Plug In to These Top Investment Ideas in Robotics

The current pace of innovation in robotics is unlike anything we've ever seen. With falling costs and increasing functionality, artificially intelligent robots are very quickly finding their way into the business world.

Amazon (AMZN 2.35%) likely kicked off this global robotics arms race. As one of the earliest adopters of this new wave of robots, they shelled out $775 million to buy Kiva Systems in 2012. More than 100,000 Kiva bots now tirelessly buzz around Amazon's distribution centers, which I previously estimated was worth $15 billion to shareholders. The improved factory automation allowed Amazon to deliver more than 5 billion Prime items in less than two days last year.

The king of e-commerce shows no signs of slowing down, but the rest of the world is now scrambling to keep up. Industrial robots are no longer a luxury, but a necessity in order to stay competitive. China has gone so far as to enact policy that aims to convert the majority -- if not all -- of its manufacturing to automation by 2025. Considering the sheer size of the country's industrial production, which is still growing at more than 6% annually, the Made in China 2025 initiative is a massive undertaking.

Perhaps the biggest winners in the growth of industrial automation are the suppliers of the robotic systems themselves. Japan-based Fanuc (FANUY 1.12%) and German-based Kuka (KUKAF) have the fortunate "problem" of not being able to keep up with customer demand. Both companies are doubling their annual supply capacity just to supply the world's thirst for robots. Fanuc could be an investment opportunity, as the world's largest industrial robotics company that is also the fastest-growing of its peers.

We've been keeping a close Foolish eye on this developing robotic trend. Last year, I spoke with Brian Gahsman of the AlphaCentric Global Innovations Fund, who is investing exclusively in robotics and automation. Brian shared his thoughts about why the industry is so intriguing and where he saw opportunities arising. We caught up again last week, this time discussing where the global adoption curve currently stands and the huge opportunity for robots in healthcare (spoiler alert: There's lots of competition coming for Intuitive Surgical (ISRG 1.05%)!). 

Our entire conversation is captured in the following video, which includes a full transcript below.

Simon Erickson: Hi, everyone. Motley Fool Explorer [advisor] Simon Erickson, here, talking today about robotics. We're bringing in Brian Gahsman. Brian's the portfolio manager of AlphaCentric Global Innovations Fund, which is dedicated exclusively to automation and robotics. Hey, Brian -- great chatting with you once again, today!

Brian Gahsman: It's a pleasure to be here. Thanks for having me, Simon.

Erickson: You know, Brian, last time we spoke at length about industrial robots. We talked about the arms race in workplace automation, where companies have rapidly deployed robots to keep up with each other to improve their cost structure and stay competitive. You've mentioned in the past companies like German-based KUKA or Japanese-based Fanuc that are supply constrained providers of robots due to the overwhelming demand.

My first question for you is about the industrial market. Where do we stand in the adoption curve of this? Is there still a ton of upside in the industrial market, or are we starting to reach saturation because everyone's trying to keep up with everyone else?

Gahsman: The issue of saturation -- I don't think we're even close. Actually, I know we're not even close. I don't have a specific number of how many publicly registered manufacturing companies there are in the world, but we're not anywhere near full adoption by any means. China -- with their Made in China 2025 plan -- has the most aggressive policy of adopting a full manufacturing automated system for their entire country. We don't have that policy here, yet. We're still at the early stages of adoption with companies that can afford it.

Yes, some of the largest players in the world. Largest companies. Obviously, Amazon has been using industrial automation and robotics for quite some time, now, for their distribution centers. We've talked about Foxconn. Walmart competing with Amazon. All those huge companies, as well as the automobile manufacturers, have adopted this technology.

But it's not just those large companies. I recently was able to do a tour of a manufacturing facility in Buffalo, Minnesota. Unless you have a detailed map, I don't know anybody would know that that town exists. But even in that rural area of Minnesota, I toured a company called Whirltronics, which makes lawn mower blades for some of the largest suppliers in the world. The largest OEMs. I did a tour of that facility, and they had been implementing for the past 10 years this automation. They had a Kawasaki robot on their first line of automation that has been running for 10 years.

Since that time, they have added newer and newer lines to their manufacturing lines. Their most recent one is a section with Fanuc robots along with centers and a completely automated line altogether. There's no human interaction other than the programming of it. They've increased their output to $6 million since adding these automation systems. It's literally changed that company altogether.

