There's been a lot of hype recently about the virtual and augmented reality markets. Tech M&A advisory firm Digi-Capital believes that the global VR market could reach $30 billion by 2020, while the AR market could be worth a whopping $120 billion.
Therefore, let's take a closer look at two VR-related stocks that didn't rally and outperform the market in 2016 -- Intel (NASDAQ:INTC) and InvenSense (NYSE:INVN). Are these two laggards actually value plays on the VR market? Or do their core businesses face too many headwinds to make them compelling buys?
What's Intel's VR strategy?
Intel stock has stayed nearly flat over the past year due to ongoing concerns about sluggish PC sales and weak demand for its data center chips. Those two businesses still generate the lion's share of Intel's revenue, although the chipmaker has been expanding into adjacent markets like Internet of Things (IoT) modules, non-volatile memory, and virtual reality.
Back in August, Intel unveiled Project Alloy, a mixed reality headset which is powered by Intel's sixth generation Core processor and RealSense depth-sensing cameras. The headset, which is similar to Microsoft's HoloLens, uses depth-sensing cameras that enable it to project "holographic" computer images on top of real-life objects. Unlike Facebook's Oculus Rift and Sony's PlayStation VR, the Alloy is an "all-in-one" headset which doesn't need to be tethered to a high-end PC or console.
Intel is offering Project Alloy as an open-source reference design for companies in a bid to gain market share in the headset market. If that effort pays off, it could evolve into a new stream of revenue for Intel over the next few years, considering that Piper Jaffray estimates that annual shipments of VR headsets could reach 500 million by 2025.
That plan sounds promising, but Intel's rival Qualcomm (NASDAQ:QCOM) also recently launched a similar VR reference design powered by its Snapdragon 820 processors. If Qualcomm leverages its dominance in the mobile market against Intel, Project Alloy might flop and shatter Intel's VR and AR ambitions.
What's InvenSense's VR strategy?
InvenSense, the chipmaker which produces motion sensors for iPhones and other mobile devices, shed about 30% of its market value this year due to slowing smartphone sales and tough competition from larger rivals like STMicroelectronics (NYSE:STM) and Bosch. That's why InvenSense's revenue has fallen by double digits annually over the past two quarters.
To diversify away from motion sensors for smartphones and tablet (which generated over 60% of its sales last quarter), InvenSense has been selling more sensors for IoT devices, drones, and VR and AR headsets. InvenSense's sensors already power the HTC Vive.
During last quarter's conference call, InvenSense CEO Behrooz Abdi said that the company was developing a new "motion tracking device specifically designed to meet their rigorous performance demands of head mounted displays." Abdi also noted that popular AR games like Pokemon Go could boost demand for higher-accuracy motion sensors in newer smartphones.
That strategy sounds ambitious, but Bosch and STMicro are pretty tough competitors. Several headsets, including the Oculus Rift, use Bosch's sensors instead of InvenSense's. STMicro, which produces the motion sensors for the Apple (NASDAQ:AAPL) Watch, could eventually switch back to STMicro's sensors for its iDevices -- which would likely leave a gaping hole in InvenSense's top line.
But are Intel and InvenSense bargains?
Like most other VR-related stocks, Intel and InvenSense aren't really "pure plays" on the market. Intel is still mostly valued on its PC and data center businesses, while InvenSense's future relies heavily on orders from Apple, Samsung, and other major mobile device makers. If those businesses aren't healthy, it probably won't matter if headset makers embrace Intel's Project Alloy or InvenSense's next-gen VR motion sensors.
Looking ahead, analysts expect Intel to grow its annual earnings by 10% per year over the next five years, giving it a 5-year PEG (price-to-earnings growth) ratio of 1.5. That isn't really "cheap," since a PEG ratio under 1 is considered undervalued, but it's much lower than InvenSense's 5-year PEG ratio of 3.2 -- which assumes an annual earnings growth rate of 20% over the same period.
That makes Intel look cheaper than InvenSense, but I wouldn't call it a "bargain" due to the ongoing headwinds facing its PC and data center businesses. Therefore, investors should pay attention to Intel and InvenSense's VR efforts, but they shouldn't invest in either company based solely on those headline-grabbing efforts.