Christopher Landers, November 1, 2016
Picture yourself on a beach in Hawaii. Imagine feeling the sun on your skin, that refreshing ocean breeze, and even the taste of that piña colada. This will be the last time you have to simply imagine this because virtual reality is now a virtual reality.
Virtual reality, or VR, is technology that immerses you in a computer generated environment and replicates sights, sounds and other sensations. This technology stands to disrupt over $360 billion in existing industries and will generate an additional $100 billion by 2025.
It has applications in every major industry- education, retail, defense, real estate, construction, etc. Video games will be completely immersive. Every concert ticket sold will be essentially a front row seat. Health care checkups will take place from the comfort of your living room. The applications are literally endless.
Even though the VR industry is still in its infant stage, the numbers are already staggering. It has raked in over $1.2 billion dollars in private capital this year. $1 billion of that was in the first two months, more than the tech industry has ever claimed in an entire year! VR is the future and everyone, including the biggest tech companies, know it and want to get in on it, investing billions of their own capital.
Now don’t go rushing to your AmeriTrade account to buy shares of Apple or Google. The top ten tech companies have invested $4 Billion out of a combined $2.8 TRILLION available capital! That is the equivalent of pennies! We’re talking less than a quarter of 1%. Buying them means you’re buying the rest of their baggage. Whether that is good or bad, it’s barely scratching the surface of VR exposure.
VR requires the use of a headset that is composed of graphics cards, audio processors, display screens, and motion sensors. With that being said, there isn’t a single public company solely dedicated to VR. They all outsource production of key components through other companies.
Investing in private VR companies isn’t a viable option for the normal retail investor. To invest in private companies, you need to be “in the know” and you need to have lots of dough. Not too many of us can write a check with eight figures on it.
So, to capture that direct exposure to VR, you have to dig a little deeper. Through a proprietary selection method and supply chain analysis, I sought to surgically extract the public companies that stand to gain the most from the rise in the VR revolution.
The first is Photronics Inc. Photronics makes photomasks which are the blueprints for circuitry. These are necessary for the production of chips and flat panel displays. They’ve spent the last two years shifting resources to begin producing photomasks for Organic Light Emitting Diode screens (OLED). OLED is the new technology that will completely phase out your standard LCD screens. It provides a clearer picture, sharper colors, and can support Ultra High Definition viewing.
Major device producers like Samsung and Apple have stated that all of their upcoming devices will only have OLED screens. Guess who sits at the tippy top of their supply chain for display and processor production. If you guessed “Photronics,” congratulations. You’ve earned your gold star for the day.
Since the financial crisis, this company has drastically increased its production efficiency and profitability. Their margins have risen to 28% vs. their peers’ 22%. ROE sits at 7% vs. their peers’ 3%. And, across all metrics, they are a steal. Looking forward to revenue and earnings growth near 20% next year, they have a price target of $12.50, meaning they are undervalued by 23%.
The next best VR stock is NXP Semiconductors. NXP makes graphics cards, audio processors, motion sensors, and other components used in VR hardware. This is through their appropriately named “high performance, mixed signal” segment. This company is a must have for a VR index. Their ROE is 25% vs. the industry average of 15%. ROIC sits at 14% vs. their peers’ 9%. Once the demand for VR picks up, revenue and earnings will skyrocket. On top of that, they’re undervalued by a whopping 34%.
Now, I started really looking into this stock in August. My director and I had several long conversations about it. Apparently, Qualcomm was listening in because on September 29th, they made an acquisition offer for NXP. They must’ve agreed with my valuations as well because they only offered a 25% premium, knowing there was plenty more upside potential for NXP. This is very telling in this industry as all of these stocks are potential takeover targets.
Third in line is Technicolor. Even though you may have never heard of this company, I guarantee that you have seen some their work. They are the only vertically integrated content producer that is capable of converting all of existing content into VR. This is the same company that pioneered color pictures in the early 1900’s. They’ve been at the forefront of innovation for over 100 years as trends and technology evolve. Wizard of Oz, Looney Tunes, even the Avengers; those were all Technicolor. They’re continuing this reputation of innovation by introducing VR cable service next year.
Technicolor has completed a massive restructuring after emerging from bankruptcy in 2010.
Its leverage levels have dropped from over 5x in 2009 to 2x in 2015. They plan on dropping to below 1.5x by the end of next year. They have also increased free cash flow since their restructuring by 24% per year. Cash currently sits at €385 million which is more than enough to cover their annual debt amortization of €63 million.
Revenue and profitability has increased as well. The extra cash is being given back to shareholders through dividend raises and share buybacks. With the introduction of all of these new VR headsets, people are going to demand more content. This will lead to revenue growth of 30-40% through the end of next year with earnings more than doubling. This gives them a target price of $9.50, meaning upside potential of 51%!
The last stock I want to talk about is Vuzix Corporation. Vuzix is a headset manufacturer. It derives its revenue through both govt. and non-govt. sales. It has shifted to more enterprise and consumer-level sales since its IPO in 2010 and has extended its reach internationally.
Now, their headsets are not like the bulky Oculus and HTC headsets you’re probably picturing. These are sleek, lightweight, and futuristic headsets. Its products have been met with immense success since hitting the market. Their first product, the M100, was received so well by its enterprise customers that it forced Google’s headset off the market. This is a $120 million company beating out Google, a $500 billion company. Talk about David vs. Goliath!
Vuzix’s products have won over 20 Consumer Electronic Show awards. Their most recent product won the CIE Wearable Device of the Year award earlier this year. They also hold over 40 patents in wearable technology with 23 pending. Now all of this sounds great, but here is the real kicker.
Intel invested nearly $25 million in Vuzix last January. Intel has a reputation for acquiring companies it invests in within 24 months. As you can see with NXP, I seem to have a little knack for picking companies that are going to be acquired. I’m betting this happens by Q1 next year.
So, if you’re reading this, Jim Cramer, that’s MY call of the day.
Even without Intel, the rise of VR will boost Vuzix to the top. Their superior technology and usability differentiates them from even the biggest players in the market (sorry Oculus). Revenue and earnings will likely grow by triple digits. You’ve got to love these small cap tech companies. I’ve set a price target of $10.50 meaning Vuzix is undervalued by 39%!
Now that I’ve lost you with all of the talk of ROE, acquisitions, and fair values, let me bring you back to reality. This index recommendation is the culmination of over 200 hours of work. I can count on one hand how many times I’ve left school before midnight this semester.
I know VR isn’t an established industry YET, which is why we need to get into NOW. There is not a single industry VR technology cannot and will not disrupt.
This is why I recommend that the Roland George Investments Program invest $70,000 in these VR companies.
Ultimately, though, it’s your call.