The point is that a town as small as Nowhere, Minnesota, [has not reached] a saturation point. It's the global adoption from large companies that has come all the way down to even small companies being able to compete and do things they weren't able to do before when they had restraints of, maybe, 700,000 units a year. They implement this technology and, all of a sudden, they're able to sell 4 million units a year. There is no question to the argument for the capital expenditure of adopting the technology.

Now, we've talked about a handful of the largest companies in the world and an example of a much smaller one, but this adoption has not even come close. If you want to use percentages, I would say -- and that's aggressive -- maybe 20% of the manufacturing companies in the world have implemented industrial automation or robotics at this point.

Erickson: And are you seeing this being supply constrained for those suppliers that you mentioned? KUKA. Fanuc. Are they making as much as they can, right now, to keep up with demand?

Gahsman: That's the second question -- capacity. What are the capacities of the companies that are making the equipment? In the past six months, we have seen Fanuc, KUKA, Yushin Precision, and Harmonic Drive Systems set up footprints all over the world for manufacturing. They've increased their capacity. Fanuc has facilities in Dearborn, Michigan. In New Jersey. Yushin Precision has Yushin University in San Francisco as well as plants, here. What they've done is they've made some serious capital expenditures and spread their footprints.

Now, if you want to order a fully automated Fanuc system, they don't have to assemble it and ship all this hardware over from Japan anymore. They can produce it in the U.S. for U.S. customers. Likewise in China, Europe, and the rest of the world. If that capacity expansion hadn't happened, then we would be having an entirely different conversation about investing in industrial automation. But those companies are on top. They are answering the need to increase capacity. At this point, there is no shortfall [of] potential purchases as far as capacity is concerned.

Erickson: Is Buffalo, Minnesota, anywhere close to being as cold as Buffalo, New York?

Gahsman: Colder.

Erickson: That's a statement right there. Let's talk a little bit more about China. You mentioned Made in China 2025, the policy where China's trying to automate the majority of its manufacturing with robots. I've seen some research, too, Brian, that says 40% of the world's robots will be placed in China by 2019. How important is China to your thesis of investing in robotics?

Gahsman: China is one of the main drivers of demand right now. A better way to answer that question is if you take China out, then where are we? Well, we are still at the beginning stages of massive global adoption. If there was no China, the investment thesis for the space would not change at all. But adding China and its aggressive proposals for 2025 added an exponential boost.

I mean, if we talk about China's plan to do this, what about the U.S.? Especially now with pretty aggressive trade restrictions being put into place, I can see the U.S. implementing a similar strategy. And then what? China and the U.S.? And then Europe is to follow? Being able to invest in an entire space that is dedicated to this robotic automation right now -- I don't know that there is anything else that has the potential growth that this does.

But China has gone from one of the lower-quartile demand countries to the top in about one year's period of time, and that is going to continue. If you want to call it sticky money, per se, as far as investing is concerned, they did not implement that policy lightly. That is a huge goal to meet. To be able to have enough companies in the world to supply that demand and top it for the rest of the world is a huge thing.

Not to mention just purchasing these systems, but also the ongoing maintenance and revenue streams, and training, and software. [As far as] these robotics companies, as I said in our last interview, China has made an effort to purchase or take a strategic stake hold in a lot of these European and Japanese companies, but they are not building the robots or automation systems in-house, and I have not heard word that they plan to do that.

So, these same companies I've been invested in since early 2014 are going to remain being the same players in the space, but we're only seeing about 60% of the actual robotics automation companies in the world being traded publicly at this point. And just after me saying that to you, that statistic had already changed, because there are companies raising capital and coming out because the technology is out there, now. Every year there are 50 to 100 new players in this space altogether.

Erickson: Speaking about that competitive advantage -- "sticky money," like you called it -- are the suppliers still capturing the vast majority of their profits, or their value, or their sales from the upfront sale of the robots, or is there becoming a larger component of that service? Of that training, of that software piece that's recurring in nature once they get established?

Gahsman: There is definitely constant recurring revenues from the maintenance of the robots. When a company purchases a system (a lot of these firms say KUKA, for instance), they'll make a completely individualized automation system for your specific needs.

