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The new industrial revolution

From artificial intelligence to virtual reality, we explore some of the ways that private investors can buy into the emerging technologies that are reshaping the world
October 20, 2017

Imagine: it’s 10 years from now, and you’ve finally decided to give Glastonbury a try. In fact, you actually paid extra to stand on stage with your favourite band, singing along to the words in front of the euphoric crowd. But wait: there’s a problem. You haven’t organised dinner yet. So, you remove your virtual reality headset, before asking your voice assistant to order groceries for this evening. Delivery robots make life much easier these days. For now, you’re content to re-immerse yourself in the festival – safely tucked away in the backseat of your driverless car.

Such a scenario might sound implausible, but some of the technologies enabling these experiences already exist. This is epitomised by the investments of the SoftBank Vision Fund, launched last year, which aims to “enable the next age of innovation and make tomorrow’s world possible”. The fund has backed trends including artificial intelligence (AI) and autonomous vehicles – exemplified by its investment in Brain Corp, a producer of self-driving technology for robots. The Japanese bank’s portfolio is enormous, having secured $93bn (£71bn) in commitments at last count out of a planned $100bn. And major institutions including the Saudi sovereign wealth fund and Apple (US: AAPL) are investors; naturally, this inspires greater confidence in the enterprises it endorses.

The Vision Fund is fuelled entirely by private capital, but it provides a useful overview of promising sectors. When it comes to new technologies, opportunities should by no means surpass the reach of retail investors. While many of the most talked-about public technology stocks are based in the US and Asia-Pacific regions, these companies are increasingly acquiring or collaborating with foreign businesses to bolster their competitive advantage. And, as this article will explore, there are various entry-points into these technologies here in the UK.

Key to the expansion of recent technologies is the scale of ‘big data’ available today, and the advancement of computer processing power. High-tech and everyday products are now more connected than ever before, collectively representing the ‘Internet of things’: a world in which data is continuously shared across our devices. This has both driven and been enhanced by the rise of AI, robotics and virtual reality (VR) among other technologies; the applications of which transcend the entertainment market, serving sectors as varied as healthcare and defence.

It is, of course, vital to remember that technology companies in their emergent stages can carry inherent risks. One need only revisit the bursting of the dot-com bubble at the start of this century to see how tech stocks with sky-high valuations can come crashing down when the veil of potential is lifted. But it can still prove worthwhile to make judicious calls on nascent trends, in the context of a diversified, balanced portfolio. The smartphone offers a clichéd but relevant example of a disruptive product that is now intrinsic to everyday life.

1. Artificial intelligence

Albert Einstein was perhaps prophetic when he said: “It has become appallingly obvious that our technology has exceeded our humanity”. This was demonstrated famously in March 2016, when AlphaGo – a program conceived by AI specialist DeepMind – successfully beat 18-time world champion Lee Sedol at the Chinese board game ‘Go’. To buy into DeepMind, look no further than Alphabet (US:GOOGL), which acquired the UK business in January 2014 for £400m. These days, among various projects, DeepMind works with the NHS to improve diagnostics and time to treatment. Its ‘Streams’ app, used by the Royal Free Hospital in London, sends mobile updates to doctors about their patients’ conditions. 

AI is synonymous with quality control, efficiency and workplace optimisation, and we expect to see a rising number of investable stocks in this space, across many industries. In their report, Artificial Intelligence: the next digital frontier?, analysts at the McKinsey Global Institute estimate that tech giants around the world spent $20bn-$30bn on AI in 2016 alone.

With rising interest in investment opportunities, it perhaps is no surprise that Smith & Williamson launched an artificial intelligence fund in July this year. The UK asset manager even uses a proprietary AI tool to help select equities for inclusion. Meanwhile, Aim-traded Polar Capital (POLR) announced its own Automation and Artificial Intelligence Fund on 9 October. At the time, technology director Ben Rogoff said “intelligent machines will require a rewriting of fundamental design and manufacturing principles” which “could prove as significant as the introduction of just-in time (JIT) inventory management and the reinvention of logistics in the 1980s”.

