The Hottest Trend In Electronics Isn’t Wearables

Wearables were all tech investors could talk about last year, with innovations like the Apple Watch and fitness tracker products. This year, though, Apple’s (Nasdaq: AAPL) disappointing sales have tempered investor enthusiasm for the group. 

New innovations in virtual reality seem to be getting a lot of attention, but we could still be years from a mass-market, profitable product. 

#-ad_banner-#As investors search through patent applications and hunt for the next big consumer electronic craze, one trend has emerged under the radar.

Industry demand is projected at double-digit growth over the next several years, with unit sales in the billions. Investors have completely missed the trend because it involves components hidden away inside the most popular tech gadgets.

One company controls nearly two-thirds of the market for this hot tech trend and is doing what it takes to keep its lead through innovation.

A Voice-Assist Future
All of the major consumer electronics companies have a product push tied to voice-assist technology. Apple was one of the pioneers with Siri, but others have recently unveiled major innovations. Amazon’s (Nasdaq: AMZN) desktop speaker, Alexa, takes voice commands for everything from music to internet searches. Google’s (Nasdaq: GOOGL) Home can control the smoke alarm, and Microsoft’s (Nasdaq: MSFT) Cortana can text your contacts with directions.

The trend toward voice-assist interaction in consumer electronics wouldn’t be possible without micro-electromechanical systems (MEMS) microphones. New products are incorporating more microphones to improve clarity and recording when sound comes from different directions. There was just one microphone in the first iPhone, but there were four in the iPhone 6s. Motorola’s Droid Turbo has five mics, and Amazon’s smart speaker Echo has seven.

Research firm IHS forecasts the MEMS market could grow from 3.6 billion units last year to over 6 billion in 2019. The market value of industry sales could rise at a compound annual rate of 13% to $1.3 billion through 2019.

This Company Dominates MEMS And Is Spending To Keep Its Advantage
Knowles Corporation (NYSE: KN) is the runaway leader in the space, with 59% of the MEMS microphone market, and is a supplier to Apple, Samsung and Amazon. The company has been making audio electronics for over 70 years, and was spun off from Dover Corporation in 2014.

The company is also the market leader in acoustic components within hearing aids, and holds a strong position in capacitor products used in medical implants. Nearly two-thirds (61%) of 2015 sales were from MEMS, with the rest booked in its specialty components segment.

To innovate and improve performance, the company is spending on software development to allow mics to activate intelligently. In 2015 the company completed its acquisition of Audience Inc., a leading provider of intelligent voice and audio solutions, in order to improve user experience in mobile devices.

Revenue has slipped by 11% over the last two years as microphone component prices become cheaper. The company has also booked restructuring charges over the last few years in order to consolidate its manufacturing and improve profitability. Despite the headwinds, Knowles beat earnings expectations by an average of 81% in each of the last four quarters to report $0.71 per share. 

Knowles agreed to sell its speaker and receiver product line to Loyal Valley Innovation Capital in May. Deal terms weren’t disclosed, but the product line accounted for $374 million of 2015 sales and $441 million in assets, and the sale could mean a significant boost to cash. In its 2015 annual report, management pointed to the potential for significant improvements in profitability, a reduction in capital expenditures and stronger free cash flow due to the planned sale.

The company has just $345 million in net debt, which could be completely paid off with the sale of the speaker line. At a multiple of 1.6 times sales, a conservative estimate on retail tech deals, the company would still have more than $250 million in cash after paying down debt. That kind of cash position combined with dominance of a growing market could make Knowles an acquisition target itself, or attract interest from activist investors.

Shares currently trade for 19.5 times trailing earnings. Forward earnings are expected to jump 42% to $1.01 per share. Even a conservative 17-times multiple means a 24% increase in the shares to $17.17 each, which seems likely, as the company stands to improve fundamentals significantly and benefit from market growth.

Risks To Consider: The MEMS market is still relatively new and competitors may chip away at Knowles’ market share or cause the leader to compete on lower prices.

Action To Take: Take a position in the market leader in one of the hottest trends in consumer electronics by buying shares of Knowles

Editor’s Note: It pays to invest in the companies supplying those making technological leaps and bounds. Tesla CEO Elon Musk is building a large battery farm in Hawaii to store energy from island sunshine. It’s just his latest move to grow his energy storage business. Here are three little-known energy companies riding Tesla’s huge 10-bagger technology wave. This report reveals the full story.