July 15, 2021  |  Global Equity
Digital Reality: What’s Next After Google Glass?

Global Research Analyst

William Benton, CFA, CPA, partner, is a global equity research analyst. He covers small-cap consumer companies. Previously, he covered mid- and large-cap technology, media, and communication services companies. Before joining William Blair Investment Management in 2007, William was a technology research analyst with the firm’s sell-side research group for 10 years. In this position, he was twice named “Best on the Street” in The Wall Street Journal’s annual analyst survey. Before joining William Blair in 1997, he worked at SBC Warburg, U.S. Cellular, May Company, and Monsanto. He is a member of the CFA Society Chicago and holds the CMA designation. William received a B.S. in finance from the University of Illinois Urbana-Champaign and an M.B.A. from Dartmouth College’s Amos Tuck School of Business Administration, where he was a Tuck Scholar.

Global Research Analyst

Drew Buckley, CFA, partner, is a global equity research analyst. He covers small-cap technology, media, and communication services companies. Before joining William Blair in 2008 as a global research associate focused on technology, media, and telecommunications stocks, he spent two years as a senior associate in Ernst & Young LLP’s investment management assurance practice. Drew is a member of the CFA Society Chicago. He received a B.S. in business from the University of Colorado–Boulder.

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In less than a decade we’ve moved from Google smart glasses to Oculus virtual reality headsets; what’s next? In the third installment of our Convergence series, which examines five growth themes that are shaping the future of investing, Hugo Scott-Gall speaks with Global Research Analysts Bill Benton, CFA, and Drew Buckley, CFA, to discuss a vision of the internet in which the virtual and physical worlds become a seamlessly interconnected realm.

Comments are edited excerpts from our podcast, which you can listen to in full below.

 

What is the metaverse? Am I in it? Are you in it?

Bill: It’s actually not a simple question. I don’t know if there is one definition. I think of it as effectively doing everything you do in the physical world within a digital ecosystem. People sometimes think about it as a Roblox or Minecraft experience, where you can create things, interact, and spend money virtually. That gets close, but so does the Tencent ecosystem in China. They have a gaming platform, a chatting platform, entertainment payments, and programs that allow you to connect.

Do you agree with that, Drew?

Drew: Yes. If you’re a science fiction reader, Ready Player One or Ready Player Two are great descriptions of the metaverse. Effectively, at the end point, as Bill was saying, your whole life is lived in digital form. You have a body, of course, and you sustain that life in the physical world, but everything else you do is digital. That’s where you get your education, where you work, where you spend your leisure time. Even sensations—touch, smell, sight—are communicated from the digital reality to your body.

Bill: Obviously we’re not in that metaverse yet. We’re in this in-between state we call “digital reality,” where the virtual and physical worlds are becoming interconnected. Pokémon GO is one example; you can also try on eyeglasses online. Technology itself is not as pervasive as it needs to be to get us to real digital engagement.

There is an argument that virtual and augmented reality are conceptually appealing, but their growth has been a disappointment. The penetration hasn’t come through in the way some have forecast. What are the constraining factors from a technology point of view?

Bill: The technology is older than you would expect. Nintendo offered a Virtual Boy 3D gaming system in the mid-1990s; a decade ago we were talking about Google Glass. But it hasn’t taken off, like you said. A couple of years ago I was talking to a manufacturer of virtual reality devices in China, and it was always “tomorrow.”

Adoption has been slow because of a bad customer experience. You had a chicken-and-egg problem. You need good hardware, but you also need good software. It was disappointing until the last year. Now it feels like the software and hardware are connecting. Unit production of virtual reality headsets is doubling, but so is demand, so it’s still hard to find some of the devices that allow you to interact with this virtual world.

Older generations need to know why you’d want something like this. You have to prove this new technology is better for you than whatever you’re giving up to use it.

— DREW BUCKLEY, CFA

Drew: The one thing I’d add to that is connectivity. You need fast speed, low latency, and a lot of bandwidth to deliver the information and graphics necessary to make the metaverse a real thing, and we just aren’t there yet. But 5G is going to be a big step in that direction. And 5G’s not the end: there will be 6G, 7G, 8G, 9G.

You also need people to adopt the new technology. The younger generations are much faster to adopt. But older generations, even people my age, in their 30s, need to know why you’d want something like this. You have to prove this new technology is better for you than whatever you’re giving up to use it.

So there are three things: hardware/software, connectivity, and consumer adoption. Let’s focus on the hardware and software for a moment. When do you think we’re going to see the technology widely adopted? Because the third part, consumer adoption, is really going to be driven by the first two.

