When I wrote early this year about the coming Internet boom, my purpose was to highlight dot-com 2.0 stocks and companies that would benefit from an increase in domain names and advertising.
I recommended four names: Verisign (Nasdaq: VRSN), Google (Nasdaq: GOOG), Marchex (Nasdaq: MCHX) and ValueClick (Nasdaq: VCLK) as companies ready to ring the cash register. Since that article was published in January, all but ValueClick have easily beaten the market, with 40% to 50% gains in Google and Verisign and a whopping 120% gain by Marchex.
But there is another facet of the Internet boom coming -- and no one is talking about it. When it happens, I think it will be one of those things that people look back on and ask: "In hindsight, it was so obvious. Why did I not invest?"
This next big wave is something that is already affecting the way people use the Internet and bringing about massive changes in the software and hardware space. It plays on the same emotions that made YouTube and Facebook (Nasdaq: FB) household names.
We Are Social Animals
As humans, we feel compelled to share ourselves with friends, family and, well, the world. This drive goes way beyond being connected to the ones we love. It is way deeper. It drives people to post things that they would never think about sharing in person.
Think about it: A Google search for "cat videos" results in more than 900 million sites and videos. Are there really almost a billion things we need to see or know about cats?
Now understand that each of the billions of videos posted online required someone to have their smartphone or video camera ready. What happens when someone simply has to say, "Record a video?"
|Google Glass users will be able to record video or stream it directly to the Internet almost at will. As a result, companies will need to supply extra hardware, storage and networking to support the growth.|
That is what Google Glass promises to offer.
Glass users will be able to record video or stream it directly to the Internet almost at will. The quality of video on the Internet may go down, but the quantity could explode higher. A release early next year is rumored, and Google is now allowing product testers to sell their glasses online.
With 1.1. billion users, Facebook also has big plans for video on its site. The social network has delayed the rollout of its site's video ads, but the opportunity to reach that many users with a video feed is enthusiastically anticipated by advertisers.
What does this mean for the Internet? Video eats up a tremendous amount of bandwidth and storage, neither of which has kept up with current demands. I can only imagine the explosion in content when Google Glass users have opportunity to record or stream every minute of their lives.
And the impetus isn't just from Google Glass. The preponderance of smartphones is driving a huge increase in video growth. Cisco Systems (Nasdaq: CSCO) estimates that smartphones will outnumber people by 2016, reaching 10 billion, and sending out an immense amount of traffic.
Only a third of the world's population is online and Internet traffic hit 242 exabytes in 2010. (An exabyte is equivalent to 1 quintillion bytes; a quintillion is a billion billion, or a 1 followed by 18 zeros.) Cisco estimates that data traffic will exceed 966 exabytes per year by 2015, which is the equivalent of all the movies ever made crossing IP networks every four minutes ...and that is without the explosive growth in video that I'm forecasting.
Who Will Benefit?
For the Internet to support the massive increase in bandwidth, someone will have to supply the hardware, storage and networking. Cisco Systems is a major player here and the shares recently went on sale due to a weak outlook on business in China.
I think investors could do well with Cisco or other players, but my favorite is a best of breed with two horses in the race.
EMC Corp. (NYSE: EMC) is one of the world's largest suppliers of enterprise storage and has been gaining market share against peers in the industry. The company also owns 80% of VMware (NYSE: VMW), the leader in cloud virtualization -- so not only do investors get an industry leader in storage with stable cash flows, they also get growth upside as the computerized world shifts to cloud-based services.
EMC has been gaining share in the storage market since 2009, mostly at the expense of Hewlett-Packard (NYSE: HPQ) and Oracle (NYSE: ORCL), and has allowed management to buy back more than $7 billion in shares and begin paying dividends this year.
At EMC's most recent annual meeting, management made the long-term commitment of returning 50% of free cash to shareholders. There is $3.5 billion left in its share buyback program expiring in 2015, which could mean that the share count could decrease by 7%, even after dilution from convertibles and warrants.
Adoption of cloud services has just begun to gain momentum with tech research firm Gartner predicting growth of 18.5% this year to $131 billion. Estimates for the potential size of the market vary, with growth to $270 billion expected by 2020. As more users start to overload servers with video content, more companies will switch to a cloud-based system to save on hardware costs.
EMC trades at 13.6 times trailing earnings, well below the multiple of 17 times for the general market. This is a company with a ton of growth and cash flow ahead, and I think it deserves a premium price on the market. Revenue has increased at a compound annual rate of 10% over the past five years and could pick up momentum over the next few years.
With estimated earnings of $2.05 per share in 2014 and a price-to-earnings ratio of 17, my target price for EMC is $34.85, equaling 46% upside. Even that target may not account for the possibility of huge growth over the next few years as storage and cloud services increase. I own shares and would be a buyer at any price below $27 per share.
Risks to Consider: EMC's largest segment, information storage and infrastructure, accounts for 75% of sales and has been weak with year-over-year growth of only 2% in the most recent quarter. The company has some strong long-term upside, but shares could be weak over shorter periods.
Action to Take --> Storage, networking and cloud names like EMC could surprise the market over the next couple of years as an explosion in Internet video content demands more bandwidth and storage. Look for companies that already have strong cash flow and can benefit the most from the coming boom.