In tech investing, it's always wise to remember that it's the unknowns and the little guys who usually do the disrupting. Real innovation is much more likely to come from an unknown problem solver than a tech heavyweight with a giant balance sheet.
There are innumerable examples of how disruptive innovation comes from outsider companies. That's why the smartest place to profit from the wearable tech trend could be not in a tech company, but in a company that has dominated the eyewear industry for decades, such as Luxottica (NYSE:LUX).
And then there are those companies whose products operate behind-the-scenes, and are the secret weapons that make things work. Getting an embedded MEMS or controller into a strong selling new device category can make all the difference for a component vendor. Behind-the-scenes component maker NXP Semiconductors (NASDAQ:NXPI) could benefit greatly from the wearable tech boom because of its relationship with Apple. Another good choice is awesomely innovative InvenSense (NYSE:INVN), a company that has an unfair advantage over competitors in its patents for the manufacturing process of CMOS-based MEMS.
Behind-the-Scenes with Apple: NXP Semiconductors
Dutch-based NXP Semiconductors beat analyst estimates with its fourth-quarter earnings report last week, and the stock moved up sharply (5.2%). On a full year basis, NXP delivered product revenue of $4,678 million, and 13 percent year-on-year growth. The company was on a tear last year, moving up 75%.
NXP Semiconductors makes a range of industry-standard commodity chips, as well as very specialized high performance mixed signal processors. It is a 12.8 billion dollar company, and for the first quarter it projects earnings of between 84 cents and 96 cents a share. The company's guidance sees revenue between $1.21 billion and $1.25 billion, compared to analyst expectations of $1.23 billion.
A lot of investors bought into NXP Semiconductors last year because of NFC, or Near Field Communications technology. Some say that NFC is declining technology at this point. The technology certainly has security problems, the standard isn't universal and it's a battery hog. Most new smart phones host Bluetooth Low Energy; few use NFC.
But NFC is also used in features like computerized car locks, entertainment systems, drive-by-wire throttle controls and digital credit cards. NFC is a shorter range technology and removes some of the obstacles around mistaken payments. Verification is a shorter process than with Bluetooth, where users have to scan for nearby Bluetooth devices and authenticate them--often a lengthy process. With the switch to credit cards with chips, it seems likely that NFC has great potential and is simply a technology that hasn't fully figured itself out yet.
NXP Semiconductors is also a lot more than a maker of Near Field Communications chips.
NXP has a host of components that can go into wearables, including gyroscopes and accelerometers. The M7 coprocessor in the Apple iPhone is actually an NXP chip that Apple has "rebranded." (There has been some confusion about the M7 coprocessor. In a late September tear-down by Chipworks of the Apple 5s, they were able to locate the M7 in the form of the NXP LPC 181. The LPC1800 series are high-performing Cortx-M3 based microcontrollers. This represents a big win for NXP, according to Chipworks, as it's not an Apple-branded part, so it might be that the M7 designation is simply Apple's marketing branding.) Since the company is already behind- the-scenes with Apple, NXP Semiconductors components could well be used in the iWatch--if and when the iWatch makes an appearance.
NXP Semiconductors' competitors include Dialog Semiconductor (OTC:DLGNF), Skyworks Solutions (NASDAQ:SWKS) and Cirrus Logic (NASDAQ:CRUS). But as Seeking Alpha contributor Pim Keulen points out, NXP Semiconductors is not overvalued compared to its main peers. Only Skyworks Solutions' trailing P/E ratio is better.
In terms of negatives, Goldman Sachs downgraded the company on January 2 from Buy to Neutral, citing expectations that cyclical growth will slow in 2014. The company's current debt-to-equity ratio is 3.076, making it more leveraged than its competitors.
Another avenue could continue to keep this chipmaker's stock engine revving. The company is expanding its automotive business in China through a joint venture with the state-owned Datang Telecom. (NXP currently has an 11% share of Chinese market for semiconductors.) The Dutch micro-chip maker has ownership of facilities in Jinlin and Guangdong. The deal between Apple and China Mobile (NYSE:CHL) is another positive development for NXP Semiconductors, according to Pim Keulen.