Machine translation

In a recent report, The State of AI 2017, Numis and MMC Ventures note the difference between machine learning and ‘deep learning’. The former entails programmes learning through training, rather than being programmed by rules. Meanwhile, deep learning is “a subset of machine learning that is delivering breakthrough results in fields including computer vision and language”. Like an animal’s brain, “networks of artificial neurons process input data to extract features and optimise variables relevant to a problem, with results improving through training”.

One of the more common uses of AI is language translation, enabled by machine learning. Again, Google is a leader here: its translate service knows more than 100 languages. And, last November, the company announced the launch of a ‘neural machine translation’ service whereby whole sentences are translated in one go, bringing greater accuracy. In the UK, language technology specialist SDL (SDL) is also exploring the power of machines. The first half of 2017 saw lower usage of machine translation for Asian languages because of their relative complexity, but SDL’s management told us that progress was now being made with Japanese. The launch of their own neural translation solution bolsters the group’s offering.

Algorithmic advertising

More generally, AI can help businesses to understand their customers, and thus provide targeted content. Mobile advertising specialist Taptica (TAP) uses machine learning to monitor changing behaviour and trends, before marketing particular products and services. Meanwhile, media companies such as Netflix (US:NFLX) use AI to gauge viewers’ preferences, before recommending new programmes. Spotify and other music streaming services have similar techniques, proposing playlists based on the songs that a person has already listened to. In fact, Spotify acquired an AI start-up, Niland, in May this year, noting that the business “shares Spotify’s passion for surfacing the right content to the right user at the right time”. We recently noted the media speculation that Spotify might undergo a listing on the New York Stock Exchange. This would put it in direct competition with other US-listed companies that have music streaming services enhanced by AI, including Apple (US:AAPL), Amazon (US: MZN) and Pandora (US:P).

Good morning, Moneypenny Siri

Without doubt, translation tools are useful, and personalised streaming services have transformed the way we consume TV and music. But the notion of mechanical employees had always seemed clinical, and ultimately too futuristic to become a reality. Enter voice assistants. Built into so-called home listening devices, these rely on speech recognition. The Amazon Echo is one variety, humanised by the personality ‘Alexa’. Users can ask questions, play music and even add items to their online shopping baskets. Meanwhile, Apple’s HomePod, embodied by the company’s Siri assistant, is due to be released later this year. And, although it has a somewhat less catchy title (LF-S50G), Tokyo-listed Sony has a speaker lined up that uses Google assistant. These simulated voices enable greater connectivity across their parent companies’ ubiquitous hardware devices, encouraging customers to remain loyal to the brand in question while playing a central role in the internet of things.

The potential applications of AI are almost infinite. There are, of course, ethical and security issues – the sharing of personal information required to enable artificial learning, and the privacy threats stemming from having all-seeing, all-hearing products in one’s home. Not to mention the recent innovations in biometric passwords, whereby machines can identify a person through voice or facial recognition. But as computers continue to advance, we expect to see many more companies benefiting from the data capacity, memory and customisation that AI can bring, unimpeded by the limitations of the human brain.

 

2. ROBOTS AND AUTOMATION

Robotics and automation are underpinned by AI, but they have carved out a significant market of their own across multiple sectors. And their presence is only predicted to grow.

With automation come efficiencies and cost savings, arguably representing a partial antidote to the ‘productivity puzzle’ troubling the UK in recent years. The Bank of England’s chief economist, Andy Haldane, said in March this year: “Productivity growth has consistently underperformed relative to expectations since at least the global financial crisis.” And “with each year that passes, and as each new turning point in productivity has failed to materialise, this mystery has deepened”. While the broader productivity puzzle refers to the stagnation of the UK economy, it seems fair to theorise that the robotic processes assisting UK companies might ultimately help the economy.

