Real Returns For Virtual Reality Index



What is VR?

Virtual reality refers to computer technologies that use hardware and software to generate realistic images, sounds and other sensations that replicate a real environment. It simulates the user’s physical presence in this environment. The idea of virtual reality dates back to the early 1800’s. Artists would attempt to paint 360-degree murals to give the viewer the feeling of actually being present in the scene depicted. The modern idea of VR came about in the 1930’s with “Pygmalion’s Spectacles,” a pair of goggles that would immerse the wearer in a fictional world and would replicate sights, smells, feelings, and tastes. Major advancements in mobile devices, computing power, and display technology have enabled VR to become a reality.

Industry: Virtual reality has started to penetrate a wide variety of industries. As a result, several industry, research, and consulting firms have started tracking the economic impact of this technology. Some are less conservative than others, but the general consensus is that the VR industry will have its first $1 billion year in 2017. The majority of sales this year will be from hardware. This is a promising sign as more hardware sales will result in a larger available market for VR content. By 2025, the industry will generate over $100 billion.

Investment Rationale

Disruptive Industry: Starting by simulating sight and sound, VR is moving towards replicating taste, touch, and smell. One sense at a time, VR technology revolutionizes human perception of a real environment without physically being there. Now, thousands of years of human sensory evolution is set to be forged through computers anytime, anywhere. There is no part of peoples’ lives that VR cannot and will not infiltrate. Virtual reality is a virtual reality. Early Entry: As revolutionary as this may sound, VR is still in its infant stage. However, the sky is the limit for the industry which will generate over $100 billion by 2025. In the first two months of 2016 alone, the VR industry raked in over $1 billion in private equity. Though this is more than the tech industry has ever secured in an entire year, they haven’t even scratched the surface. There are 10 major public companies trying to get into the VR space, investing $3.5 billion so far. We want to be part of that $3.5 billion out of the $100 billion market potential right now.

Proprietary VR Index: Of the combined $2.5 trillion market cap of the public companies looking into this technology, less than a quarter of 1% is directly exposed to VR. That being said, there are no public companies completely devoted to producing VR products. The big name companies outsource production of software and hardware. This is precisely why we are here. We seek to surgically extract the companies who stand to benefit the most from the coming VR revolution. These companies will form the first ever index that is solely dedicated to VR that will, in turn, profit the most.

Takeover Targets: The initial idea for this index came about in August, at the beginning of the semester. I filtered through the entire U.S. stock universe and selected the four that were best positioned to profit from the VR revolution. The final decision was made on September 19, 2016. On September 29, ten days after selecting my stocks, Qualcomm Inc. announced that they were negotiating a deal to acquire NXP Semiconductors. The stock shot up nearly 25% that day. This is very foretelling. The semiconductor industry has been going through a massive consolidation process over the past few years. My stocks were selected because of the products they make. An added bonus to this is that the differentiability, sophistication, and effectiveness of their products make them all prime targets for acquisition, which is a shareholder’s dream come true.

Industry Growth Drivers

Gaming: The gaming industry was the first to embrace VR with open arms and, therefore, will be the main driver. The U.S. has nearly 200 million active video game players. Four out of five American households own some form of video game platform. Globally, there are over 1 billion people playing video games, almost half of the global online presence. The average player is over the age of 35, meaning they have an established lifestyle and steady income stream. Most of the initial growth will be driven by core gamers, with casual gamers to follow in 2017. Steam, the largest online gaming network in the world, reports that over 95,000 users are playing games that require VR HMDs, up from less than 10,000 in 2015. Gaming software revenue already brings in over $20 billion a year. VR games and hardware are projected to add $12 billion to that and overtake sales of standard games by 2020.

Mobile Devices: There are currently over 4 billion smartphones and tablets in the world. The average user spends 3 hours per day on their device, 2.6 hours of which involve mobile apps. As over 80% of adults own a smartphone and 50% own a tablet, the groundwork in this enormous market has already been laid for VR to run rampant in. The cheaper HMDs compatible with smartphones and tablets will drive adoption at the consumer level. As economies of scale are established, prices will come down and further drive demand and adoption. This will lead to the development of more VR content and application. The majority of VR content and software revenue will be generated through multimedia and live event streaming, an industry that generates $7 billion per year. Live sporting events draw in over 1 billion viewers each year. As a base case scenario, if only 10% of those viewers adopt VR viewing at $50 per event, that would equate to $5 billion in revenue per year.

