Technology Market

Drivers of Change

A variety of major developments in technology is set to transform this sector over the coming years. Cloud technology is changing the corporate IT landscape, with basic cloud services becoming more affordable. At the same time the cost of storage has decreased – and compute power has risen. By 2020, we expect there will be 1.7MB of new information created every second for every human being on the planet.

These developments have created the conditions needed for artificial intelligence (AI) to have a significant impact. The technology has begun entering real life applications – and while the focus is currently on solving relatively basic tasks, future applications will include a wide range of industries.

Internet companies have been embracing AI proactively, while machine learning techniques will likely be widely deployed across the sector by 2025. The development of AI-powered voice recognition is likely to enable more effective use of voice commands for internet apps. Virtual Reality (VR) and Augmented Reality (AR) will also become more mainstream.

Opportunities

The opportunities are considerable. Today, AI is focused on solving relatively basic tasks, such as making online purchasing recommendations or assisting doctors with diagnoses. Even this first stage of AI – known as Narrow AI – is still in its infancy.

By 2025, AI is expected to be deployed broadly across the internet sector, playing a role in everything from marketing and operations to finance and HR. This will bring opportunities for companies to personalize their offerings to a far greater extent than they do today. Meanwhile, the deployment of advanced robotics could become central for vertically integrated ecommerce companies, leading to greater operational efficiency.

Other areas of opportunity include the rise of autonomous vehicles, faster transaction speeds, the rise of mobile broadband driven by 5G and the use of blockchain to create standardized digital credentials.

Threats

The sector faces many threats and challenges as progress continues. Naturally, companies will need to embrace innovation and avoid falling on the wrong side of relevance. But there are other areas of concern. For one thing, the growing reliance on networks and connected devices and systems has opened up new security vulnerabilities. Given the frequency of cyberattacks against companies, political organizations and government officials, the importance of cybersecurity in this climate should come as no surprise.

Another issue is the erosion of consumer trust, with people becoming more concerned about the use of their data following recent data breaches. The monetization of social media has historically relied on accessing consumer data, but in the future this data may increasingly be controlled by consumers themselves – thereby driving up the costs of gaining access to this data. GDPR has given consumers greater control over their personal data – and these standards may become global practice by 2025, replacing looser standards in other markets including the U.S.

Strategic imperatives for Success

To succeed in this environment – and meet customers’ evolving needs – companies will need to invest in growth and fully understand the potential applications of emerging technologies. A rapid pace of innovation is essential in this evolving environment. Companies with access to sufficient capital will naturally be at an advantage when it comes to achieving the necessary scale – but smaller, nimbler players will also have a role to play.

Companies that are willing to embrace opportunity are positioning themselves successfully for the years ahead. Others, however, may face challenges such as losing market share or experiencing customer churn – and companies which fall behind may find it difficult to catch up with more innovative competitors in the future.

Software

Forces such as AI, cognitive, digital engagement and cybersecurity will have a profound impact on the software sector, which is set to increase its share of the global economy. With AI becoming a reality, companies with access to the data needed to feed AI processes will deliver better customer experiences. Large cloud platforms will be well-placed to deliver on the promise of AI – but there will also be opportunities for smaller companies to leverage their abilities in new ways. Alongside these developments, we expect new regulation to be introduced for AI in light of its potential to disrupt employment and create new geopolitical risks.

Company specific thoughts:

A number of companies in this sector have built platforms with massive scale and/or potential reach – these include Microsoft (MSFT), salesforce.com (CRM), Shopify (SHOP), Workday (WDAY), ServiceNow (NOW), Splunk (SPLK) and Red Hat (RHT). These have also proven willing to sacrifice additional margin upside in the short term to invest for future growth opportunities as they embrace automation, machine learning, AI and/or hybrid-cloud adoption. The small advantages they are achieving today will compound quickly over time – and this will make it difficult for others in this sector to catch up.

IT Hardware & Semiconductors

The three key areas of AI, 5G and autonomous vehicles are set to drive unprecedented demand for compute power and storage. In order to take advantage of the opportunities, companies in this sector need to continue investing in technology and developing partnerships with end-market customers. Players which can provide higher compute power and more memory will be best placed to capture the content opportunity. Meanwhile, semiconductor/hardware companies could be threatened by cloud providers designing hardware and semiconductor components.

Company specific thoughts:

IBM is likely to benefit from the AI megatrend in light of its Watson platform. Apple (AAPL) could be a major beneficiary of AI and VR/AR-related trends, while the data generated by these technologies – together with autonomous driving – could create strong tailwinds for Micron Technology (MU). APH and TXN are also well positioned to benefit from the rise of autonomous driving, while Amphenol Corporation (APH), Broadcom (AVGO) and Texas Instruments Incorporated (TXN) have well-diversified end markets.

That said, some companies are facing headwinds. While Celestica (CLS) is seeing a mix shift towards emerging non-traditional markets, legacy technology end markets still account for 65%+ of the company’s growth. FLEX will experience headwinds if cloud-based revenues cannot offset declining legacy CEC businesses, while the continuing migration of Hewlett Packard (HPE) to cloud will also pose headwinds.

