined by 6%. Selling private data is a toxic label, and this could limit the upside to shares over the next year.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make. 

3 Analyst Day Takeaways on Why iRobot Will Lead for Years to Come

Following iRobot’s Analyst Day, 3 themes stood out that confirm iRobot will remain one of the leading consumer robotic companies in the world for years to come. They include extremely low household penetration rates domestically and internationally, iRobot’s multi-million unit install base, and the company’s ability to scale the technology into many other consumer robotic categories.

We have barely scratched the surface. iRobot estimates only 10% of U.S. households own a robotic vacuum cleaner, and outside the U.S., penetration rates are estimated to be considerably lower (~2-3%). However, robotic vacuum sales have been growing at a 22% CAGR since 2012, and we anticipate 20%+ growth to continue in this category through 2020 as more households adopt this technology for the first time. We believe the biggest driver to growing adoption is increasing customer awareness through increased marketing spend. Despite Wall Street criticism around the company’s initiatives to increase marketing spend, we believe devoting extra resources to sales and marketing will drive incremental revenues and profit in the long term. As displayed in the chart below, iRobot believes the immediate addressable market is 2x their current install base, and looking out further, the company believes they have barely scratched the surface.

Source: iRobot 2018 Investor Day Presentation

Growing install base an undervalued robotics asset. The company highlighted their U.S. install base is over 13M units. We view this large and growing install base as a very underappreciated asset. As a Roomba is helping the consumer clean, it is also benefiting iRobot by gathering large data sets on how the robot interacts with the world. iRobot can then use the data to train their proprietary AI algorithms and improve their robots functionality. This is akin to a self-driving car testing on public roads. iRobot’s CEO, Colin Angle, said the biggest challenge any robot has to overcome is interrupting the world. By having access to millions of robots across the world, we believe the company will continue to build the highest performing robots on the market.

iRobot is much more than a vacuum company. iRobot’s mission is to drive robot adoption among the consumer. Today, that primarily consists of Roombas and Braavs, but we believe the company is capable of scaling this technology across many types of other domestic robot categories like lawn mowers, security systems, etc. Given the many years of robotics expertise, as well as the proprietary data iRobot has access too, we expect the company to begin to enter new robotic categories in the coming years. While iRobot’s Management team did not give too much information on the company’s new product launches in 2H18, they did hint that the company could soon be expanding outside of robotic vacuums and mops.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Key Questions on the Evolving Future of Transportation

Advancements in self-driving car technology will eventually result in full-scale autonomous transportation. Considering the level of investment from deep-pocketed tech and auto companies and the caliber of human capital that accompanies it, the space has become “too big to fail.” This note explores three key questions we’re working through as we consider the autonomous future:

  • What will an automaker of the future look like?
  • What will the future of transportation look like for consumers?
  • Who is going to win in the future of transportation?

What will an automaker of the future look like?

In order for an automaker to succeed in the transition to autonomy, we see three core competencies: manufacturing capability, autonomous systems, and services.

Manufacturing Technology

Despite all the work going into and the hype around autonomous systems, expertise in manufacturing cars can’t be overlooked. We’ve seen the challenges Tesla has had scaling their production. Technology companies are at a significant deficit here and will likely rely on partnerships with traditional auto to bring a product to market.

Tesla is trying to solve the manufacturing problem on its own. Elon Musk said, “The biggest epiphany I’ve had this year is that what really matters is the machine that builds the machine, the factory, and that this is at least two orders of magnitude harder than the vehicle itself.”

To tackle this problem, Tesla has made acquisitions in the manufacturing space and has chosen to develop software and sensors in-house. We’ve written a lot about Tesla’s efforts (and shortfalls) in manufacturing the Model 3 at scale. We think they’ll get there.

Autonomous Systems

Software is the brains behind autonomous vehicles. This is both the most complex element and where the true value lies in autonomy. The winner in this space will have a good chance at owning the operating system of the car.

A few notable investments in this space: GM’s acquisition of Cruise, Ford’s investment in Argo AI, and Delphi’s acquisition of NuTonomy. Autonomous software investments are typically the largest in the space. We expect this trend to continue as traditional automakers, who already possess manufacturing skill, attempt to acquire or partner with the tech that will keep them relevant as the industry transitions.

Sensors are the eyes and ears of autonomous vehicles. We break the sensor category into LiDAR, radar, and cameras. Most autonomous solutions today require all three, but Tesla thinks it can reach full autonomy without LiDAR.

