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Augmented Reality Stocks – The “Picks and Shovels”

Whenever an exciting disruptive technology like augmented reality (AR) starts to catch the attention of retail investors, the pundits immediately feel compelled to start saying something about what stocks you should buy. A cursory look at the Motley Fool article on “Augmented Reality Stocks: What to Watch in 2018” says you should “play the long game” with Microsoft, Apple, and Facebook. It’s the same “Invest in Everything With Google” mantra that we hear every time there’s a new technology, and no real pure plays for retail investors.

Sure, there are a few augmented reality stocks out there. One of these we’ve talked about before is Vuzix, the company that makes AR headsets. Then there are the many promising AR startups, like the prospect of Magic Leap, which may actually come to fruition given that they’ve managed to debut a product. So where does this leave retail investors who want to invest in augmented reality stocks? The answer may lie in looking for the “picks-and-shovels” of augmented reality. These would be the companies who are selling the components needed to create augmented reality hardware. We know that many companies are working on bringing new hardware to market, and that’s evident by the demand for AR talent:

Source: CB Insights Newsletter

Essentially, we’re looking for companies that stand to benefit by supplying the key components that all augmented reality hardware providers will need to purchase. So what key components might these be?

In thinking about how augmented reality works, it’s quite easy to visualize. Whatever device you are using “sees” the real word and then overlays something on top of it. Like this:

Stock photo of lady pretending to point at an AR projection

This means that every augmented reality device will need the ability to see in the real-world. So how do machines see in the world today?

We’ve written extensively about computer vision which interprets the images it’s being shown in real-time, or LiDAR which uses a sort of radar to see so that it can be used in day or night. We’ve talked about a few computer vision stocks like ISRA Vision and Cognex, both of which have performed quite well. Now we’d like to touch on something we haven’t talked about before called 3D sensing.

3D sensing and VCSEL for Augmented Reality

Credit: MicroVision

A critical function of augmented reality is a device that can “see” what’s happening in the real world. Google Glass was supposed to be such a device, but we’re all still waiting for something to take off. The popular game Pokémon Go hinted that the device might be a smartphone. The idea of smart contact lenses has even been proposed, and our article on that topic is one of our most popular in terms of daily hits from people searching for that term. What the pundits think is that Apple has the answer in a future version of the iPhone, and that they have a 2-year lead over everyone else according to an article by Reuters. That same article talked about how pervasive 3D sensing will be in the future:

Gartner predicts that by 2021, 40 percent of smartphones will be equipped with 3D cameras, which can also be used for so-called augmented reality.

One critical component of 3D sensing is something called VCSEL which stands for Vertical-Cavity Surface-Emitting Laser. VCSELs are a commonly used infrared light source for 3D sensing solutions because of “high accuracy, small size, low power consumption, and high reliability”, according to an article by LEDInside on the topic. VCSELs have been around for quite a while with applications in communications, and now they’re being put to use in smartphones:

Credit: Finisar

Let’s look at some companies making VCSELs.

Augmented Reality Stocks – The “Picks and Shovels”

Finisar Corporation (FNSR)

With a market cap of around $2 billion, Finisar is the world’s largest supplier of optical solutions for the communications industry as seen in the below market share analysis provided by the company:

Source: Finisar

One component of their optical solutions are VCSELs, and Finisar claims to be the worldwide leader in VCSEL technology and manufacturing having shipped more than 300 million VCSELs to date for use in communication products.

In December of last year, Apple awarded $390 million to Finisar so that they could build out a 700,000 square-foot manufacturing plant to “exponentially increase its R&D spending and high-volume production of vertical-cavity surface-emitting lasers (VCSELs).” VCSELs power some of Apple’s most popular new features, including Face ID, Animoji (a completely useless feature), and Portrait mode selfies. Production is expected to come online in the second half of this year. An article by Apple Insider provides us with some good insights on how meaningful these revenues are expected to be:

Finisar revealed VCSEL revenue was in the “low-single-digit millions” for the quarter, but that figure is anticipated to grow to “tens of millions” of dollars per quarter starting in January, Munster said. The analyst notes that once the firm’s operation is at full capacity, it will see revenues from VCSEL sales hit $30 million. By comparison, Lumentum, Apple’s largest VCSEL supplier, saw revenues hit $40 million in September quarter.

