Disruptive Technology, Slow and Fast
As bottom-up stock pickers, we are inundated with comments from smart people about the next major breakthrough in this or that. Sometimes it comes from a pharmaceutical company talking about a novel treatment, such as cancer vaccines. Sometimes it is a new currency, such as Bitcoin. Sometimes it is a new fashion trend, such as Crocs. Sometimes it is a revolutionary new technological or industrial endeavor, such as graphene “the miracle metal”.
Before the breakthrough, scant few concepts fall within our circle of competence. Furthermore, when we have a defensible level of competence, the stocks are usually valued at prices that do not afford investors an acceptable margin of safety. Our standard approach when investing in new or disruptive technologies is to set objective milestones, monitor actual developments, and revisit the investment thesis when milestones are passed. The most common result is that the first milestone is never reached. When a first milestone is reached, it often takes several years longer than anticipated.
We use “big data”, another popular buzz word, to avoid the trappings of charismatic and visionary storytellers. It happens to be the oldest form of big data. That is we use decades of collective experience and history books. However, our big data also indicates that revolutionary change of some variety is inevitable and that we need to look expectantly and constantly.
That being said, milestones are being achieved slowly in several potentially revolutionary fields. Our old form of big data indicates that transformative change takes a lot longer to occur than visionaries imagine, but when transformations happen, they happen faster than imagined. Advances in electric vehicles (EVs), alternative energy, artificial intelligence, etc. have heightened our attention, to say the least.
The first wave of innovation rarely results in successful businesses. There are several microcap stocks of failing companies that were in the first wave of companies that built charging stations for EVs. However, ChargePoint was started a little later and benefited from observing the challenges faced by the first wave. ChargePoint has quite a few Fortune 500 companies as clients and recently announced that it was taking over GE’s EV charging network. It seems logical to us that smaller fleets of corporate vehicles will be EVs before millions of individuals drive EVs. An expanding network of EV charging stations with large customer bases is a milestone of sorts.
Presently, the adoption rate of EVs seems to depend on overcoming the limitations of driving range, battery life expectancy, and the cost of lithium-ion batteries. The 2017 Chevy Bolt has made giant strides regarding all three limitations. Perhaps the biggest potential game changer is described in an article[1] about a claim of a new battery which could replace the lithium-ion battery because it is safer, faster charging, longer lasting, and cheaper. We were dubious until it was revealed that the claim was made by the inventor of the lithium-ion battery. Still, at best, this is still a few years away from a transformative situation.
Tesla’s vehicle production fits our observation that change takes longer to start and then happens faster than estimated. Tesla is always talking a big game and it is hard to keep track of how far into the future each of the multitudes of projections are expected. In 2014, Tesla had a goal to produce 75,000 vehicles during 2015, 100,000 during 2016, and 500,000 vehicles in 2020[2]. The company did not hit its 2015 or 2016 goals but in May of 2016, Tesla said that based on its current order rates, its goal of producing 500,000 cars was moved closer, to 2018. This is another potential milestone, should they make it.
Since going public in 2006 Tesla has generated operating losses over $3 billion as it has made massive investments in battery technology and production capacity. The company will have to spend considerable amounts of money on the plant, property, and equipment needed to meet the fivefold increase in production goal of 500,000 vehicles, and again to hit the next fivefold increase. If the charismatic visionary’s story eventually occurs, current investors may realize attractive returns. Perhaps emblematic of a cult following, Tesla’s bonds that mature in 2020 yield 8% and the bonds that mature in 2030 yield only a little more at 8.5%[3]- bond holders seem to think the chance of the company making good on its bonds are almost equally likely in three years and thirteen years. Presently we see little margin of safety in both the stock and bonds, though market participants have kept pushing the stock higher and higher through the first half of 2017.
Much has also been prognosticated about autonomous driving vehicles (ADVs) during the last decade or more. Though only a few of our ADV functional milestones have been passed, the fact that tech giants such as Apple, Alphabet (Google), and Uber are eagerly exploring ADVs is another milestone of sorts. ADVs have been used for a number of years in farming, construction, and in factories, so we understand why so many people are inclined to extrapolate a rapid takeover by machines. But autonomous driving is probably still in the “gonna take longer than anticipated” phase even while advanced driver assistance systems (ADAS) will become increasingly commonplace in our vehicles.
Several early milestones are being achieved in multiple alternative energy technologies. Alternative energy is an area where many first waves of innovation have occurred and where we expect to see meaningful adoption by large corporations as a vetting process for these technologies. This adoption will be a precursor, likely over several years, to alternative energy adoption by the mass market. Wind power has been making great strides in certain regions, but to us, the most exciting advances relate to developments in solar power. For example, Dominion Energy expects more than 5% of their total generating capacity to be powered by solar facilities and even Saudi Arabia is investing in solar power.
Presently, for solar power to become a major source of energy on the power grid, a number of physical limitations need to be overcome. First, the portion of the sunlight energy that is captured by the solar panels is low. Currently, widely available panels convert around 15% of the sun’s energy and this needs to improve closer to the theoretical limit for a single solar cell of 33.7%[4]. Secondly, no one seems to have figured out how to store a large amount of solar energy, as we discussed above with regard to batteries, though utilizing the power grid itself seems a good solution for something on the order of 15-25% of peak power demand. The third limitation is how to transmit solar power from a remote sunny place back across the power grid and how to manage grid costs in a distributed generation environment. Solar power seems many years away from being a major source on the power grid.
The cost to produce a watt of solar power has dropped precipitously and history suggests a chance for further large decreases, much in the same way as the price of computing power has declined. So there may be a large diffuse alternate role for solar power. If costs decline enough and storage technology improves, solar power may become a simple supplementary source of power at discrete locations. Still, an investment in solar panels to power a home would yield poor financial results for many people and in many places, for the time being.
In conclusion, interesting and headline-grabbing technologies appear to be in various stages of disrupting the world as we know it. Perhaps even more than before, rapid technological disruption means that first wave innovators are likely to fail. Therefore, we must look for those milestone achievements that indicate durable competitive advantages exist for new technologies and their pioneering companies. We continue to monitor these technologies for the dual purpose of avoiding investment losses in those companies that are likely to be disrupted as well as to find those few pioneering companies that will become dominant leaders.
[1] https://news.utexas.edu/2017/02/28/goodenough-introduces-new-battery-technology
[2] http://gas2.org/2014/07/14/can-tesla-sell-500000-vehicles-2020/
[3] Per Thomson Eikon 6/27/2017
[4] http://news.energysage.com/what-are-the-most-efficient-solar-panels-on-the-market/ and https://en.wikipedia.org/wiki/Shockley%E2%80%93Queisser_limit