Healthcare: Healthcare applications will be the main driver for VR technology at the enterprise level. There are over 8 million physicians and first responders who will use VR for both direct and robot-assisted surgery, data visualization, 2D/3D/4D image modeling, rehabilitation/therapy, and education and training. VR applications have risen from $450 million in 2005 to just under $1 billion in 2015, a CAGR of approximately 10%. With a current patient monitoring market of over $16 billion, VR has plenty of room to grow. I project VR in the healthcare industry will generate over $10 billion by 2020, a CAGR of 77%, with the majority of revenue coming from specialized software. The growth will take off once hardware is refined and becomes HIPAA compliant.

Military: There are 7 million military personnel in member states of NATO that will benefit from VR-based training platforms. The defense industry spends $9 billion per year on simulation and training platforms. Training through VR platforms allows a multitude of situations to be repeatedly simulated at substantially lower costs without putting service members in unnecessary danger. The Air Force has presented a plan to incorporate VR in pilot qualification and training programs to save over $400 million per year. As a result, the Pentagon has increased its annual simulation and training budget through 2022. The average contract ranges from $6.36 to $6.74 billion. The military is also using VR to treat service members suffering from post-traumatic stress disorder. VRspecific spending for treatment has increased from $10 million in 2000 to $60 million in 2015.


Education: VR companies will provide schools and districts with education platforms based on a subscription and licensing business model. The education software market currently sits at $5 billion for grades K-12 and $7 billion for postsecondary education. Despite rhetoric and action concerning U.S. Dept. of Education budget cuts, appropriation percentage of the budget has increased every year by an average of 80% since 2011. In 2015, 10 primary and secondary schools received grants to begin testing VR software. These schools were able to incorporate 25% to 50% of their content into the VR platforms. The Department of Education expanded this grant in 2016 to 40 schools, this time including post-secondary schools, to test their efficiency. As VR hardware is adopted at the consumer level, educational use of VR will begin to increase at the same rate, affording students the ability to complete assignments using the same platforms they do at school.

Business Description: NXP Semiconductors makes microchips used in VR products. Their hardware products include central processing unit chips, graphics processing units, motion sensors, power management systems, audio processors, touch screens, and WIFI chips for companies that make VR compatible hardware, such as head-mounted displays (HMDs), smartphones, tablets, and PCs. They also produce software development kits (SDKs) which enable content producers to develop their own VR software and applications.

Revenue Breakdown: NXP generates revenue through three segments: high performance mixed signal products, standard products, and corporate and other. Their high performance, mixed signal represents 79% of their revenue and can be broken down into eight application areas: automotive, mobile, consumer, computing, wireless, lighting, industrial, and identification. Their standard products segment accounts for 20% and the corporate segment accounts for 1% of their revenue. In June, NXP announced that it will divest its standard product segments to a consortium of financial institutions for $2.75 billion. This segment generated $1.2 billion in revenue in 2015. The planned divestiture will enable NXP to focus on its high performance mixed signal segment. The deal includes the standard products segment’s management team, 11,000 employees, and seven manufacturing facilities, lowering operating expenses by over $300 million annually. The deal is expected to close in the first quarter of 2017.


Products: NXP offers a multitude of VR-based products through their HPMS segment. Their newest product, the i.MX 8 Series processor is program-ready for virtualization, 3D graphics, and 4K and Ultra HD video. These chips are based off of the ARM family of processors, meaning they are smaller, more efficient, and more powerful than their predecessors. They are capable of performing millions of instructions per second and require less power to operate, making them ideal for the complex processes involved with PCs, smartphones, and wearables. Their MMA955xL intelligent motion sensors are capable of programming sensations of freefall, tilt, 3D orientation, vibrations, sudden acceleration and deceleration, and shocks. These come ready to be integrated into existing mobile and stationary gaming platforms and consoles. Additionally, their i.MX software development kit allows customers to completely customize graphics and virtual environments in 4K, Ultra HD, and HDR quality across multiple screens.

