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Equity Perspectives

Relentless innovation in e-commerce, hosted software, social networking, mobility, and cloud computing has transformed the way we work, shop, play, travel, learn, and consume content, and the pace of change will likely increase.

Of all the "growth rivers" with the potential to flow long distances, nothing captures the imagination like the perpetually expanding digital ecosystem of substantial new markets enabled by the Internet. Relentless innovation in e-commerce, hosted software, social networking, mobility, and cloud computing has transformed the way we work, shop, play, travel, learn, and consume content, and the pace of technological change will likely increase.

Never mind how slow the economy has been over the last several years. Companies that have enabled consumers and businesses to navigate a rapidly interconnected world using all kinds of innovative applications anywhere, anytime, and with any device—"the new Triple A"—have achieved phenomenal secular growth.

The strongest evidence can be found in e-commerce, hosted software, social networking, cloud computing, and in the boom in mobility.

As a detailed analysis by McKinsey pointed out, the Internet now accounts for a larger percentage of gross domestic product (GDP)1 in many developed countries than agriculture and energy, and its role in GDP growth is increasing rapidly.2 One driver is the geometric [exponential] growth of mobile Internet devices versus their stationary desktop counterparts thanks to better processing power, improved mobile operating systems (such as Android and iOS) and applications, improved coverage with ever-expanding bandwidth, expanded service, and lower prices. (See Chart 1.)


 

Chart 1. Mobile Internet Devices Poised for Huge Growth

Reduced usage friction via better processing power + improved user interface + smaller form factor + lower prices + expanded service = 10x more devices

Source: Morgan Stanley. Projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.


All of which explains why Lord Abbett has focused on companies that provide:

  • Industry-leading search technology, e-commerce platforms, coupon sites, digital photography services, and online real estate data
  • A wide range of social media platforms that have enabled users to buy (and share opinions about) practically everything and have turned into powerful advertising vehicles that can target potential customers based on their search habits
  • Online streaming video and music services
  • Interactive restaurant reservation platforms
  • Online travel expense management
  • Advanced wireless networking equipment that can connect users more efficiently
  • "Big Data" software that makes astronomical amounts of machine-generated data accessible, usable, and valuable to everyone in a timely manner

The faster consumers and businesses can consume data in any location, the greater the commercial possibilities, in our view (see our article, "Will Creative Destruction Rekindle Growth?" on lordabbett.com), and not just in the United States, Japan, and Korea—three countries with the highest penetration of both landline and mobile Internet. We also see significant upside potential in emerging markets such as India, Indonesia, the Philippines, and Argentina, where the number of Internet users is showing much higher year-over-year growth, thanks to smartphones as powerful as personal computers were several years ago, which can now spread applications to the masses. (See Table 1.)


 

Table 1. Global Internet Usage Has Shown Significant Growth, but Emerging Markets, Particularly Those Without Landline Systems, Are Growing Even Faster

Source: United Nations/International Telecommunications Union.
Note: All data (except China) as of June 12, 2012. 2.4 billion global users and 8% year-over-year growth rate based on the latest available data. China Internet user data as of December 12, 2012, per CNNIC. MMs = millions.


The implications of that kind of growth are staggering. Consider how the number of connected objects is on track to reach 50 billion by the end of the decade (see Chart 2); how global mobile traffic will likely follow suit (see Chart 3) and become a much greater part of the Internet (see Chart 4); how the growth of increasingly powerful smartphones and tablets is in its early stages (see Chart 5); and how smartphone penetration of emerging markets still has a long way to go (see Table 2).


 

Chart 2. The Number of Connected Objects Is Expected to Reach 50 Billion by 2020

Penetration of connected objects in total "things" expected to reach 2.7% in 2020 from 0.6% in 2012

Source: Cisco Systems.
Projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
The "Internet of Things" refers to the proliferation of microprocessors embedded in all kinds of items, ranging from home appliances, closed-circuit cameras, elevators, credit cards, cars, and many more.


 

Chart 3. Global Mobile Data Traffic Is Expected to Increase 13X by 2017

66% CAGR,* 2012–17

Source: Cisco Visual Networking Index, Global Mobile Data Traffic Forecast, 2012–2017.
Note: An exabyte is a unit of information equal to one quintillion (1018) bytes, or one billion gigabytes.
Projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
* CAGR refers to compound annual growth rate; i.e., the year-over-year growth rate over a specified period of time.


 

Chart 4. Mobile Traffic Is Grabbing a Greater Share of Internet Traffic

Global mobile traffic as % of total Internet traffic, December 2008–May 2013 (with trendline projection to May 2015E)

Source: StatCounter Global stats, May 13, 2013.
Note that PC-based Internet data bolstered by streaming video. Projections are based on current market conditions and are subject to change without notice.
Projections should not be considered a guarantee


 

Chart 5. Smartphone Usage Is Still Early Stage with Tremendous Upside

Global smartphone versus mobile phone users, 2013E

Source: Morgan Stanley Research estimates.
Note: One user may have multiple devices. Data as of May 2013. Projections are based on current market conditions and are subject to change without notice.
Projections should not be considered a guarantee.