Through the prism of potential

As with most technologies, there are two sets of beneficiaries when it comes to investing in robotics and automation: those providing the solutions, and those interweaving these solutions into their working practices. Blue Prism (PRSM) falls into the former category. It provides, in its own words, “robotic process automation” via a digital workforce of software robots. Its software is used by organisations around the world to carry out rules-based, back-office tasks that can take up employees’ time. Shareholders appear to be convinced of its bright prospects. When the company floated on Aim in March 2016, it placed 27m shares at 78p each; today, the shares are worth 1,208p. And revenues were up a whopping 133 per cent for the six months ending 30 April 2017. But the shares are trading at a significant premium, particularly for a business with a relatively short public history.

Ideagen (IDEA), meanwhile, provides governance, risk and compliance (GRC) software to highly regulated industries, and among its offerings sits Pentana, a leading audit automation product. This is designed to save auditors thousands of hours every year, provide more accurate audit reports and a higher level of control. Analysts at research business Gartner say the GRC market was worth $4.4bn in 2016, and is growing by around 13 per cent every year. We imagine this growth will also mean rising demand for automation.

Alfa Financial Software (ALFA) provides “automated processing using business rules” to the asset finance industry via its main product, Alfa Systems. Its IPO in June this year was the biggest UK technology listing since 2015. The company's recent maiden half-year results impressed with 57 per cent revenue growth, although its forward earnings multiple remains exceptionally high – a commonplace issue among popular tech stocks.

Automated warehouses

Out of the office, online retailers are also benefiting from robotics and automation. Along with Amazon, UK-listed businesses ASOS (ASC) and Boohoo (BOO) have been vocal about automating their warehouses. Boohoo raised £50m via a share placing in June this year to fund an automated “super-site” of around 600,000 sq ft, aiming to achieve more than £2bn of net sales capacity. At the time, management said this would cost approximately £150m in total over three years. Meanwhile, Ocado (OCDO) uses automated grocery fulfilment centres. That said, it is currently the third-most shorted stock in the UK, according to ShortTracker, and an IC sell tip; the company’s technological edge doesn’t seem to have helped its investment case yet.

Robo doc

Given their hallmarks of precision and excellence, it is unsurprising that robots have entered the healthcare sector. In the US, Nasdaq-listed Intuitive Surgical (US:ISRG) is the leader in robotic-assisted surgery. Its da Vinci Surgical System allows doctors to operate on patients with minimal invasion, making small incisions and then using a magnified 3D high-definition system, with small instruments that are more flexible than a surgeon’s hands. In the second quarter of 2017, global da Vinci procedures grew by around 16 per cent year on year, while a new model was launched (the Da Vinci X) to provide surgeons with robotic assistance at a lower price.

Among other companies specialising in robotic surgery, PricewaterhouseCoopers’ ‘What doctor?’ report names Verb Surgical, which is working with Johnson & Johnson’s Ethicon and Alphabet’s Verily to develop surgical robots. Hansen Medical develops and sells medical robotics to operate catheters, and Nasdaq-quoted Mazor Robotics (US: MZOR) uses surgical guidance systems to perform spine and brain surgery.

Broad-brush approach

ETFs including the iShares Automation and Robotics UCITS (RBTX) and the Robo Global Robotics and Automation UCITS (ROBG) offer concentrated exposure to companies engaging with robotics and automation. That said, when it comes to funds, a more specific approach can of course increase the level of risk being taken. Caution is key: the ETF following the Robo Global index, like some of the themes it incorporates, is a recent phenomenon – it only listed in 2014.

 

3. DRIVERLESS CARS

Autonomous vehicles: another technological advancement enabled by AI, and an area that has attracted heightened press attention in recent months as competition intensifies between the major developers. The aforementioned SoftBank Vision Fund led a $164m financing round on 10 October in Mapbox, a mapping company whose ‘Drive’ platform uses sensor data to enable semi- and fully-autonomous driving.

