After more than a decade of wireless internet coverage, connectivity chips, and cloud computing growth, connectivity is becoming ubiquitous. There are tens of billions of devices hooked up and sharing data via a network, and billions more will be put in service in the next decade — a movement often referred to with the catch-all phrase the “Internet of Things,” or IoT.
Investing in the IoT is easier said than done, though. Hardware can get easily commoditized and profit margins eroded, so picking businesses with a technological advantage or building sticky services based on IoT devices is key. Three that Fool.com contributors think have plenty of growth ahead are Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG), Limelight Networks (NASDAQ:LLNW), and Texas Instruments (NASDAQ:TXN).
Internet search goes “Internet of Things”
Nicholas Rossolillo (Alphabet): When it comes to a future of connected devices, I like Google’s approach. Sure, nearly 80% of revenue came from online advertising during the second quarter of 2020, but this is a highly profitable business model (historically around 30% operating profit margin) that is being used to reinvest into innovative new businesses.
Internet ad revenue declined 9% last quarter, but Google Cloud — cloud computing being an essential piece of infrastructure on which connected devices are based — increased 43% and accounted for nearly 8% of Google’s $38.3 billion grand total. The “Google other” segment that contains everything from the Play app store, YouTube Music and TV, and Pixel and Nest smart home devices grew 26% and was over 13% of Google’s total revenue. At those rates, the Alphabet parent will be a well diversified business no longer reliant on internet advertising before too long.
The “other bets” segment holds some other promising projects. While it is an overall drag on the business (it lost $1.12 billion on revenue of $148 million), some of the businesses contained therein include autonomous car outfit Waymo, drone delivery service Wing, and life sciences technologist Verily. All of the businesses in the “other bets” segment are currently a long shot at being monetized anytime soon, but I like the potential there and Google’s ability to feed its investment portfolio.
If Google’s other currently high-growth businesses are any indication, though, Google’s approach to investing in long-term potential disruptors can pay off in a big way down the road. It’s already a big business, but Google parent Alphabet is my top IoT pick right now.
An edge computing leader in the making
Anders Bylund (Limelight Networks): Edge computing is an important piece of the puzzle for many Internet of Things devices. Sending data all the way back to a central data center for analysis is simply not good enough for some applications, where a few milliseconds of latency can add up to a game-changing problem. Examples of this would include security cameras using artificial intelligence to separate your own family members and pets from burglars and other threats. Keeping the data for at least a preliminary analysis closer to home can spell the difference between an effective security system and a failed threat assessment.
There are plenty of edge computing companies on the market today, and many of them are great investments. I do have a favorite idea in this space, and it’s one that many investors wouldn’t even consider to be a bet on the IoT market.
Limelight Networks is best known for its high-speed content delivery network (CDN) services. CDNs speed up digital video streams, software downloads, and other bulky bandwidth consumers by serving up the content from storage facilities spread around the network hubs of the world. Limelight is not the only company to offer these services, but it is an early leader in the market for edge cloud services.
In this model, Limelight can handle data analysis requests in the network hub down the road, rather than sending the same bundle of raw data from your IoT device to some big-iron server in a remote data center. This is perfect for use cases like the AI-powered security camera I mentioned earlier, for monitoring industrial systems where a small delay can break your machinery, or for interactive communications systems where delays lead to a poor user experience.
This is not a major growth driver for Limelight quite yet, but I see the potential for big top-line gains as edge computing gets paired up with IoT devices on a massive scale. And while you’re waiting for the edge computing idea to gain market traction, you’re owning a leader in the booming CDN industry. What’s not to love?
An IoT blue chip with all-star dividend growth
Billy Duberstein (Texas Instruments): The Internet of the Things is really just shorthand for connected and automated machines that communicate without human intervention. Of course, getting the IoT up and running will require lots and lots of different kinds of chips that all need to interact with each other. These include analog chips, which detect inputs from the physical world such as heat or pressure, and convert them into digital signals, as well as embedded processors, the tiny chips that usually perform a specific function within a “smart” appliance or machine.
Semiconductor giant Texas Instruments makes analog and embedded chips across a wide variety of end markets. Over the years, TI has made a big push into industrial and automotive sectors, as management believes that factories and cars are two industries set to become “smarter” and more automated over the long term.
That still seems like a good long-term bet; however, the industrial and automotive industries are two sectors that are hurting right now in the COVID-19 recession. When you combine that with the industrial recession of 2019 caused by the U.S.-China trade war, it’s been two pretty bad years for Texas Instruments’ end markets.
Yet despite all that, Texas Instruments still generated $5.7 billion in free cash flow over the past 12 months, for a current price-to-free-cash-flow multiple of about 22.4 times. That performance during such trying times is a testament to TI’s industry-best capital allocation policies and long-term orientation, which has given TI industry-low manufacturing costs, diverse end-market exposure, and high margins.
In an age when many companies are cutting dividends and taking on extra debt, TI continues to return all of that cash flow to shareholders in the form of share repurchases and dividends, all while maintaining a strong balance sheet.
While on the subject of dividends, TI has been an all-star in that respect. Over the past 16 years, the company has increased its dividend per share 40 times over. While I wouldn’t expect the current 2.6% dividend to increase another 40x any time soon, today’s economic downturn sure looks like a good time to invest in this blue chip IoT stock for the long haul.
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