From dumb metal to intelligent actors – investing in the robot revolution

23 September 2019

By David Palmer, Co-Fund Manager HC Verbatim Portfolio 5 Income Fund

In the 1970s, robots were simultaneously hailed and decried for replacing humans on car assembly lines. A generation later, advances in automation technology have vastly increased the sophistication of robots.

Digitalisation has thus evolved automation from a human displacement story to one of improving efficiency, health and safety standards. This has considerably expanded the application universe of the simple automation model.

Previously confined to the manufacturing sector, the diverse automation landscape now spans sectors, from agriculture to mining, and represents a $1.4trn opportunity set. In parallel, demands for automation have become more specific, leading to the emergence of a new form of ‘bespoke’ automation.

The confluence of digitalisation and automation represents a megatrend – likely to endure for decades – supported by demography, regulatory trends, evolving productivity and the relative costs of labour and electronics. For investors, there is a tremendous opportunity to capitalise on a fragmenting market and evolving value chain.

Out with the old

Large integrated companies, such as Siemens, were the traditional purveyors of automation – creating a package of robotics hardware, software, connectivity and servicing. The giants still wield pricing power for large-volume production – in areas like automotive, finance, retail warehousing and utilities. However, these industries are largely digitised already, limiting the scope for volume growth by integrated automation providers.

Large players also dominate in sectors late to the automation game – such as agriculture, healthcare and building. However, these industries require a high level of domain knowledge, which large providers generally lack. For example, Ocado had to build its own sorting system because it was unable to obtain the service needed from large suppliers.

On the whole, these factors are contributing to the growing irrelevance of large automation providers. Increasingly, customers are demanding domain knowledge for particular problem solutions. This has led to the fragmentation of the automation market and emergence of new players.

In with the new

Certain established automation companies have specialised in hardware-only production. These are particularly attractive in consolidated sub-markets. Keyence, for example, supplies sensors, measuring systems, laser markers and microscopes. It is one of only two global players in the automated vision space.

However, the most interesting outcome of market fragmentation sits at the confluence of the automation and digitalisation trends. There is now an established and growing cohort of niche industrial tech companies, which have very selective customer bases. These providers are disrupting the traditional automation model by tailoring hardware and software offerings to respond to the problems faced by specific customer activity. By efficiently producing high quality products, these companies wield more pricing power over customers they are likely to retain.

This growing trend of bespoke automation is exemplified by Telford-based Protolabs. The company uses 3D printing and injection moulding to create prototype products far more quickly than traditional methods. For example, when PepsiCo collaborated with Marvel on promotional materials for the movie Black Panther, Protolabs was able to turn the concept into product in just six months.

Accessing innovation

These niche companies are often overlooked, as investors must trawl indices to find early stage listed companies. Large providers, such as Siemens, have spent about $30bn on snapping up niche businesses like these in the last eight years. therefore, investing at an early stage is key.

The second way to gain exposure to bespoke automators can be more efficient. By investing in holding companies that incubate a number of niche businesses under their umbrella, investors can gain access to a number of companies at the confluence of automation and digitalisation. For example, globally diversified holding company Roper Technologies, which listed in in the early 1990s, now has annual revenues in excess of $3bn.

Umbrella companies like Roper operate in a centralised manner, imparting margin and cashflow targets, as well as operating mantras, to the groups under ownership. Others, such as Hexagon, act purely as holding companies, keeping the company management, brand and business model in place – while providing cheaper financing and alleviating laborious operations, such as IT or procurement functions.

Automation is moving quickly. The market for the internet of things was valued at nearly $600bn in 2016 and is projected to reach $1.1trn by 2021. Investors cannot afford to overlook the companies at the forefront of this change, where automation and digitalisation intersect.

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