Where's The Next Megatrend In Tech?

Includes: MSFT, NUAN
by: StreetAuthority

By David Sterman

Although the dot-com boom ended with a resounding thud in 2000, investors should remember that the prior 18 years' worth of stunning market gains were largely due to a stream of game-changing ideas in technology that sharply boosted U.S. productivity.

A quick timeline of that decade shows just how an impressive an era it was.

  • In the mid-1990s, the Internet became a part of everyday corporate life. The advent of email led to a rapid increase in corporate communications and executive decision-making.
  • That time also saw the development of high-speed networks, allowing large corporate files to be whisked across the country in seconds.
  • The early signs of e-commerce took root as Amazon.com and eBay began a retail revolution that is still boosting productivity to this day.

The next decade also saw solid advances in terms of computing power, communications technology, sharply improved display technologies (which led to innovative TV sets), and key gains in the fields of wind and solar power.

More recently, our economy has benefited from:

  • The advent of social media [such as LinkedIn (LNKD)], which you probably hadn't heard of five years ago but is now worth $26 billion).
  • Mobile computing, which has led to mobile commerce and advertising, known as m-commerce.
  • Cloud computing, which has paved the way for robust data analysis, known as Big Data.

Trouble is, if you look out on the horizon, it's becoming increasingly apparent that there is no new megatrend in the offing. Most companies are focusing on incremental advances, from faster computer chips to higher-resolution TV sets to more accurate robotic surgical arms.

But to thrive, technology doesn't need evolution -- it needs revolution.

Take Nuance Communications (NUAN) as an example. The company has been a long-standing pioneer in the field of speech recognition software. Nuance's sales have roughly doubled in the past five years (to $1.65 billion in fiscal 2012), and the current crop of smartphones have introduced speech recognition to the masses. But shares of Nuance have been sliding for the past year because the company is delivering few new groundbreaking innovations.

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To look at what tomorrow's game-changing technologies might be, we can look at where venture capital money is flowing. VC firms tend to heavily speculate on winning business models that will be mainstream in five or 10 years.

And judging by recent funding trends, VC firms are underwhelmed. According to Ernst & Young, the amount of VC money invested around the world fell 20% in 2012 to levels seen back in 2009, when the global economy was still on very tentative footing. Out of the 323 VC firms in business at the start of 2012, 53 of them closed up shop by year's end. Here in the U.S., VC funding slipped 15% from 2011 levels to around $30 billion.

The current year isn't looking much more promising. According to the MoneyTree Report, there were 1,223 VC-backed investments in the U.S. in 2012. We're on pace for around 1,150 deals this year.

In a look at VC activity in this year's second quarter, analysts at PricewaterhouseCoopers noted that software (with $2.1 billion in new investments), biotech ($1.3 billion), IT services ($654 million) and medical devices ($543 million) attracted the bulk of the funding.

Clean technology, which was a key area of focus for VCs five years ago, received less than $400 million in fresh capital in the most recent quarter. "Investors cannot seem to flee the space quick enough," note analysts at CB Insights, who add that in years past, a single clean energy VC deal was often greater than $500 million. Interest in the formerly hot fields of computer networking and semiconductors are also falling well below past peaks.

Although the VC industry deployed $6.7 billion in the second quarter, most of that went towards existing VC investments that needed further capital to stay afloat. The dollars earmarked for new investments, also known as the initial round of founding, were around $1.1 billion, according to PWC. The analysts at Ernst & Young add that "VC funds are adjusting their investing strategies, preferring to invest in companies that are generating revenue and focusing less on product development, pre-revenue businesses."

(As a side note, the U.S. remains the main focus for global VC investors. California's Bay Area took in $11.2 billion in VC money in 2012, followed by New England ($3.6 billion), Southern California ($3 billion) and the New York metro area ($2.4 billion). In contrast, the U.K., Germany, Israel, France and Canada each took in $1 billion or less, according to Ernst & Young).

So what types of companies are the wave of the future? These are the top six recipients of VC funding in 2012, according to VentureBeat:

  1. Fisker Automotive. The cutting-edge car maker received a $277 million investment in 2012 but has since filed for bankruptcy.
  2. SquareTrade, a provider of after-market consumer electronics warranties, received $238 million in funding. A valued service perhaps, but not a source of innovation.
  3. Square, which facilities smartphone and tablet-based payments, got a $200 million injection. The company's products are already popping up in bars, cafes and elsewhere, and management would be wise to pull off an IPO before the "me too" competition emerges.
  4. Drilling Info, which provides what it name implies to energy exploration firms in North America, pulled in $166 million last year.
  5. Sapphire Energy, which bagged a $139 million investment, is yet another firm that hopes to turn algae into petroleum, but after hundreds of millions have been spent on rivals that failed to scale up their technology, it's unclear if Sapphire will make it to the IPO starting gate.
  6. Box raised $125 million to further develop its cloud-based data storage platform. The company's OneCloud synching system may be a better mousetrap than the existing cloud-focused storage firms, but time will tell.

It may be churlish to ding these companies, several of which likely have bright futures. But the question again needs to be asked: "Where's the game-changing innovation?"

On a broader level, it's time to start to wonder if the technology sector will be able to deliver the Next Big Thing in coming years that send technology stocks to new highs. Right now, the 1990s and even the 2000s are starting to look like a golden era that may not soon be revisited.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.