Looking beyond Apple for opportunities in the next iPhone

Over the last few years, global smartphone adoption has surged to more than 2.5 billion users, and is on a clear path to double again. However, the pace of radical innovation appears to have stalled: manufacturers have focused on iterative upgrades to screen size and camera quality while Apple has only introduced marginal improvements to its iPhone design over the last three years. This suggests one of two things: either that this beacon of innovation has run out of ideas or that it is working on something truly revolutionary. We believe it is the latter, and that Augmented Reality (AR), enabled by 3D sensing, will be the cornerstone new feature of the iPhone 8, introduced this Autumn to mark the tenth anniversary of the original iPhone.

Augmented Reality, which allows users to superimpose graphics and data onto footage of the physical world, has already become a mainstream hit through platforms like Pokémon GO and Snapchat. However, the current smartphone AR experience is relatively rudimentary because it relies on a simple 2D camera. The obvious missing link is a 3D sensor. Simply put, to properly augment content onto the real world, your phone must be able to detect the location and depth of objects around it. A 3D camera works much like the human eye, opening up incredible opportunities far beyond today’s selfie filters. Facial and gesture recognition are some of the first-use examples of this technology. But, further along the line, people will be able to see how furniture looks in their homes before they buy it or order the tie on the person next to them with one click.

Currently the two leading technological approaches to 3D sensing are known as “Time-of-Flight” and “Structured Light.” The former measures distances by determining the time it takes for a light pulse to travel to an object and back, whereas the latter illuminates an object with a regular pattern of multiple light beams and calculates distances based on the deformation of the reflected light pattern. In both cases, the 3D sensing module consists of three key components: a vertical cavity laser light source (VCSEL), an optical system, and an optical sensor. Although Apple has not revealed anything about its latest release (as usual), recent earnings calls of the leading global laser supplier confirm the receipt of very large-scale orders, on a timeline that fits perfectly with Apple’s expected release date.

Based on our extensive research, including patent application reviews and conversations with industry experts, we believe that STM will be supplying at least one of the 3D sensors in the new iPhone. STM has revolutionised Time-of-Flight technology by using single photon avalanche diodes (SPAD), which can capture individual photons with much higher time-of-arrival resolution than of competitors’ technologies. These cameras can handle both depth and motion, and experts believe that STM is currently the only company that has been able to scale the technology down to the size required for smartphones, at a two-to-three times cheaper cost than others available. We believe that the secrecy around Apple’s plans and the technical complexity of 3D sensing has kept STM’s unique position under the radar. However, once the phone is launched, we expect the market to start recognising the company’s unique edge and leadership in this emerging $6bn industry.

We think that STM should be able to generate an additional $1bn in revenues from 3D sensing alone in 2018, significantly higher than what most analysts are forecasting. Beyond the smartphone market, STM is very well positioned to benefit from the rapid development of the internet of things, autonomous vehicles and the emergence of smart homes.

As technologies such as smartphones and smart appliances evolve, investors can still find opportunities to benefit from these developments. Looking beyond end manufacturers to the suppliers of their underlying component technologies provides a compelling access point in companies that are often undervalued because of their little-understood products.

Stuart Mitchell, manager of the SWMC European Fund

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