At the same time, even when the system arrives -- and the engineers at that manufacturing facility assemble it according to their needs and specifications (the engineers program it, do a lot of the AI internally and algorithms) -- obviously the engineers in any specific manufacturing firm are not trained to maintain these high-level robotics systems, the robotic arms and things of that nature.

So, yes, there are recurring revenues. I guess it's similar to purchasing a BMW, for instance. You can't just put a GM part in a BMW and hope it works. It's not going to work. [...] You can't interchange these things. So, there's proprietary IP that each of these robotics manufacturers have, and when you purchase an entire system, they're the ones that are going to be maintaining it, for the most part. This obviously leads to recurring revenue.

Erickson: Brian, we mentioned a little bit about the automakers. The retailers. The industrial piece. But one other industry we're seeing adopt robots now is healthcare. I know one that you've been looking at closely is surgical automation. What is the role of this? What is the impact of robots in the hospital or in the healthcare system?

Gahsman: I'll start out by saying before we even get into surgical robots, which is somewhat specific, [there is] healthcare. Companies like the Tecan Group, which is a Swiss company. The Tecan Group has, over the past decade, developed very advanced laboratory automation systems. Multiple testing lines, each automated for singular or fully linked automation components similar to a manufacturing line, except when you automate the laboratory for testing, the systems are more accurate and faster. More testing can be done -- at least four times faster than whatever was able to be done before.

So, when you look at that and a diagnosis area of the field, or a laboratory setting, the advancements that we're able to make with testing systems now, with companies like the Tecan Group automating the laboratory, are highly more advanced than we've ever been able to do before. That decreases the curve on what disease we can prevent or attack immediately. That's grown dramatically.

And then on the other side of the healthcare system, as far as pharmacy and big pharma automation, there's companies like Omnicell. Omnicell produces workflow automation systems for healthcare facilities, pharmacies, and those supply chains. They have a full suite of automation systems and robotics like their XR2 central pharmacy system. Their ROBOT-Rx central pharmacy robotic arms and medication dispensing system, which not only increases the efficiency of drug dispensing, but also the accuracy of, say, mixing drugs together that shouldn't be. All these talks about drug-pricing issues.

If we're not going to touch the insurers -- we're not going to use them in the arguments -- we've got to figure something else out. Well, what's better than to just cut the margin cost with pharmacies and drug manufacturing altogether by using things like Omnicell's technology? That will have a dramatic effect on drug pricing from behind the scenes.

And then when it comes to surgical robotics -- I think I discussed this in length the last time we had our interview -- but there have been a lot of increasing developments in this area. A decade ago we had Intuitive Surgical, which a lot of people are aware of, with their da Vinci machine that did urological procedures and has grown to become almost a household name, now. Their new da Vinci X system, obviously, can be upgraded remotely (not remotely in the operating room), but there can be a doctor that is using this tool in the U.S. that is operating on somebody in a third-world country. [This] changes the whole spectrum, altogether, as far as the logistics of surgeons in hospitals.

But, in the past five years, that space of surgical robotics, which was once Intuitive Surgical, has now grown to well over a dozen or more specialized companies in the world. The laparoscopic race, right now, is basically Intuitive Surgical versus TransEnterix.

TransEnterix received FDA approval in October for their Senhance System. They've already performed 150 surgeries. They've sold two units just this first quarter. They had not anticipated selling any units until the third or fourth quarter of this year. And they've recently filed for FDA approval to expand their surgery to hernia and gall bladder, which is directly in line with Intuitive Surgical's gastrointestinal laparoscopic surgical tool.

That is just a small piece of the pie with surgical robotics. Spine and brain surgery. The last time we talked, we talked about Mazor Robotics with their Renaissance guide system and their Mazor X. Now we also have Globus Medical, which has their ELSA-ATP system. It does very similar robotic spine and brain surgery as Mazor did.

Corindus Vascular, which does cath lab cardiovascular surgery. And besides just precautionary cardiovascular, they've also received approval to do peripheral vascular surgery. Instead of before they only had FDA approval for precautionary, and now they have approval to do peripheral vascular, which alone is a $3.4 billion market. And Corindus has the only robotic system in that space.