Bill: I think we’re on the edge right now. You’re seeing the hardware in smartphones—camera technology that’s allowing for a 3D experience is coming to market. And companies are getting more serious about building the software because they now see the need for it. Virtual reality (VR) headset sales doubled last year, and are expected to double again this year, but they’re sold out. Something is clearly happening in gaming.

Companies I speak to are discussing augmented reality more than ever because they know it has potential to disrupt their place in the market. If they can use it to create a great customer experience, they can take share from offline retailers, and they can move markets that need the technology to drive penetration but have been slow to adopt.

Drew: I think with hardware and software, you get a layering-on effect. The first set of hardware and software solves the first set of problems; the next set solves the next set of problems; and so on. Now we’re really starting to see hardware and software enable some of the use-cases you want. We’ll have hardware that can deliver better graphics, and motion capture that doesn’t make you feel sick. I think we’re on the cusp of a breakthrough.

Bill: Some people thought cloud computing wouldn’t happen. It went through a period of long adoption because people said things like, “Oh, there are security issues.” But they came up with better solutions, people came around, and the technology ultimately took off. Now everyone says everything is going to be on the cloud.

We’re at a similar stage when it comes to enabling tools in the e-commerce landscape. No one’s using them today because they aren’t good enough, but that doesn’t mean that they aren’t going to be important for tomorrow’s future shopping experience.

And the product that require this kind of interaction—like identifying the eyeglasses you’re going to wear—are penetrated at levels half that of overall spending. So, this type of technology is necessary, and it is coming. I actually think we’re at that stage. I think we’re getting right at the point of inflecting in this space.

You’re going to see it used in areas like education or surgery. And it could be very disruptive to companies that don’t adopt the technology because somebody will move their cheese.

— Bill Benton, CFA

From a hardware/software point of view, are there any other areas you think present a big investment opportunity?

Bill: In terms of finding investment themes around this, we’re often going to be looking at it as an enabling technology, very much the way I think artificial intelligence is for software. It improves existing products, but you’re going to see it used in areas you don’t see today, like education or surgery. That could expand total addressable markets. I think it will find itself into many of our existing investments. And it could be very disruptive to companies that don’t adopt the technology because somebody will move their cheese.

We spent a lot of time on the key enabling technologies, but I’m wondering if that is only half the battle when it comes to understanding this technology. Do we also need psychology—some deep insight into the human soul and its needs and its wants and desires? Is the toolkit required of an investor here different when predicting how people behave in the digital world versus the physical world?

Drew: That’s a great point. We talk a lot about tapping into the human condition to understand what people want.

Going back to your last question, content is also an area of opportunity, a profit pool that should continue to expand. Think about how advertising has moved online over the last 20 years. I might be unique, but I don’t actually mind getting ads pushed at me on Instagram if they’re for products I think I might use. Advertisers have created an interesting proposition in knowing what I want and serving me ads related to that.

If you think that through to the logical endpoint—how understanding human behavior can increase happiness—I’m not mad that they’re driving something to me that way. But the darker side is that they have all my information.

You give up an element of free will to get served ads that make your life easier by helping you find products you like. I think it’s important for companies to understand that as they look to these profit pools. What do people really want? What are they willing to give up to get it?

This technology can add to a feeling of true social connection. They’re putting VR technology in nursing homes. It’s solving a loneliness problem.

— Bill Benton, CFA

Bill: I’d just add that humans are looking for social connection, and this technology can add to a feeling of true social connection. They’re now putting VR technology in nursing homes to create a family connection remotely. It’s solving a loneliness problem.

Drew: Another example is TikTok. Think how quickly that took off. To know that was coming, you would have had have to understand what people are seeking in their social experience online. You would have had have to understand all the building blocks that came before it: Instagram, Twitter, QQ, Tencent, WeChat, etc. What do people want to use the internet for? What need is it providing? I think that will be really important to understand. And knowing that, we’ll know where the profit pools are going.

Bill: Another area where I think the technology can be used is around experiences. Disney World puts you in a ride where you fly across the world, and as you’re soaring they blow things on you. That kind of experience is another social need—to experience something different. Not everyone can do that, and the technology allows you to have these types of experiences.

A social contract exists in the physical world that is just generally more broken in the digital world.