The key market players

Among the most talked-about public businesses is Tesla (US:TSLA), the brainchild of entrepreneur Elon Musk, and arguably the most ambitious of its peers. All Tesla vehicles produced from the Tesla factory include the hardware to enable full self-driving capabilities. But while management sought to produce above 1,500 of the Model 3 cars in September alone, just 260 were produced in the whole of the third quarter of 2017. It may take longer than expected to reach mass production.

Naturally, Apple, as with most technologies, is also involved in this space: in June, chief executive Tim Cook told Bloomberg that the group is “focusing on autonomous systems”. And Alphabet entered the arena via its Waymo business. The FT recently reported that due to a clerical error, a court filing revealed just how much Alphabet had invested into its self-driving programme between 2009 and 2015 – a whopping $1.1bn. Meanwhile, private enterprise Uber has been vocal about creating autonomous taxi fleets. But it is currently in the midst of a lawsuit with Alphabet over allegations that it stole trade secrets after its acquisition of Otto – a self-driving trucking business founded by a former Waymo employee, Anthony Levandowski. Like the other major players in the area, Uber has been testing its self-driving software in vehicles – but the potential loss of the company’s London licence may distract, slowing the pace of the company’s progress. That said, earlier this month Uber said in a statement that its board has approved a proposed investment from SoftBank (this deal has not yet been finalised).

Driving in convoy

Self-driving pioneers aren’t just innovating from within; they are also collaborating and acquiring to get a foot in the door of the driverless garage. Chinese tech giant Tencent announced last month that it was joining forces with Guangzhou Automobile Group to produce connected cars and AI-aided driving. It has already bought a 5 per cent stake in Tesla this year for $1.78bn. General Motors (US:GM) acquired automation specialist Cruise in 2016 for $1bn. Intel completed its $15bn acquisition of Mobileye in August. Meanwhile, Renault, Nissan and Mitsubishi have formed the ‘Alliance 2022’ group, focusing on electric cars and aiming to launch a fleet of driverless vehicles by 2022. Together, the alliance forms the world’s largest car manufacturer.

There are currently no UK-listed companies in the running to come out on top of the global driverless car race. But investors can look at other sectors preparing for a driver-free future. Manufacturers will need software, which in turn requires top-notch cyber security features. In fact, the UK government recently published some key principles of cyber security for connected and automated vehicles. Cyber security is a highly competitive marketplace, and the fastest-growing area of the IT industry. It is likely to become more so as technology is charged with protecting people’s lives.

 

4. 3D PRINTING

It feels as though '3D printing' only entered our vocabularies in recent years. In fact, the technology originated more than two decades ago. Chuck Hull, the founder of US specialist 3D Systems (US:DDD), created the first ever 3D printed part in 1983. At the time, this was known as stereolithography. Fast forward to the present day, and the process is rapidly gaining recognition, as industry experts realise just how much change it could bring to several sectors. So what is 3D printing? In a nutshell, it is also known as additive manufacturing, and it entails objects being built, layer by layer, within a printing device. The materials used depend on the end product. And while it is still an emerging technology, analysts at Boston Consulting Group say that in 2015, the entire 3D printing market was worth $5bn; they expect this to triple by 2020.

A significant impact on global trade

With greater use of 3D printing will come major, tangible consequences – or repercussions – for global trade relationships. In a recent report, ING found that – based on estimates – 3D printing could lead to almost 25 per cent of international trade being wiped out by the year 2060, as local manufacturing supersedes the need to import goods. The main industries affected would include industrial machinery, consumer products and automotive. And, in terms of carmakers, the relationships most affected would be those between the US and its leading import partners: Mexico, Japan, Germany and Canada. So, while this hypothesis looks a long way into the future, it is worth contemplating how manufacturers might cope with shifting demand.