 

Table 2. Smartphone Penetration of Emerging Nations Is Still Relatively Low

Smartphone subscriber growth remains rapid: 1.5 billion subscribers, 31% growth, 21% penetration in 2013E

Source: Informa. Data as of May 2013.
* Japan data per Morgan Stanley Research estimate. Projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.


Also consider the potential for so-called wearable technology: smart watches, fitness bands, and computerized eyeglasses, for instance, all connected to the Internet by wireless technology.

Some smart watches function as personal digital assistants. More sophisticated models function more like smartphones and portable media players. As technology improves, still other versions may include features such as a camera, thermometer, GPS navigation, and so on.

Fitness bands can monitor your heart rate, breathing, and steps taken, and then transmit all that data to your smartphone or tablet.3 Although extremely expensive at the moment, computerized eyeglasses have been touted for their potential to help consumers:

  • Give presentations
  • Stay on top of busy work schedules
  • Engage in conference calls and interviews while on the move
  • Instantly access information

They also have the potential to help the disabled in the workplace.4 There's even a device, currently in clinical trials, that is being used during surgical procedures to allow doctors to access information quickly and easily.5

As a recent NPD Group Research report put it, "The connected consumer is driving innovation, integration, and disruption to the status quo at a dizzying rate, with almost all consumer-related industries facing a significant shift in what, how, and where to sell to the consumer. Content-based industries are migrating to a digital environment that continues to morph as streaming overtakes downloads. Meanwhile, the very market that helped create much of this disruption, the mobile market, is itself facing an ongoing overhaul with mobile-only strategies being challenged by the consumer's desire to connect across multiple platforms both within and outside of the home."

Major advances in technology have driven robust growth in cloud computing that analysts expect will last for a number of years. Among the most significant catalysts are:

  • A tremendous increase in bandwidth (i.e., the digital pipeline that can handle greater data traffic)
  • The proliferation of consumer-friendly applications with better user interfaces
  • Advances in grid computing
  • Improvements in network storage systems
  • Commodity servers that lower costs6

Hosted Software
One of the most dramatic aspects of the cloud phenomenon is the proliferation of software as a service, an application-delivery model whereby software code and associated data are hosted centrally in the cloud and usually accessed through a web browser over the Internet. The software is typically paid for on a subscription basis. Companies in this area range from the leading sales force productivity software provider to a company that helps small businesses, associations, and nonprofits connect through public relations with their customers, clients, and members, and to a firm that dramatically lowers costs by automating expense reports. They also include a provider of user-friendly, web-based medical billing, practice management, and electronic health record services.

In the meantime, ubiquitous connectivity enabled by the global expansion of the cloud and mobile devices is revolutionizing numerous industries. That's because social networks and mobile technologies make it possible to create service platforms that create value for customers with tremendous ease.7

Indeed, using the cloud may never be the same now that lower-cost hardware and commoditized software have brought easy, broad options to practically anyone with a web browser. Consumers may be most familiar with cloud-enabled e-commerce, collaboration, photo sharing, streaming music and video, Internet videoconferencing, user-generated content, storage, backup, and myriad portal services. But behind the scenes, businesses of all types are moving to the cloud for software and network infrastructure, application development, application servers, databases, operating systems, security, troubleshooting, monitoring, testing, business software, business intelligence, collaboration, content management, customer relationship management, high-performance computing, and project management, among other uses.8

"The magnitude of upcoming change will be stunning," said Mary Meeker, the venture capitalist and former Internet analyst. "And we are still in spring training."9

Connectivity Enters a New Phase
According to Michael Mandel, chief economic strategist for the Progressive Policy Institute, the most potential lies with the industries that are not as digitized today.

"The Internet has mostly transformed information-intensive industries like journalism, entertainment, communications," he said. "It becomes much harder to use the Internet to transform physical industries; it's much more complicated. You need a lot of sensors, big data capability to process it, ways of getting it to people to make decisions. Physical industries, like manufacturing and transportation, haven't been affected that much."10

Enter the "Internet of Things," also known as "Machine to Machine" communication, terms that refer to the proliferation of microprocessors embedded in all kinds of items: home appliances, cars, credit cards, passports, family pets, the closed-circuit camera on your street, the elevator in your office, and many more. Along those lines, Lord Abbett's growth team has invested in a maker of devices that help people reduce home energy use and another product that keeps families safe in their homes with more reliable technology and more detailed information than traditional battery-powered alarms.

Connect all those with applications and services that synthesize and analyze the data in this greatly expanded network, and you have the makings of another technology revolution.11 As Peter Lucas, Joe Ballay, and Mickey McManus put it in their book, Trillions: Thriving in the Emerging Information Ecology:

"The challenges and opportunities—technical, business, and human—that this technological sea change will bring are without precedent. Entire industries will be born and others will be laid to ruin as our society navigates this journey.