High Tech

For enterprise software companies, technologies such as AI, cybersecurity, cloud computing and big data are likely to drive an upgrade cycle. AI will offer buyers improved productivity and insights into their data, while cybersecurity will likely be a minimum investment for next-generation enterprise software. If legacy enterprise software is not updated with new technologies, customer churn and reduced maintenance renewal rates are likely – but companies with a high mix of modern technologies are likely to see stronger demand.

Company specific thoughts:

The companies which are best positioned for this transition are BlackBerry (BB), Kinaxis (KXS.CN) and Shopify (SHOP), which have the highest mix of next-generation technologies in their existing offerings. For example, BB’s QNX platform is positioned as a leading operating system for Advanced Driver Assistance Systems (ADAS) – a precursor to autonomous vehicles. Others such as Sierra Wireless (SWIR), Mitel (MITL) and Enghouse (ENGH.CN) have a high mix of legacy software – and while they are modernizing their portfolios, they could see higher levels of customer churn or reduced maintenance renewal rates in the future.

Payments, Processors & IT Services

AI, machine learning, IoT and blockchain technologies are set to increase the velocity of transactions and expand the global pool of consumers able to access financial services. The information needed to assess risk will become fully embedded in the products, while the speed of transactions could be multiples of the speed available today. Against this backdrop, it is likely that a wave of M&A will continue for years, with incumbents battling digitally native new entrants. Meanwhile, companies will need to develop new technologies alongside existing technology infrastructure in order to prepare for greater demands on legacy systems.

Company specific thoughts:

A number of thought leaders in this sector have proved willing to undertake strategic M&A in order to advance technology while avoiding being disintermediated. These include Accenture (ACN), MasterCard (MA), PayPal (PYPL), Square (SQ) and Visa (V). While many of these companies represent incumbent technology, they are also investing in new emerging technology and startups. In due course, these developments could be used as a feeder pool for further acquisitions.

Communications Equipment & Semiconductor Capital Equipment

As people suffering from unemployment look to develop new skills, there could be a shift towards education for a portion of the adult population, while digital entertainment could lead to additional spending in the coming years. Automation brought about by AI, VR and AP could result in new types of jobs and work and enable the development of higher-margin businesses. Self-driving vehicles could also result in infotainment opportunities. In light of these developments, companies will need to invest heavily in data center technology in the coming years, while demand for legacy technologies may decrease.

Company specific thoughts:

Companies that are well positioned in this sector include NVIDIA (NVDA), Arista Networks (ANET), Synopsys (SNPS), Cisco Systems (CSCO) and ASML. NVDA, ANET and ASML are pushing the boundaries of technology, while SNPS and Cadence Design Systems (CDNS) are playing a notable role in chip development. Meanwhile, CSCO’s large install base means the company is well positioned to capture more data.

When it comes to area of opportunity, NVDA and ANET could benefit from more spending on data centers. EDA and Semicap Equipment could benefit from more investment in complex chips. There are also opportunities to make more use of robots/AI in everyday applications, from manufacturing to healthcare.

Internet

With big data, cloud computing, AI and machine learning set to become ubiquitous by 2025, internet applications and services are likely to become more personalized and seamless across devices. Likely developments include virtual reality becoming a fixture for ecommerce and online entertainment companies, while AI and machine learning could make ad-based models more effective. The sector is likely to see continued aggressive investment across the large platform companies, particularly in the areas of AI and machine learning. However, large platform companies are also likely to face more regulatory scrutiny in the coming years.

Company specific thoughts:

Amazon (AMZN) and Alphabet Inc (GOOGL) have the big data access and compute power infrastructure needed to benefit from developments in AI and machine learning. AMZN appears to be well positioned to lead robotics innovation, while GOOGL’s investments in Waymo autonomous vehicle technology have positioned the company to lead innovation in autonomous vehicles. Where VR/AR is concerned, the acquisition of Oculus by Facebook (FB) means the company is well positioned to take advantage of future developments.

Challenges could include a widening competitive gap between eBay (EBAY) and AMZN as the latter’s investments in big data, AI and robotics lead to a more compelling user experience. Meanwhile, growing adoption of VR/AR could bring challenges for Netflix (NFLX).

Communications Infrastructure, Telecom & Cable Services

The adoption of cloud computing, machine learning and other applications is likely to have the biggest impact on network providers and internet/broadband infrastructure players, driving increased capital deployment in datacenter, fiber and mobile and small-cell infrastructure.

Meanwhile, enhanced broadband connectivity – together with advances in internet and IT applications – will create growth opportunities for broadband, datacenter and tower operators. While scale and rapidity of deployment will be an advantage for large players, niche competitors may also play a role, potentially providing acquisition fodder for national/global players.

Company specific thoughts:

The global scale of companies like Digital Realty Trust (DLR) and Equinix (EQIX) brings advantages when it comes to capturing demand. And on a national or regional scale, GDS (China), INXN (Europe) and CONE are similarly well positioned. Where mobile infrastructure is concerned, American Tower Corporation (AMT), Crown Castle International (CCI) and SBA Communications (SBAC) already possess national scale in the U.S., and – in the case of AMT and SBAC – key emerging economies.

Conversely, some companies in this sector, such as Frontier Communications Corporation (FTR), DISH Network Corporation (DISH) and CenturyLink (CTL), are at risk of losing share in key segments. But some have offsetting initiatives around 5G, fiber and other areas which may enable them to leverage growth drivers in the coming decade.