3D printing has not yet reached the point of global mass production. Even so, sales are still growing (if marginally) for 3D Systems, with second-quarter revenues up 1 per cent year on year at $159.5m. Its peer in the US, Stratasys (US:SSYS) serves a similar range of industries, including aerospace, healthcare, dentistry and education, to name a few.

High-speed sintering: the path to mass production

3D printing isn’t just confined to the other side of the pond. Xaar (XAR), an Aim-listed inkjet technology specialist, says that mass production is now a reality thanks to high-speed sintering (bear with us). They note that this improves users’ time to market and return on investment. Essentially, a fine layer of powder is deposited onto the surface of a powder bed; then, an inkjet printhead prints an infrared absorbing fluid onto this surface. Infrared energy then melts (or ‘sinters’) only the printed sections. This process is repeated layer by layer to build the intended item. Notably, while revenues and profits were down slightly in Xaar’s latest half-year results, its 3D and advanced manufacturing divisions grew by 200 per cent year on year.

Xaar’s resident ‘HSS’ expert, Professor Neil Hopkinson explains, that in the short term, aerospace and sports and leisure will gain the most from this technique, while the automotive industry will be a longer-term beneficiary, with advantages including lighter car parts. Structured heels on running shoes are just one example of how 3D printing might benefit ordinary people as well as industrial consumers.

 

5. VIRTUAL REALITY

In 1999, The Matrix became a global blockbuster film. Its storyline in brief: a group of characters interacts within a simulated reality, projected by machines. At the time, this was utterly futuristic – proved more so by the fact that viewers were forced to attend their local cinema or rent the video, watching a two-dimensional screen in either scenario. This was before the advent of 3D movies, before innovation changed the way we consume TV and, of course, before virtual reality became a true possibility.

VR in numbers

VR entails the creation of an immersive, completely digital environment using specialised hardware and tailored content. And after years of almost coming to fruition, the VR market finally seems to be taking off. Zeus Capital says that over the past four years more than $15bn has been invested in developing VR technology. And investment of another $50bn is expected between now and 2025. Companies of all sizes are striving to engage with this burgeoning trend, although the major hardware developers are those you might expect: Facebook and Google, to name a couple. According to PwC’s 'Global Entertainment and Media Outlook 2017-21', there will be 275m VR headsets in the market by 2021 across 10 markets. Correspondingly, global VR revenues will reach $15bn in four years’ time, up from $869m in 2016.

Hardware or content?

What are the investment opportunities in VR?  In terms of headsets, look to the US and Asia, where most of the big tech giants have created devices. Harold Evans at FinnCap points out that the “barriers to entry are enormous on the hardware side”. The pricing of these products will be key to the market’s success. Facebook (US:FB) bought Oculus, the producer of the Rift VR headset, back in 2014 and has already cut its price twice in the past year – seemingly to make it more accessible. This month, chief executive Mark Zuckerberg announced plans for Oculus Go, a cheaper mobile headset to be released next year. More varieties include Sony’s Playstation VR device and HTC’s Vive headset.

Here in the UK, there are several listed companies generating VR content. Earlier this year, SoftBank led a $500m funding round for Improbable, the private British business using virtual reality to create simulated worlds; this may ultimately become another Vision Fund constituent. Importantly for those concerned by overseas tech giants swallowing up British talent, this investment gave SoftBank a non-controlling stake in the start-up.

Gaming is traditionally the most obvious use for VR and Aim-quoted Frontier Developments (FDEV) has launched a VR-specific version of its popular game Elite Dangerous. Mercia Technologies (MERC) also has exposure to virtual reality gaming content via its investment in nDreams. Those that work with gaming companies – for example, Keywords Studios (KWS), a provider of digital game services – should also benefit from rising interest in VR content. Keywords’ offering includes localisation services – translating video games and voice-overs – and player support.