Many auto manufacturers and tech companies have made hardware acquisitions. Above and below are some of the investments that major auto companies have made in autonomous software and sensor companies:

Services

A significant part of current automakers’ revenue comes from servicing and maintaining the vehicles they have sold. As EV and autonomy play out, and ride-hailing fleets reduce car ownership, these service revenues will need to be replaced by software services. Down the road, connected cars will resemble a platform much like a mobile device. Owning the operating system and/or providing software services through that OS could more than make up for lost maintenance revenue.

One of these services could be in-car entertainment. With steering wheels, and eventually the need for driver attention, going away, the interior of a car will look much different. Seating arrangements and space will not resemble the current layout, but more importantly, we’ll be free to spend our time differently while in transit.

Tech companies will all be vying for the opportunity to provide in-car entertainment to consumers. Similar to smartphones today, there will be those that own the operating system (Apple, Google) and those that build on top of it to deliver content (Netflix, Snapchat). Outside of these opportunities, companies will also leverage the connected car platform to deliver targeted advertisements to riders. Imagine being prompted with a coupon for Starbucks while on your way to work. Companies will be able to target individuals with location-based advertisements much easier than through smartphones.

What will the future of transportation look like for consumers?

There are three themes that will impact what the future of auto will look like for consumers. We’ve written in-depth about these topics here: Auto Outlook and Detroit Auto Show.

Electric Vehicles will be prevalent. Electric vehicles currently account for ~1% of all vehicles today, but will reach 35% by 2030. As battery technology improves, range anxiety decreases for consumers. We’ve also learned that EVs can be fast.

Cars will drive themselves. Today, 99.9% of all vehicles have little to no automation. By 2040, 90% of vehicles sold will have Level 4 or 5 autonomy. Our transportation experience won’t change dramatically until autonomy becomes more prevalent.

Car ownership will decrease, giving way to more ride-hailing. Today, the current household has an average of 2.0 cars. We think that over the next 15-years, this number could go down to 1.25 cars per household and, longer-term, decrease even further. While some individuals may not like the idea of giving up ownership of a vehicle, there are plenty of benefits. For starters, people would not have to pay car insurance, worry about maintenance, store a vehicle, or for those of us in less favorable climates, scrape windows in the winter, or worry about parking during a snow emergency.

As ride-hailing networks become more reliable with autonomous vehicles, more people will be willing to decrease or give up household ownership of vehicles. Traditional auto and tech companies are making large bets on it, as outlined above and below:

Who is going to win in the future of transportation?

If the connected car is a platform like the smartphone, who will be the Apples and Googles of transportation? Waymo, Uber, and Tesla are early candidates for winning the operating system of the car, with each taking their own unique approach. Waymo has focused on building autonomous systems first and will seek to launch or partner with a ride-hailing network second. Uber has built a ride-hailing network first and is now racing to catch up in autonomy. Each will seek to partner with existing car manufacturers for producing vehicles. Tesla decided to manufacture vehicles first and is narrowing in on autonomy second; believing that a ride-hailing network is the last hurdle that needs to take place.

There are plenty of other entrants that could compete in this space including OEMs, who have invested large amounts in autonomy and certainly have the manufacturing scale component already solved, as well as a host of tech companies that could provide autonomous systems or software services to manufacturers. The bottom line is that the value chain in the transportation industry is being disrupted, and the massive opportunity to capture value in an industry transition will create a number of new winners.

At this point, it’s clear that one winner will be the consumer. With access to more ubiquitous, clean, and affordable transportation without the burden of car ownership, mobility will be more accessible than ever.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

iRobot’s Earnings Disappointment Doesn’t Change Long-Term Story

Heading into the Q4 print we were confident iRobot would report better-than-expected revenues and guide 2018 sales above street expectations (see note here), which they did, but we incorrectly judged the magnitude lower EPS could have on the stock. Shares of iRobot finished down 30% due to investors concerns with decelerating revenue growth and lower-than-expected profitability. That said, with the revenue outlook being inline with our expectations and the lower earnings forecast being largely attributed to increased marketing and R&D spend (and not price erosion), we remain believers in the long-term iRobot story. Following iRobot’s results our two key takeaways are 1) the domestic robot market is and will remain one of the fastest growing robotic markets over the next 3 years and 2) iRobot will continue to lead the wave of home robot adoption.