Growth Drivers: The spread of wireless connectivity and mobile computing is the main driver for NXP. They specialize in near-field communication (NFC) products, enabling secure connection between devices and servers. NFC is the international standard when talking about secure connectivity, and NXP has led the industry in advancement of this technology. In the VR space, many will claim NVIDIA (NVDA) as the leader in graphics processing units. NVIDIA specializes in aftermarket, high-end graphics cards. NXP is an original equipment manufacturer (OEM), meaning their products are built directly into the device by manufacturers. This essentially eliminates the risk of customers exhausting their funds with their initial purchase, guaranteeing revenue quicker. Over the past four quarters, NXP has grown its OEM revenue by over 50% while NVIDIA’s has contracted.

Competitors: NXP’s largest competitors, by market cap, are Texas Instruments Inc. (TXN), Infineon Technologies AG (IFX), and Analog Devices Inc. (ADI). However, none of these companies have the same product focus as NXP. The semiconductor industry as a whole has suffered from a decrease in demand over the past two years. A flurry of consolidation led by acquisitions has brought the industry back up from its slump. NXP’s products are differentiated from their competitors through their efficiency and low energy requirements. When talking about VR, the headsets that have independent displays and do not house a smartphone, are tethered to desktops by both display and power cords. As the products offered at the consumer level becomes more refined, customers will demand more advanced wireless hardware, and NXP will be there to deliver.


Capital Structure: NXP funds its operations through a combination of debt issuances and loans through revolving credit facilities. They currently have $8.3 billion outstanding in fixed coupon bonds and senior notes whose maturities extend through 2023. Their revolving credit facilities offer up to $1.16 billion with $2 billion outstanding due in 2022. They currently hold a BBB- credit rating from Standard & Poor’s and a Ba2 credit rating from Moody’s.

Estimates: Since NXP is dabbling in the rising VR market as well as the self-driving automotive industry, I estimated that revenue growth will be 55% in 2016 and 65% in 2017. This is consistent with the growth they have seen since acquiring Freescale. Cost of revenue has historically been 53% of sales. Their operating expenses are expected to decrease after the divestiture of their standard parts segment in 1Q17. 2 years of acquisitions and divestitures has caused volatility in their earnings. After shaking off the rough first two quarters of 2016, earnings will show a 10% growth for the remainder of the year. Next year, their earnings will grow by 40% compared to 2014.

Valuation: Using the sales franchise model, I estimate that the fair value of NXP is $146, representing an undervaluation of 42% from its current price, 33% from the proposed acquisition price from Qualcomm, and 22% from NXP’s required purchase price. The growth duration model indicates a fair value of $128, representing an undervaluation of 24% from the current price, 16% from Qualcomm’s proposed acquisition price, and 7% from NXP’s asking price. My valuations average to a fair value of $137 and an undervaluation of 34%.

Risks: NXP is based in the Netherlands and trades on American exchanges through an American Depository Receipt (ADR). This means that geopolitical conflict, exchange rates, and local inflation have an effect on the stock price. Another risk facing NXP is the integration of Freescale. This acquisition makes NXP one of the largest semiconductor companies in the world. If the integration is not conducted carefully, the $12 billion deal would end up being a waste and could taint NXP’s original business as well. Finally, NXP must continue to evolve and offer new technologies to the ever-changing market. Being involved in the VR, mobile, and automotive industries requires them to outperform their competition on a consistent basis.


Business Description: Photronics Inc. makes the molds for companies like NXP Semiconductors to produce their microchips. The molds are called photomasks which are microscopic blueprints for circuitry, allowing mass production of VR semiconductors. Their photomasks are used to form LCD drivers and the newly developed OLED displays. Both are the base for all upcoming VR display products. They custom-fabricate their photomasks to meet the specifications of their customers and can produce photomasks ranging from 2500 nanometers down to 45 nanometers in diameter. Photronics also converts existing photomasks so companies can transition to VR compatible microchips.