Musical headsets

Outside of gaming, EVR Holdings (EVRH) creates virtual reality music content. This provides an alternative to physically attending concerts, instead allowing people to watch from home while wearing a VR headset. Since its Aim IPO in May last year, EVR has announced agreements with hardware developers, rights holders and major music labels. But here’s the thing: the company’s flagship product, MelodyVR, hasn’t launched yet. EVR has no revenues and no official forecasts; the more than 150 per cent rise in share price over the past 12 months can be attributed to newsflow and optimism alone. Zeus, EVR’s broker, says that in its base case scenario, MelodyVR’s gross revenues could be approximately $650m in 2021, while the bull case scenario says $1bn. But it is difficult for them to make firm predictions, given the company’s early stage. Chief executive Anthony Matchett is waiting until there are around 25-30m VR headsets in the market before the app goes live, which might occur by Christmas or in early 2018. For now, the company’s reliance on a buoyant hardware market makes it an interesting, if highly speculative bet.

Virtual education

Beyond entertainment, VR also facilitates instruction and education. As part of its offering, Pennant (PNT), the small-cap defence training and software specialist, uses VR for defence training exercises. Products include a virtual parachute training simulator. Participants remain in a safe environment and there is no need to take equipment out of service. Meanwhile, Learning Technologies (LTG) demonstrates how educational experiences can be enhanced with VR: its Preloaded division is working with the Tate Modern to create an immersive Modigliani exhibition. FinnCap’s Mr Evans notes that education could be an area of significant potential for VR, as could augmented reality, for that matter; particularly if content providers were to win contracts with schools.

 

6. AUGMENTED REALITY

Augmented reality (AR) entails digital objects being overlaid onto real-life surroundings. And headsets aren’t always required; AR can be experienced through smartphones alone.

Snap (SNAP), which listed on the New York Stock Exchange in May 2016, is among the best-known applications to have bridged the gap here between ‘techies’ and normal consumers. Anyone with the Snapchat app on their phones can apply digital filters to their faces (such as dog ears or a floral headdress). But the company has had a tough few months. Over the past few weeks, the shares have continually traded below the IPO price of $17, and have endured target downgrades from banks including Morgan Stanley, which led the IPO. That said, management is exploring new ways of monetising the platform – its '3D world lenses', for example, allow businesses to advertise their products on people’s screens.

Apple, meanwhile, launched its ARKit platform for app developers seeking a route into the AR market. The product works with iPhones and iPads – keeping clients within the Apple family. While AR offers a different experiential medium from VR, there are also other types of multi-sensory technology. IP Group (IPO), which is in the midst of trying to acquire Touchstone Innovations (IVO), has invested in Ultrahaptics, a company using ultrasound technology to give the sensation of touch.

 

First movers: the winners?

These are all promising technologies, although they are still very much in the developmental, and thus high-risk, stages. People and companies increasingly expect ultra-connectivity between, and greater immersion in, their products and services. As such features become prerequisites of modern life, we imagine these technologies will garner more air-time in the investment world. Adding clout to this argument, audit and consulting house PwC identifies these same themes, among others, in its 'Tech Breakthrough Megatrends' report.

It is difficult to say which businesses will succeed: the first movers within each technology may act as pace-setters, rather than the ultimate winners. It is possible that the UK businesses innovating in these areas will be acquired by bigger, wealthier tech companies from overseas. The uncertainty for UK business after the Brexit vote can partly be blamed for a recent proliferation in such activity (see SoftBank and ARM Holdings, or indeed Chinese company Canyon Bridge and Imagination Technologies (IMG). But takeovers aren’t necessarily a bad thing: we’ve seen what a premium the behemoths are willing to pay. And, with such innovation being displayed by listed UK tech companies, they may well make it on their own, or indeed become acquirers themselves.

With business people like Elon Musk at the helm, we will undoubtedly be discussing trends again in 10 years’ time that were once deemed highly improbable. For example, Mr Musk’s recently announced plans for intercity space rocket transportation. Given the meaning behind Mr Musk’s infamous acronym ‘BFR’, we should also perhaps anticipate relaxed censorship of corporate language.