20% Growth Through 2020. In addition to providing 2018 guidance that implies 20% year/year revenue growth, iRobot expects this type of growth to continue through 2020. Although investors view 20% growth as a deceleration over prior years, we view this forecast as in-line to our estimates and higher than most longer-term consensus models. Given Management’s history of providing conservative guidance, we think there is room for these numbers to go higher as we make our way throughout the year. Demand will be driven by increased Roomba and Braava sales from both domestic and international homes.

iRobot Leading Domestic Robot Wave. The company announced they will be rolling out a slate of new products in 2H18, which is expected to account for 25% of total sales. While the company did not give much detail on these new products, we anticipate they will enhance both the Roomba and Braava product portfolios. The company continues to heavily invest in R&D, and we believe the company will soon expand their core presence outside of vacuums and wet-floor products.

Link to model here.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Expect iRobot to Have Cleaned Up During Holiday Season

iRobot is the leading manufacturer of robotic vacuums and wet floor products in the world. Based on holiday pricing trends we believe the company sold more robots than expected in the Dec-17 quarter. In addition, we believe the domestic robot market is one of the fastest growing robotic segments, and given iRobot’s positioning and premium tech, we expect the company to sustain 20%+ revenue growth in 2018. While increased competition has been a growing threat to iRobot’s market share in recent quarters we believe these threats are overblown and believe the company is in position to outperform current expectations over the next year.

Strong Pricing Trends Across Entire Portfolio. Over the last 3 years, we have tracked iRobot pricing across the company’s 4 larger US distributors (Best Buy, Amazon, Bed Bath & Beyond and Target) on every Friday in the quarter. While pricing is not a perfect indicator to demand trends, price discounting has historically had a solid correlation to iRobot’s quarterly results. As displayed in the chart below, the company experienced on average higher pricing across all products we track (Roomba 980, Roomba 960, Braava 380T and Braava Jet) in the Dec-17 quarter than they did in the Dec-16 quarter. We find this encouraging because we felt pricing last holiday season was strong, which translated into the company beating Dec-16 Street revenue expectations by ~$6M (or 3%), and EPS by $0.08 (or 20%). Given these strong pricing data points, coupled with Management’s history of providing conservative guidance we expect the company to once again exceed Dec-17 Street estimates.

While pricing remained similar Y/Y at Best Buy, Bed Bath & Beyond, and Target in Dec-17 quarter, we would like to highlight prices on Amazon increased over regular retail price regularly throughout the quarter. Given Amazon’s pricing strategy is based more on supply and demand trends, we believe above regular retail pricing late in the Dec-17 quarter is the strongest sign of demand.

Expect Solid 2018 Guidance, but Likely Conservative Although we expect iRobot to beat Dec-17 Street estimates, the key number investors will focus on is how the company guides for 2018. Despite concerns about increased competition, the domestic robot market is inflecting, and given the most penetrated robotics vacuum market in the world (the U.S.) is less than 10%, we believe there is plenty of room to run both domestically and internationally. The Street is currently expecting iRobot to guide 2018 revenues to ~$1.0B, which implies ~16% Y/Y growth. iRobot has experienced 3 consecutive quarters of 20%+ growth and is on pace to grow over 30% in CY17. In addition, we anticipate the robotic vacuum market to grow 26% Y/Y in 2018. (Link to domestic macro model here.) Given the current market dynamics and iRobot’s market positioning, we believe Street numbers are conservative. However, given Management’s history of consistently beating expectations, we wouldn’t be surprised if the company guides in-line to modestly above consensus, but expect multiple beat and raise quarters throughout the year.

Robot Lawnmower Positive 2018 Catalyst. While iRobot continues to not provide any color on when they will release a lawnmower, we continue to believe it is likely they will introduce a robot lawnmower in 2018. However, most importantly this a “when” not an “if”, they will introduce a robotic lawnmower. We’re modeling for the lawn mower to launch in Mar-18 (and account for 5% of revenue in the Jun-18 quarter) and account for 8% of 2020 revenue. The Street is not modeling the lawn mower.

Model Adjustments. Given the expectation for better than expected demand in the Dec-17 quarter, we are raising our revenue estimates to the high-end of the company’s 2017 guidance ($870 – 880M vs cons $875M). We are leaving our 2018 estimates largely unchanged, but would like to note our current estimates of $1.1B are above consensus ($1.0B) due to our model factoring in ~$60M in lawnmower revenue. Assuming the lawnmower gets pushed out till 2019, we still believe iRobot can grow ~23% Y/Y. Link to model here.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.