Arthroscopic surgery. Smith & Nephew out of London with their NAVIO Surgical System which is more precise bone surgery than anything that's ever been out there. Radiation therapy. We've got Accuray Cyberknife. Elekta has a [long] menu of different radiation therapy equipment.

Now entering this space recently is hair transplants. Restoration Robotics with the Artas Systems, which is a $23 billion market with a growth rate of 17% by 2023.

Exoskeleton systems. Ekso Bionics. Myomo. Revolve Robotics. And those exoskeleton systems are not specifically related just to healthcare, but also human assistance. A person in a distribution center can lift pallets of much heavier things than a person could ever lift without any of the physical strain that was there before.

That's just a short list of examples of this medical robotics space, and a subgroup of medical robotics is surgical robotics, and it is growing more rapidly than I have seen. And when I created my proprietary universe back in 2014, I had Intuitive Surgical. Now we're invested in over a dozen of these and it's growing faster than it ever was. Industrial automation, we've still got Fanuc, Yaskawa, KUKA. The largest players that were there.

I think that surgical robotics is almost faster-growing. And if you want to put a price on things, well, the economics of industrial automation is there, permanently beneficial. There's no going back. But when you talk about the healthcare space, what's more important? The economic benefits or human life?

Erickson: Well, the life is more important, but the eternal question has always been that hospitals don't have huge capex budgets. Are you starting to see that change, where you're starting to see more systems get placed in the last couple of years?

Gahsman: Yes, we're definitely seeing that with the adoption, with the amount of surgeries performed. Intuitive Surgical, just last year alone, worldwide procedures were up 17%. They sold 216 new units last year. Revenue is up 18%. Their revenues were at $892 million last year. That's Intuitive Surgical alone. TransEnterix that just got FDA approval in October of 2017 [did] 150 surgeries. Multiple units sold. They're soon going to be able to be used in more and more procedures.

The demand is out there. If you want to talk about hospital budgets, a lot of the time, the head of surgery goes into a meeting and has a lot of clout in the budgeting. These budgets are on paper. You can look at the numbers. The budgets are being focused on implementing these surgical robotic systems.

So, what do we cut in that scenario? What do we cut out of the budget? Well, I just explained about the [indecipherable] automation of lab where Omni sells automation of pharmaceuticals. Alone, with those two aspects of healthcare in a hospital, already you've created more ability to budget for these surgical robotic systems which are being adopted in every country all over the world.

Erickson: Absolutely. It sounds like we're hitting an inflection point in multiple industries. Brian, we've got about one minute left. Anything else you'd like to pass along to our audience of individual investors that they should be keeping an eye on in the robotics industry?

Gahsman: Well, something of high focus, as well (things that we haven't talked about yet) would be the smart factory. We're hearing about the smart factory more and more, now. It's also called Industry 4.0. In [1778], we started doing mechanized production with steam. And in 1870 we started using electric power for manufacturing. And in the early 70s, we used electronics and IT automation, and now what is called Industry 4.0 is using IoT and AI for full automation and interconnections between each different unit of the assembly all the way to the logistics process.

If you look at companies like Kardex, or KION, or KUKA, or Fanuc, [which] recently did a partnership with Hitachi, all were working on this smart factory 100% [indecipherable] from start to finish. Instead of having a master brain or system dispensing information to each different assembly line or product model, each individual section can communicate on its own, make its own decisions, and adopt to production requirements individually.

Also, in the end of the distribution or logistics portion of it, Kardex has completely enclosed areas which normally, even with just-in-time inventories, you still have a huge area of a warehouse with all the product that's supposed to go out. Now, if you watch a video on Kardex's smart factory system, you'll see it can all be condensed in a quarter of the space and all done with robotic arms and bar codes.

The manufacturing line has gone from all-human input, to some human input, to now from start to finish shipping smart factory. Industry 4.0 with the AI is going to be one of the largest changes in topics that you're going to be hearing about in this space, and as I said, Fanuc, Kardex, KION, and KUKA are the four companies to keep an eye on as far as the smart factories are concerned.

Erickson: Absolutely. It sounds like quite a bit for investors to keep an eye on in the robotics space. Brian Gahsman, the portfolio manager for AlphaCentric Global Innovations Fund. The ticker on that fund is GNXIX. Brian, thanks very much for joining us this afternoon.

Gahsman: Thanks for having me, Simon.