Revenue Breakdown: Photronics’ business model is structured around designing custom photomasks that meet their customers’ specifications. 75% of their revenue comes from international operations. The majority of their revenue, 39%, comes from Taiwan, one of the most prominent semiconductor capitals in the world. 28% comes from Korea, 25% comes from North American clients, and the remainder comes from Europe. Photronics has strategically placed factories next to the largest semiconductor manufacturers in the world with the intention of becoming their main suppliers. The company has begun moving towards photomasks for OLED displays, which are predicted to phase out LCD screens. LCD displays rely on a single backlight, usually placed on the side of the device, to illuminate the pixels in the screen. This creates inconsistency and gives you limited control over the brightness. Pixels on OLED displays are all self-illuminating. In addition to that, LCD pixels are independently colored. The blue pixels have a tendency to fade and die off quicker than the rest of the colors. OLED pixels are all white with color filters over them, giving them all the same length of life, clarity, and brightness. This is necessary to view content in Ultra HD, especially when wearing a head-mounted display.

Growth Drivers: Photronics has spent the last year increasing CAPEX and R&D expense by $40 million to prepare for the rise in OLED display technology. OLED displays are becoming the standard in the industry thanks to their superior display and life compared to LCD screens. Samsung already exclusively uses OLED displays in all of their devices. Major players like Apple have expressed intentions to follow suit. Rumor has it that Samsung will become one of the major suppliers for the industry. Fortunately, Samsung is Photronics’ biggest customer. As a result, the company has secured a deal to begin building a plant in China to increase efficiency and total OLED photomask output.



Competitors: The Company’s largest competitors in the semiconductor supply and testing industry by market cap are Lam Research Corp (LRCX) and Teradyne Inc. (TER). LRCX and TER have put more focus towards refurbishing, cleaning, and testing existing semiconductors. PLAB’s move to secure a foothold in the coming OLED display takeover as well as its penetration into the Chinese market has given it a strong competitive positioning. Additionally, Photronics’ P/E ratio of 12.59, P/S ratio of 1.35, and P/B ratio of 0.99 versus the industry averages of 18.87, 2.58, and 2.57 makes the company relatively cheap.

Capital Structure: Photronics has financed its operations through bond issuances. It has $57.5 million in outstanding 3.25% fixed coupon bonds that mature in 2019. It also has up to $50 million available in its revolving credit facility through 2018. The company has struggled in the past with downward credit rating revisions due to liquidity concerns. This was due to outstanding debt that the company paid off and macroeconomic concerns related to the financial crisis in 2008. Additionally, the company went through a massive restructuring initiative in which it ceased operations in its Shanghai facility in order to cut costs. Reuters has issued it a combined credit rating of A+ with a 4 basis point probability of defaulting. Bloomberg has rated it as IG6 (investment grade) with a 3 basis point probability of default.


Pro Forma Income Statement

Estimates: Revenue will grow by a modest 10% for the remainder of 2016 due to the decreased demand seen over the past 18 months. Once OLED display sales pick up in 2017, revenue growth will increase by 12%. In 2H17, Photronics’ $40 million of capex for its OLED production capacity will be in full swing and revenue will grow by 20%. Cost of revenue has historically been 75% of revenue. Despite the high costs of OLED photomask production, their new factory in China will increase efficiency and COGS will decrease to 73% of revenue. I assumed a flat tax rate of 16% as this has been the average over the past 16 quarters. With these assumptions in mind, annual earnings per share will grow by 19% in 2016 and 20% in 2017.

Valuation: Using the Residual Income Model and assuming a book value growth rate of 4.1%, the fair value of Photronics is $13 indicating an undervaluation of 26%. Using the Growth Duration Model with assumed earnings growth rates of 10%, 20%, and 25%, Photronics has a fair value of $12 indicating and undervaluation of 19%. Averaging those values together gives an undervaluation of 23%.


Risks: 75% of Photronics’ revenue comes from international operations. This leaves them moderately exposed to foreign exchange, geopolitical, and macroeconomic headwinds. Their photomasks are constructed using quartz, plastics, and electronic grade chemicals. Pricing fluctuations in these materials could have an impact on the company’s bottom line, though the current pricing outlook remains stable. Similarly, a sudden decrease in demand in the semiconductor industry as seen in prior years or internal consolidation of photomask manufacturing by producers could negatively affect the company’s top and bottom line.

Technicolor SA (OTC: TCLRY)


Business Description: Technicolor is a complete multimedia content producer. They are one of the only publically traded companies currently capable of providing every level of service required for creating VR content. Starting with the customer’s initial idea, they provide auditioning services, camera and sound crews, special effects, editing services, marketing services, screening, and broadcasting services. Along with featured films and documentaries, they produce VR animated content and video games. They also convert existing content into VR. They work with the biggest film and game studios from Hollywood to Hong Kong.