For a company that had $1.4 billion in 2017 revenues, $120 million in additional revenues from VCSELs every year accounts for less than 10% of total revenues. That’s not exactly moving the needle much. So what about Apple’s largest supplier of VCELs, Lumentum?

Lumentum (LITE)

With a market cap of around $3.8 billion, Lumentum also sells optical and photonic products. They recently acquired a company called Oclaro, and here’s what the end result looks like in regards to revenue breakdown:

Credit: Lumentum Investor Presentation

According to their latest 10-Q filing, “Lasers net revenue increased by $24.4 million, or 22.6%, during the nine months ended March 31, 2018 compared to the nine months ended April 1, 2017, primarily due to increased sales of solid state laser products.” At the moment, VCSELs account for about 17.6% of the company’s revenues.

AMS AG (AMS.SW)

One name that came up during our research was a $7.5 billion Swiss firm called “ams” which builds sensors in four main areas:

Source: ams investor presentation

In March of last year, ams acquired Princeton Optronics, a pure-play VCSEL company with the “world’s highest power conversion efficiency” and revenues of about $10 million a year. Prior to that they acquired Heptagon, a Singapore company that offers a line of VCSEL products under the Lumos brand. That acquisition coincided with a $200 million investment in Singapore to expand production of VCSELs. In February of this year, ams acquired machine learning company KeyLemon which is working on facial recognition technology. While the company doesn’t provide color on what percentage of revenues are coming from the sale of VCSELs, looking through the Q1 2018 Results presentation leads us to believe that 3D sensing is a key focus for the company going forward.

Source: ams investor presentation

Since ams is already providing optical sensor solutions to the top 15 mobile phone OEMs, they should have the channels in place to sell VCSELs to these same customers. Additionally, they’re targeting autonomous driving with a “large program win for VCSEL illumination in automotive 3D LIDAR.” The company expects to “support large scale internal production of differentiated high power VCSELs in 2019.”

In addition to these three companies, there are others as well which aren’t so pure-play and likely never will be. With a market cap of $106 billion, Singapore semiconductor firm Broadcom (AVGO) sells a range of VCSEL products. So does Philips Photonics, a self-described “global leader in VCSEL technology and designs” which happens to be a subsidiary of the $38 billion Dutch technology company Koninklijke Philips (PHG). Then there’s Japanese electronics manufacturer Sumitomo Electric (SMTOY) which acquired Emcore’s VCSEL operation back in 2012 which at the time was generating sales of around $10 million. Point is, it’s a fragmented space with lots of players.

An Augmented Reality ETF?

While we’ve talked about just a handful of stocks here, there certainly aren’t enough names to merit the creation of an Exchange Traded Fund. That didn’t stop Kensho from trying to create an index around the theme though. If you recall, Kensho was a startup building stock indices using AI of which three turned into ETFs. Let’s just say their AR/VR index doesn’t look that compelling:

Kensho's Augmented Reality Stocks

Kensho’s Augmented Reality Stocks – Source: Kensho

While some of those names are questionable, the first one is actually a pretty interesting find. Himax Technologies (HIMX) is a $1.2 billion semiconductor company that mainly develops display driver integrated circuits. In August of last year, Himax jointly announced with Qualcomm “SLiM, a structured light based 3D sensing total solution” which is now available as of February this year according to a company press release:

We are pleased to announce that our SLiMTM total solution is now ready for mass production. It outperforms all the peers targeting Android market in each and all aspects of engineering. We are working with multiple tier-1 Android smartphone makers, on target to launch 3D sensing on their premium smartphones starting the first half of 2018,” said Jordan Wu, President and Chief Executive Officer of Himax Technologies.

Himax is pretty optimistic that they’ll be selling lots of SLiM solutions, as they claim “3D sensing total solutions will contribute very significant revenue and profit growth in the next 2-3 years starting 2018.”

Conclusions

The truth is that we don’t know what the end game looks like for augmented reality, but we do know that the 6 billion smart phones that people carry around with them are likely to end up being the most commonly used AR devices. While there may not be many augmented reality stocks per se, there are some interesting opportunities here to invest in VCSELs which appear to be some of the picks-and-shovels for the augmented reality devices that we will all be carrying around in our pockets soon.

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