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Novato 5
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October 2016


The next “really big thing” is here, and it is bigger than “the last really big thing”. Remember Metcalfe’s Law? That the value of the network grows in proportion to the square of the number of users connected to that network. Robert Metcalfe, the inventor of Ethernet, first postulated this to describe the value created by networking computers in the early 1980’s. In other words, a network becomes exponentially more useful as the number of its participants grows.

In one of its earliest incarnations in the 1980’s, Metcalfe’s Law was applied to the networking of personal computers. Here, the value proposition was merely the sharing of basic resources, some files and some printers. Over the course of the decade only about 65 million PCs were connected. And yet, an investment boom was born. In the 1990’s, computers were connected to the Internet. By 2000, about 1 billion devices had Internet access. The result, investors enjoyed the technology bubble of the late 1990’s. In January of 2007, the late Steve Jobs introduced the iPhone, and this promoted not only new Internet connections, but also an ability to easily connect with each other. About 3.5 billion connections later, the social networking revolution was born. Prompting the rise of Facebook, Uber, Airbnb, and the sharing economy broadly.

So what is the next “big thing”? It is machines connecting to other machines, a vast network of all kinds of devices interconnected, and, of course, interconnected through the Internet. This is often referred to as the Internet of Things, or IoT. To fully appreciate the scale and scope of this opportunity, we anticipate tens of billions of connections rather than the four billion today. Moreover, we expect the speed with which the IoT develops to be dramatically faster than its predecessor networks. The reason for the accelerated development will be massive business adoption. Firms already recognize the need to participate or become relics of the past. And the likes of GE, Cisco, Intel, and others to ensure participation are already spending billions of dollars on various efforts.

Early incarnations of the IoT are evident already. Intelligence in homes controlling various appliances is making the mark. Smart thermostats, control systems for lighting, and even modules for controlling entertainment are enjoying market acceptance. Notice the technology being applied to the automotive industry in the form of driver assistance functions, and ultimately, self-driving cars. Robotics embedded with this technology is revitalizing factories allowing for a manufacturing renaissance in non- low cost labor geographies. Even forward thinking municipalities are deploying IoT to control street lighting, traffic flow, and other public utility related services.

Again, these events are happening now, and the pace of change is about to accelerate. Why accelerate? Because as the number of networked devices grow, the opportunity for application development and deployment grows concomitantly. An accelerating, self-reinforcing cycle is born. Furthermore, the payback from the IoT and its associated applications should be much more compelling than that of social media or even the early networks of computers, owing to unmatched productivity gains. Again, ensuring broad –based and extremely rapid business participation.

Now stock market observers suggest that not much is actually happening, that the market is in a consolidation phase until after the US Presidential elections. Many are anticipating a moderation of the already disappointing economic growth, calling for a recession in 2017. This is rapidly becoming conventional wisdom. And yet we see something different- a secular trend and growth opportunity powerful enough to overcome most any policy obstacles. We would note that at significant points of inflection, conventional wisdom is often wrong. Two recent examples, the policy leaders and cheerleaders for the housing bubble in the mid-2000’s saw nothing coming that would interrupt the party- conventional wisdom at the time, “party on”! Next stop, the “Great Recession”. And more recently, the United Kingdom vote to leave the European Union. Prior to the vote most polls and certainly conventional wisdom pointed to the UK remaining with the status quo. Next stop, the “Brexit”.

So here we are again, the economy is about to be transformed by a bunch of sensors, actuators, software, semiconductors, and communications technologies. These will lead to applications and services that are difficult to imagine today. The pace of change will be startling. Investors recognizing the opportunity will enjoy enormous returns. 2017 promises to be an exciting year, particularly for the contrarian.

Michael P. De Santis - General Partner
Bruce M. Lupatkin - General Partner