The Internet of Things (IoT) is at the heart of the Fourth Industrial Revolution (4IR). Machine-to-Machine dialog is not new but converting machine data into actionable insights is new: technology is finally at a point when unstructured data from the physical realm can be converted into structured, digital, usable information. For the first time, the lines between physical and digital realms are blurring – and at the heart of this is the AI revolution.
While AI might feel like another overused buzzword, it truly marks the start of something extraordinary. AI refers to a computer’s ability to self-program instantaneously in order to make real-time decisions. We’re at the early innings of this technological leap: without this leap data collected from the physical realm would evaporate into oblivion. And in fact, that is what has been happening these last few years.
Several technological leaps need to be nurtured simultaneously so that IoT can thrive, including lightning-fast connectivity, advances in AI, and advances in semiconductors. At Oak Universe, we call this the “Grand Confluence”– and it is happening now.
The Grand Confluence
The Grand Confluence is exciting because it solves very pertinent business problems: supply-chain disruptions exacerbated by political grandstandings, and the elevated risk of future pandemics. It’s serendipity that the problem and the solution have emerged at the same time. The solution is to digitize the value-chain from procurement to the factory floor to the C-Suite.
The ideal transmission of data and information through the value-chain flows roughly as follows:
- Digitization of procurement systems and the factory floor with IoT chips and matching software to convert data into information.
- Connecting the entire set-up to the product distribution infrastructure.
- Connecting this IoT infrastructure to C-Suite systems like Accounting and Financial Planning.
- Real-time information flows through the entire value-chain.
- Leading to lower operating costs and lower working capital requirements, especially for asset-heavy industries.
- Finally leading to a higher and more stable free cash flow.
The business case for the Fourth Industrial Revolution instigated Oak Universe into galvanizing a 4IR-focused private equity fund. Oak Universe’s mission is to help European SMEs thrive in a volatile 21st century business environment. IoT and other technologies are the tools that help us fulfill our mission. Here at Oak Universe we’re convinced about the business case for Industry 4.0 and its supporting technologies like the IoT.
But still, investors might ask if we are really seeing any movement in the IoT space? Can it really offer the solution to a pertinent problem – or is it another fancy technology in need of a problem only to justify its existence?
We believe it’s a solution to a pertinent business problem, but it’s hard to quantify the value of this technology. This means, that pinning down a dollar value to IoT – in terms of investments and returns – is impossible. Nevertheless, reputable Consulting firms like McKinsey have attempted to quantify the technology. They estimate that the global IoT industry will be worth $3.7 trillion by 2025 – from digitizing factories alone.
On a qualitative level this estimate makes sense to us. However we are more bottom-up in our approach at Oak Universe. We like to keep our ears to the ground, and so we took stock of what some of the champions of IoT have to say about this. And then, we turned our attention to specific companies: a few semiconductor giants and a leading sensor company.
Ears to the Ground
In our on-going reconnaissance of IoT, we noticed that the first real use-case is Automobiles. Modern cars are packed with sensors – both inside and outside – that need to convert physical data like pressure, heat, gas leaks, nearby objects etc. into 1s and 0s thereby allowing an army of semiconductors to process that data. It’s no surprise then that companies that have been focused on modernizing cars into mobile datacenters are now at the forefront of IoT.
NXP Semiconductors is one of the world-leaders in making microcontroller chips for automobiles. While almost 50% of their revenue comes from the Automotive sector, their management team is becoming increasingly bullish on IoT as a revenue stream. In their latest earnings presentation for Q3 2020, NXP’s management declared that they expect their IoT & Industrials segment to outperform all their other segments over the next 3 years:
Intel, the original semiconductor behemoth, also specifically breaks out IoT as a revenue stream. Compared to Intel’s core business, the IoT segment is small; it makes up less than 5% of their revenue. But Intel is investing heavily in this sector. One of their recent high-profile buyouts was MobileEye – an Israeli semiconductor company focused on making chips for Autonomous Vehicles. Intel has now merged this company with their IoT business segment. As mentioned earlier, the tech synergy between Automobiles and other IoT applications is obvious.
Intel also gives us some specific examples regarding the business case for IoT. They collaborated with Audi, the German car manufacturer, at their Neckarsulm factory to improve their quality control. Audi produces about 1,000 cars a day in this factory. Each car has 5,000 welds. That amounts to about 5 million welds per day for inspection. That was an impossible task. Audi used to use an industry-standard sampling method in which they would randomly inspect a few vehicles a day. Each vehicle took 18 engineers to inspect. This was time-consuming and labor intensive. But with a new Intel IoT system, Audi is now able to automatically inspect all its vehicles, thereby reducing labor costs by 30-50%. Their ultimate goals are better quality cars, fewer recalls, and having a long-term reputation of quality and durability.
Intel is surely a bellwether company in the semiconductor industry – but they’re not the only big hitter in town. The largest Semiconductor manufacturer in the world, Taiwan Semiconductor Manufacturing Company (TSMC), simply manufactures chips for other companies and doesn’t design any from scratch. TSMC’s founder Morris Chang says, that he would like TSMC to be “everybody’s fab”. And for almost any chip company not named Intel or Samsung, it is just that.
TSMC started breaking out “IoT” revenue as a separate segment in early 2019. While there is not a lot of data, there is enough. Here is an overlook of TSMC’s quarterly IoT Revenue over the past two years:
TSMC’s IoT revenue has more than doubled in the last two years. That’s a CAGR of 48% per year. This tells us, that a potential long-term growth trend in semiconductor chips built specifically for IoT has begun.
So far we’ve been talking about the champions of digital semiconductors, but there are both analog and digital semiconductor chips. Analog chips are the ones that convert physical data like heat, light, and pressure into digital data of 1s and 0s. One of the current champions of analog chips is Texas Instruments (TI). From 2013 to 2019, TI saw its industrial & automotive revenue go from 42% to 57% of its total firmwide revenue. In other words, IoT is now TI’s core business. Here’s a telling excerpt from their last annual report:
“We see good opportunities in all of our markets, but we place additional strategic emphasis on industrial and automotive. Our industrial and automotive customers are increasingly turning to analog and embedded technology to make their end products smarter, safer, more connected and more efficient. These trends have and will continue to result in growing chip content per application, which will drive faster growth compared to our other markets.”
While TI’s analog chips are good at processing data from the physical realm, that data must be collected first. For that, we need sensors. One of the biggest sensor companies in the world is Honeywell. We dug into their product line-up to spot any significant increases in sensor sales. But we came across something more interesting: Honeywell’s own factory automation plans.
At a Credit Suisse event for Institutional Investors, Honeywell let everybody know that Honeywell “walks the talk”. They make sensors for their big Fortune 500 customers, but they’ve been busy using their own products to spruce up their manufacturing processes.
This caught our attention: Honeywell has realized about $750 million in direct material productivity savings since 2018 and a 50% improvement in quality year-over-year. It appears that in 2020, they spent about $23 million to automate some of their processes to reduce waste. If we assume, that they spent $23 million a year since 2018, that’s a total of nearly $70 million that implies an ROI of more than 900% per year if we amortize their $750 million savings equally over 3 years. Now that really is walking the talk.
We’ve cited examples from five industry leaders so far. The message is clear. Big hitters are taking IoT seriously. For them it’s no longer a buzzword, but a cash flow stream – either in the terms of cost savings or additional revenue.
Ignore IoT if you must, but we certainly won’t. For our portfolio companies, IoT is a means to a desired end. The desired end is this: digitize value-chains to make them as agile and real-time as possible with seamless connections from the C-Suite to the factory floor to the storefront and back. That is the Oak Universe mission.