— Bill Benton, CFA

Has the hierarchy of needs simply been transplanted from the physical world to the digital world? So people behave in the digital world the same as they do in the physical world? Or is the digital world freeing in a way, leading people to behave differently? It can be a chance for reinvention. There are fewer constraints. I ask because I think there is tremendous upside for us as investors in getting it right.

Drew: I think it’s different. The digital world allows anonymity: You can change who you are depending on which reality you’re in. There are also all sorts of smaller communities where you can seek out like-minded people, which is more difficult in the physical world. And you can broadcast as much as you want. You can show yourself doing dances on TikTok or show pictures of your kids on Instagram, or just consume. And because digital reality allows people to be different, you need psychology. We’re not psychologists, but we try to understand what makes somebody do something. We keep coming back to that as we try to understand what drives user engagement and staying power, then how to monetize that.

Bill: I think at the core the wants and needs are exactly the same, but there is a greater likelihood of bad behavior in the digital world than the physical world. A social contract exists in the physical world that is just generally more broken in the digital world. People do dances in both worlds, but in the digital world you have people who want to signal their status. They’ll throw virtual flowers that cost thousands of dollars at performers they like; they’ll throw virtual eggs at people who don’t sing quite as they should when doing karaoke.

Drew Buckley, CFA, partner, and William Benton, CFA, partner, are research analysts on William Blair’s Global Equity team.

Global Research Analyst

William Benton, CFA, CPA, partner, is a global equity research analyst. He covers small-cap consumer companies. Previously, he covered mid- and large-cap technology, media, and communication services companies. Before joining William Blair Investment Management in 2007, William was a technology research analyst with the firm’s sell-side research group for 10 years. In this position, he was twice named “Best on the Street” in The Wall Street Journal’s annual analyst survey. Before joining William Blair in 1997, he worked at SBC Warburg, U.S. Cellular, May Company, and Monsanto. He is a member of the CFA Society Chicago and holds the CMA designation. William received a B.S. in finance from the University of Illinois Urbana-Champaign and an M.B.A. from Dartmouth College’s Amos Tuck School of Business Administration, where he was a Tuck Scholar.

Global Research Analyst

Drew Buckley, CFA, partner, is a global equity research analyst. He covers small-cap technology, media, and communication services companies. Before joining William Blair in 2008 as a global research associate focused on technology, media, and telecommunications stocks, he spent two years as a senior associate in Ernst & Young LLP’s investment management assurance practice. Drew is a member of the CFA Society Chicago. He received a B.S. in business from the University of Colorado–Boulder.

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Glossary

INDICES
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid ARM pass-throughs), asset-backed securities, and commercial mortgage backed securities.

The MSCI ACWI IMI Index is a free float-adjusted, market capitalization-weighted index that captures large, mid, and small cap representation across developed and emerging markets.

The MSCI ACWI ex-US IMI Index is a free float-adjusted, market capitalization-weighted index that captures large, mid, and small cap representation across developed and emerging markets, excluding the U.S. The Value and Growth Indices are a subset of the Index that adopt a framework for style segmentation in which value and growth securities are characterized using different attributes. Multiple factors are used to identify value and growth characteristics.

The MSCI ACWI Small Cap Index is a free float-adjusted, market capitalization-weighted index that captures small cap representation across developed and emerging markets.

The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of emerging markets.

The MSCI World Index is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of developed markets.

The Russell 2000 Index is a market capitalization-weighted index designed to represent the small cap segment of the U.S. equity universe.

Index performance is for illustrative purposes only. The indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly.

TERMS
Alpha is a measure of an investment's return in excess of the market's return, after both have been adjusted for risk.

Beta is a measure of the volatility of an investment relative to the overall market, represented by a comparable benchmark.

Half-life is a statistical measure of the time required for the discrepancy between price and value to contract by half of its starting value. Fundamental value estimates are based on the Dynamic Allocation Strategies team's proprietary research.

P/E Ratio is a measure of valuation which compares share price to earnings per share, calculated using estimates for the next twelve months.

Standard deviation is a statistical measurement of variations from the average.

QUANTITATIVE MODELS – FACTOR DEFINITIONS
The William Blair Earnings Trend Model captures information about short- and medium-term changes in analyst estimates in an attempt to anticipate future estimate changes and stock performance. The score combines measurements of earnings revisions, momentum, and earnings surprise.

The William Blair Valuation Model combines varying metrics used to characterize the relationship between the stock’s trading price and its intrinsic value. By going beyond using only one or two measures, the model attempts to build a more holistic version of a stock’s worth vis-a-vis the market. The score combines measurements of earnings/cash flow based, asset-based, and model-based factors.