Revenue Breakdown: The Company generates its revenue through three segments: Entertainment Services, Connected Home, and Technology. The Entertainment Services segment accounts for the majority of their revenue, 46%, and entails their vertically integrated multimedia production capacity. Connected Home accounts for 40% of total revenue and includes products like cable settop boxes, satellite set-top boxes, HDR video and recording devices, wireless connection and network platforms for the internet of things (IoT), and software solutions. Their technology segment accounts for the remaining 14% and entails product, brand, and patent licensing. Within their technology segment lies their Research and Innovation division which is focused on imaging science, VR and other immersive technology, and artificial intelligence. The majority of their revenue, 52%, comes from the U.S. and the western hemisphere. 42% is derived from Europe while the remainder comes from Asia.

Growth Drivers: The rise in demand for animated content will be Technicolor’s biggest growth driver through 2017. The company has announced that it will begin providing virtual reality cable service in 2017, but the majority of VR content released through 2017 will be animated feature films and video games. Technicolor is able to develop and produce content compatible with all VR headsets. Most SDKs and production platforms have limited compatibility. For example, applications and content produced on Oculus’ SDK are only viewable on an Oculus headset. Technicolor bridges the gap between producers and platforms and gives their content a broader viewing base. This year, commercial content and development tools have raked in $600 million, approximately 61%, of the public and private funding coming into the industry. Software and content represents potentially 70% of the entire coming VR industry. As hardware sales pick up this year and next year, Technicolor will have a larger customer segment to distribute content to.

Competitors: Technicolor’s main competitors are Dolby Laboratories (DLB), Viacom Inc. (VIAB), Twenty-First Century Fox (FOX), and Lions Gate Entertainment Corp. (LGF). All of these companies are actively working to provide VR multimedia content, leaving them at the mercy of critic reviews. Technicolor’s biggest advantage is its comparatively smaller size, popularity, and technology segment. It is important to take note that Technicolor is over 100 years old and has always been at the forefront of new technology and trends in the entertainment production sector. It works with the biggest studios in the industry and has helped with the production of VR promotions for movies like The Martian, Avengers: Age of Ultron, and The Jungle Book. Its strategic restructuring and acquisitions of some of the premier content, animation, and design studios have positioned it to be a dominant player in the upcoming VR marketplace.


Capital Structure: After its default and restructuring in 2010, the company has prioritized deleveraging itself while showing the ability to produce organic growth. The company has €9 million in outstanding bonds that mature in 2017, €1.3 billion in outstanding term loans maturing in 2020, and €500 million in perpetuities. Its acquisitions have enabled it to produce a stream of positive free cash flow, improving its overall credit outlook. Moody’s upgraded it in August from B1 to Ba3 with a positive outlook. Standard & Poor’s upgraded it to BB- from B+ in April. Reuters has it as a BBB- with a 17 basis point probability of defaulting. The company has stated it will use its free cash flow to further deleverage itself. It has gone from over 5x debt/EBITDA in 2009 to 1.9x in 2015. The company plans on reducing this to 1.5x in 2017. It also has access to two untapped revolving credit facilities with balances of €210 million. Its €385 million cash balance and €200-€250 million annual free cash flow will be more than enough to cover its annual debt amortization of €63 million.

Estimates: Since Technicolor SA is based in France, they operate under IFRS accounting standards as opposed to GAAP. IAS 34 dictates that interim financial reporting can be done in quarters or halves. With that in mind, 2H16 revenue will increase by 30% due to the increased focus on their Connected Home segment as well as the rise in demand for VR content. 1H17 and 2H17 will see revenue growth of 40% thanks to the launch of their VR cable demo. The company is still going through a restructuring phase as it fully integrates its connected device acquisition from Cisco and continues its deleveraging initiatives. The company announced a share repurchase program in 2015 that will take place through 2020. I estimated 6% of its shares would be repurchased each half to reward investors for their patience and confidence in the company. As a result, earnings will grow 44% in 2016 and over 200% in 2017.