"There are already many more computing devices in the world than there are people. In a few more years, their number will climb into the trillions. We put microprocessors into nearly every significant thing that we manufacture, and the cost of routine computing and storage is rapidly becoming negligible. We have literally permeated our world with computation. But more significant than mere numbers is the fact we are quickly figuring out how to make those processors communicate with each other, and with us. We are about to be faced, not with a trillion isolated devices but with a trillion-node network: a network whose scale and complexity will dwarf that of today's Internet. And, unlike the Internet, this will be a network not of computation that we use but of computation that we live in."

The Expanding Digital World
One of the common themes in Lord Abbett's growth portfolios has been the extent to which connectivity has enabled companies to grow very rapidly in all parts of the world, even though Internet adoption is still in its relatively early stages. Today, only 2.7 billion people—just over one-third of the world's population—have access to the Internet. But a recently launched global partnership called Internet.org aims to make Internet access available to billions more. We expect that these will participate in future e-commerce. Perhaps just as important, the existing 2.7 billion users can be expected to integrate the Internet to a much greater degree.

Of course, there are huge barriers in developing countries to connecting and joining the knowledge economy, but the goal of Internet.org is to overcome three key challenges:

1) Making access affordable. Partners will collaborate to develop and adopt technologies that make mobile connectivity more affordable and decrease the cost of delivering data to people worldwide. Potential projects include collaborations to develop lower-cost, higher-quality smartphones and partnerships to more broadly deploy Internet access in underserved communities.

2) Using data more efficiently. Partners will invest in tools that dramatically reduce the amount of data required to use most apps and Internet experiences. Potential projects include developing data-compression tools, enhancing network capabilities to more efficiently handle data, building systems to cache data efficiently, and creating frameworks for apps to reduce data usage.

3) Helping businesses drive access. Partners will support development of sustainable new business models and services that make it easier for people to access the Internet. This includes testing new models that align incentives for mobile operators, device manufacturers, developers, and other businesses to provide more affordable access than previously possible. Other efforts will focus on localizing services—that is, working with operating-system providers and other partners to enable more languages on mobile devices.12

"The world economy is going through a massive transition right now," said Facebook founder and CEO Mark Zuckerberg. "The knowledge economy is the future. By bringing everyone online, we'll not only improve billions of lives but we'll also improve our own as we benefit from the ideas and productivity they contribute to the world."13

The Lord Abbett Approach
In searching for the best companies in the global digitization race, the growth team looks for four key attributes: a sound business model that scales well; favorable industry trends; a demonstrable competitive advantage; and, of course, good management capable of making the right decisions and maintaining investor trust. We try to concentrate on the companies that have secular growth opportunities, which should enable them to grow over three- to five-year periods or longer. When it comes to technology, that means focusing on disruptive trends, which subsequently should allow such companies to grow at a strong rate.

Once a company meets those criteria, the growth team will look at a company's revenue and earnings growth to be the primary driver of stock outperformance. When the fundamental prospects of a business and the technical profile of a stock improve in tandem, we might double a position on a stock after a significant jump and maintain that position if rigorous research suggests there is further potential for appreciation. It is also critical to know when to sell and not give back too much of our earlier gains on investments in companies when they were riding high.


1 GDP, or gross domestic product, refers to the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment, and government spending, plus the value of exports, minus the value of imports.
2 "Sizing the Internet Economy," McKinsey Global Institute, May 2011.
3 Steve Kovach, "The Next Big Thing in Tech Is Wearable Computing, and These Experts Will Tell You Why," Business Insider, November 6, 2013.
4 See "Top 10 Google Glass Uses That Could Revolutionize Businesses," V3.co.uk, August 2, 2013; and Maria Doyle, "How Google Glass Is Now Being Used During Surgery," forbes.com, November 5, 2013.
5 Matthieu Pélissié du Rausas, James Manyika, Eric Hazan, Jacques Bughin, Michael Chui, and Rémi Said, "Internet Matters: The Net's Sweeping Impact on Growth, Jobs, and Prosperity," McKinsey & Company, May 2011.
6 Kash Rangan, Milesh Dhruv, and Jaimin Soni, "The Cloud Wars: From Disruptive to Pronounced to Tectonic," presentation, Bank of America Merrill Lynch Global Research, May 21, 2010.
7 Brandon Gutman, "Sears' Ph.D. of Social Media Explains How Brands Can Create Orbits to Pull in Customers," forbes.com, April 11, 2012.
8 Alan Shimel, "I Have Seen the Future of the Cloud: AWS Marketplace," Network World, April 19, 2012.
9 Mary Meeker, "Internet Trends," presentation, D10 Conference, May 30, 2012.
10 Jeremy Rifkin, The Third Industrial Revolution: How Lateral Power Is Transforming Energy, the Economy, and the World (New York: Palgrave Macmillan, 2011).
11 Andrew Nusca, "The Internet of Things Is 'Fundamentally about Economic Value,'" Between the Lines, ZDNet.com, September 19, 2013
12 "Technology Leaders Launch Partnership to Make Internet Access Available to All," Internet.org, August 21, 2013
13 Katherine Jacobsen, "Zuckerberg Announces Plan to Increase Internet Connectivity," Christian Science Monitor, August 21, 2013

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