InvenSense, A Significant Unfair Advantage
InvenSense is a four-hundred employee, Silicon Valley company that is a leader in motion sensing and tracking technology used in smart phones and game consoles. The company is not dependent on wearables for its future, but it could benefit from the trend greatly.
InvenSense's customer base includes Samsung (OTC:SSNLF), Nintendo and Google. The company designs and sells micro-electro-mechanical system gyroscopes for motion tracking devices. The stock has been red hot in 2013, with shares up by 63%. The stock fluctuated after the company's latest earnings and outlook mixed expectations, but most analysts remain upbeat.
For the fiscal year ending in March, InvenSense expects to top $25 million in revenue, with only small contributions from wearables products. Assuming a wearables market of approximately 100 million units in five years (Google and Samsung are already on its customer list) and InvenSense getting $1 of profit from each mobile device (which could double or even triple in the near future, depending on the chip used) a substantial increase in annual revenue could be generated.
Over the next five years, InvenSense is projected to grow about 20% per year, even without a major deal with Apple. That number will certainly go upward if the speculation InvenSense could add Apple to its customer base has reality behind it.
InvenSense gets a lot of analyst coverage, and whether the stock has gotten ahead of itself is hotly debated. What I find most interesting about InvenSense is its fabless business model. This is a fascinating slant to the fabrication of MEMS devices that merges the reigning semiconductor technology (CMOS) with MEMS requirements. The result is smaller, lower-cost, lower-power solutions that are useful in all forms of products. (In particular, wearables.)
The process allows multiple sensor technologies to be integrated on one chip, including motion sensing, acceleration and deceleration and gyro. The key benefit is that this unburdens software and speeds up the extraction of data. The same chip that senses the motion also extracts the data, so you get finished data right out of the chip itself, not as the result of software algorithms.
In terms of wearable devices, because of their patents on the manufacturing process of MEMS devices, the company has a significant unfair advantage.
InvenSense is a risky investment. It trades at a forward P/E of 25.7, and is expensive on a price-to-book basis. Investors are paying a premium (according to some analysts). It's also impossible to know if the speculation that Apple will be added to its customer base will come true. But the technology itself is extremely impressive, and it already has some powerful clients. Samsung, for instance, is a 30% plus customer, giving an idea of the value of a deal with Apple..
While the stock has great future potential, investors should be cautious with InvenSense in the immediate future. InvenSense is moving within range of a near-term breakout according to The Street. A sustained high volume move or close about 18.31 in NXPI is telling traders the set up to next resistance at $21.82, and then anything above 22.35 could propel it to $25 or even $30 a share. Trading range breakouts can be approached several ways, but it's important to note that they can be highly unprofitable and require caution, as the breakout can be false. According to Charles Kirkpatrick, roughly half of breakouts retrace back to the breakout, and money is lost on the gyrations.
Luxottica Is Hidden In Plain Sight
As I discussed in Wearable Tech: Forget Google and Apple, Think Different (Part I), Google's sales of Google Glass will likely not be large enough to even flick the dial in Google's financials in 2014.
But in the smart glass sector, eyewear powerhouse Italian company Luxottica Group stands to not only benefit from the wearable tech boom, but also has numerous other catalysts.
Luxottica is the world's largest eyewear company with a near monopoly on the industry. It has a market cap of $24.7 billion, a P/E ratio of 32.9. According to the Street, currently there are 2 analysts who rate Luxottica Group a buy, no analysts rate it a sell, and none rate it a hold.
The Street rates Luxottica Group an A- because of its impressive record of earnings per share growth, revenue growth, good cash flow from operations, increase in stock price during the past year and notable return on equity.