Valuations: Using the Residual Income model with an assumed growth rate of 16% and a required rate of return of 10.5%, Technicolor’s fair value is $10, indicating an undervaluation of 62%. Using the Sales Franchise model with a required rate of return of 10.5%, Technicolor’s fair value is $9 indicating an undervaluation of 40%. Averaging my valuations together gives an undervaluation of 51%.

Risks: The Company has done a good job thus far of meeting its deleveraging goals. However, if the demand for VR-ready content fizzles out, the company may struggle to increase profitability. Multimedia production is somewhat seasonal in nature as major blockbuster releases typically occur in the summer and holidays. It is also very expensive. Another risk is that this is a foreign company that trades on U.S. exchanges through an American Depository Receipt (ADR). This means that the performance of the company is not the only factor that determines the stock price. Geopolitical risk, exchange rate fluctuations, and inflation all have an effect on its value.
Vuzix Corporation (NASD: VUZI)

Business Description: Vuzix Corporation is a manufacturer of wearable virtual and augmented reality display devices. In contrast to the standard, cumbersome VR headsets, their products are lightweight and worn like glasses to view VR content. They make binocular eyepieces, monocular eyepieces, and stereo/video headphones that are compatible with mobile devices, gaming consoles, and PCs. They also make applications tailored to the entertainment, aviation, telecommunications, and healthcare industries.

Revenue Breakdown: Vuzix derives all of its revenue from sales of its video eyewear. As of 2015, 96% of total revenue has come from consumer and enterprise level sales while 4% has come from government sales. This is promising as it shows a trend of Vuzix moving from government sales into the public market. When they went public, government sales accounted for nearly 40% of their revenue. Currently, enterprise level customers account for the majority of their sales. As prices come down and VR becomes more mainstream, consumer level sales will increase. 48% of their sales originate from the United States while 52% comes from international customers which indicates a much broader customer base from years prior. Vuzix has three main products on the market currently: the M100, M300, and iWear. In 2015, Vuzix sold 2,500 of its M100 smart glasses. Their newest product, the M300, was recently awarded the Compass Intelligence’s Enterprise Wearable Device of the Year award. It already has 194 enterprise customers with orders in for delivery. They are on track to sell over 10,000 in 2016. With an average selling price of $1,500, the company expects $12-$15 million in sales by the end of the year. Vuzix has increased orders by creating the Vuzix Industrial Partnership (VIP) program which guarantees customers first priority on delivery of new products. They have limited the program to 50 companies due to production constraints but have received over 130 requests for entry into the program.

Growth Drivers: Coincidentally, the introduction of virtual and augmented reality into the consumer atmosphere is Vuzix’s main growth driver. The wearable headset market has seen a CAGR of 84.5% since 2012. The market is expected to quadruple in 2017 and rise to over $10 billion in 2020. Demand thus far has been driven by enterprise consumers from the technology, healthcare, logistics, retail, and aerospace industries. The same trend was seen with the introduction of personal computing. Consumer intake really began to gain traction five years after PC introduction. 2017 will be that five year mark. Further evidence of this can be seen in the growth of VR hardware and content at the commercial level this year. The Oculus Rift, HTC Vive, Samsung Gear VR, and the Playstation VR have been making rounds across trade shows and social media, fueling the spread of the industry.

Competitors: The Company’s direct competition in the HMD market is Microvision Inc. (MVIS), Carl Zeiss Meditec AG (AFXG), and Kopin Corporation (KOPN). All of these companies are actively battling for a foothold in the HMD market. In addition to those aforementioned companies, Facebook’s Oculus, Google, Microsoft, Samsung, Sony, and HTC have also introduced their own HMD products. Though these are some big names to compete with, Vuzix’s products were met with stellar reviews and have earned numerous awards due to their superior technology and relative affordability. Google’s answer to Vuzix, “Google Glass,” received such awful feedback that Google ended sales of it in 2015. Vuzix’s success thus far has proved it has the ability to disrupt the industry, making it a prominent player in the market as well as a potential takeover target. Intel has invested $24.8 million into Vuzix thus far. Intel has a history of acquiring companies it has invested in within 24 months. Their collaboration with Vuzix occurred in January of 2015, 22 months ago.