Luxottica already beat Google to the high-tech smart glass market with the Oakley Airwave, a high-tech ski goggle that features iPhone and Android smart phone connectivity, a GPS, ski slope maps and an integrated display built into the goggles. The Oakley Split Thump offers Mp3 playing and the Oakley O ROKR offers bluetooth capability.
For over fifteen years--about as long as Google has been a company--Luxottica has been developing and patenting the display optics technology used in what is now known as smart glasses. The Oakley Airwave demonstrates what Luxottica is capable of in this space.
In a research report published on December 18, 2013, HSBC upgraded LUX to overweight. A report by Bank of America, which also rates the stock a buy, said the following.
"Finally poised to deliver as LUX reaches critical mass and looks for more targets, increasing market dominance coupled with best-in-class operational performance, ongoing strong cash flow generation and an increasingly healthy balance sheet, and finally, strong performance in the last 5 years."
Luxottica is also a dominant force in glasses retail with more than 7,000 locations around the world (including over 2,295 Sunglass Hut locations and 1,178 LensCrafters). An eye doctor is often on premises at these locations, and ready to prescribe lenses for Luxottica glasses. The company has a near monopoly on the business, with Luxottica-owned EyeMed Vision Care being one of the largest vision health insurers in the United States.
Like almost all Italian stocks, Luxottica's performance last year suffered from the antics of Italian former Prime Minister Silvio Berlusconi. (Berlusconi's most recent indictment by the Italian Supreme Court upheld a number of fraud convictions.) But instability has been part and parcel of Italian politics since the Second World War, with a self-serving coalition frequently in power. Italian companies (and people) are known for their adaptability, and it's unlikely that Luxottica as a company will suffer a long-lasting impact. On January 20, Standard & Poor's raised its long-term rating on Luxottica Group to A- and said the outlook was stable and Luxottica had improved its credit metrics.
Another major risk to the stock is that some analysts fear Google Glasses might steal some of Luxottica's business. If that fear becomes widespread, there could be a downturn, but it seems more likely that Google will be knocking on Luxottica's doors, looking for help. Google Glasses are aesthetically challenged. They elicit contemptuous stares. Bluntly speaking, they are ugly.
A partnership between the world's largest eyewear company and Google could make good sense. Google has confirmed that it will make a modular version of Google Glass that can work with any prescription or sunglass frame. Luxottica has also shown flexibility and openness as to its future plans in wearables.
Other long-term catalysts for Luxottica include the likelihood people in China and India will get better health care, which includes sunglasses and prescription glasses that Luxottica manufacturers.
While Google and Apple are getting the headlines, it seems likely that Luxottica's size, scale and experience in the eyewear industry makes them not a company to be underestimated, not to mention their patents in the smart glass field could allow them to take their smart glasses to the next level, or form a partnership with Google.
All three of these companies, Luxottica, NXP Semiconductors and InvenSense share something in common--extreme adaptability. With the wearable tech revolution looming, and consumer whims constantly changing, that's a good trait to have. What's even more significant however, is that all three companies should do well from other catalysts--even if their hopes for wearable tech fail to materialize as planned.
Right now, a torrent of analysts are telling investors that Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL) are the best ways to play the coming boom. But wearable technology is an exploding product category, and with Google Glass still in beta, and Apple's iWatch still basically a rumor, I'm skeptical the wearables trend will skyrocket these company's revenue, and stock prices, this year.
The wearable tech wave is still in its early phase. There's no need to bet on it right now, but there is a need to keep an eye on it. One thing is certain: the path will not be a straight-forward one, and there are multiple technological, user behavior, legal and production economics barriers to cross.
If you're anxious to get in on it, the best opportunities may require thinking outside the box. Doing so often pays off--both in life and in investing. Wearables are hot. Super-hot. There's plenty of buzz, but it's the same old story. Build your portfolio not on the latest hyped-up Wall Street trend. Build it from your own vision and based on your own experience and try not to make rookie mistakes of too much greed or too much pride--they can mess you up. Build it to last.
Disclosure: I am long APPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.