Capital Structure: The Company has a bold plan to fund its operations purely on cash from sales of completed products. Though there is risk involved with this plan, they have less than $4 million in liabilities and their inventory and cash reserves are in good shape. The company has over $4.5 million in cash and over $3 million in ready-to-sell inventory. $2 million of that is their iWear video HMD and $1 million is their M100 smart glasses. This means that sales from here on out translates into a pure cash injection for the company. Turnover from their iWear is projected to generate over $5 million in revenue. To help this process along, they’ve signed a deal with drone racing leagues to outfit pilots with their state-of-the-art products. Reuters has assigned it a BBB- combined credit rating with a 15 basis point probability of default.


Estimates: My first experience analyzing a small cap tech company was definitely a doozy. Large cap and well established companies are thrilled to see growth of 25%. Within the tech industry, and especially young tech companies, things are much different. After taking into account their product launches from last year and this year, I estimated year-over-year revenue growth for the remainder of 2016 of 120%. In 2017 they will see revenue growth of 150% and become profitable. However, I am betting that Intel makes them an offer by the end of 1Q17 at the very latest. SGA expenses will fall as the need to rent out booth space at tech shows will no longer be a priority once the company becomes more established in the industry. The company has relied on raising funds through equity offerings, so I estimated that 50,000 shares will be issued each quarter. Earnings will see year-overyear growth of 5% in 2016. 3Q16 and 4Q16 quarter-over-quarter growth will be 24% and 11%. Assuming no acquisition offer is made, 2017 will be a profitable year for Vuzix. 2017 will see annual EPS grow by 186%.

Valuations: Using the Residual Income Model, with a 24% growth assumption and a required rate of return of 15%, Vuzix’s fair value is $11 indicating an undervaluation of 50%. Using the Pricing Parity Model and April 2017 options, Vuzix has a fair value of $10, indicating an undervaluation of 28%. Averaging those values together gives an undervaluation of 39%.

Risks: Vuzix faces the risk of not being able to turn over inventory to meet its financial obligations. The tech industry can be extremely profitable. That is what draws so many companies into the industry. If the large cap players in the VR wearables market like Facebook, Samsung, HTC, or Google are able to produce a better device, Vuzix will struggle to keep up with the pack. However, I do not foresee this happening as they hold over 40 patents, have 23 patents pending, and have won over 20 Consumer Electronics Show Innovation awards.


Adoption Rate
VR technology has the potential to disrupt $34 billion worth of existing markets today. It will change the way people operate in certain facets of life. To predict the adoption rate of VR technology, I looked at the adoption rates of other disruptive technologies, specifically PCs and smartphones.

PCs changed the way people worked, making the workforce more efficient. So, not surprisingly, enterprise level application was the main driver for adoption of personal computing technology. The introduction of smartphones changed society completely. Mobile phones freed people from the clutches of wires. Smartphones gave people the power of the computer with the added feature of mobility. Unlike PCs, consumers drove the mass adoption of smartphones. I graphed the adoption purchases of smartphones compared to general mobile phones. PCs took longer to fully penetrate the consumer market because no technology had existed like it before. Many people had to be trained to use them. Smartphones came onto the market 10 years after the initial introduction of PCs so much of the population was familiar with their operations. As the population gets more tech-savvy, adoption of new technology happens more quickly.


VR is an interesting case because it uses existing technology, such as mobile devices, but has vastly different applications on a very broad user base. Entertainment applications will drive adoption at the consumer level. The problem is that consumers won’t purchase VR hardware until there is ample content available. Unfortunately content makers are hesitant to ramp up production until an adequate hardware base exists in the market. What we have is the classic chicken and egg fiasco. Nevertheless, I have graphed my predictions for the speed at which VR hardware will be adopted by the general population.

Index Creation

Correctly balancing a portfolio is essential for locking in the highest returns with the minimal amount of risk. After selecting my stocks, I used Excel’s Solver add in to calculate the optimal weights to produce the highest returns. The weights that fall on the efficient frontier are as follows: NXPI- 24%, PLAB- 6%, TCLRY- 11%, VUZI- 59%. Back testing from the last three years showed a monthly return of 3.74% which equates to a 44.88% annual return.


Based on my calculate weights, I recommend that we purchase 189 shares of NXP Semiconductors ($19,200), 469 shares of Photronics Inc. ($4,800), 1,437 shares of Technicolor SA ($8,800), and 6,218 shares of Vuzix Corporation ($47,200).



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