Analysis / Insights

Note: This interview was conducted on October 22,d 2010.

Changing gears, albeit slightly, today’s interview discusses macro trends in the Cleantech, Life Sciences and Technology spheres. Our guest and interviewee is well known analyst and commentator, Duncan Stewart of Deloitte Canada Research. Need we say more?

Allright, fine we will but only to say:

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Biography: Duncan Stewart is the Director of Deloitte Canada Research in the areas of Technology, Media & Telecommunications (TMT), Life Sciences and GreenTech. He is a member of Deloitte’s national TMT executive team and is a co-author of Deloitte’s annual Predictions report on trends in TMT. Duncan has almost two decades of experience in technology, media and telecommunications. As an analyst and portfolio manager, Duncan has provided research or made investments across the entire Canadian technology and telecommunications sector.

Duncan is also founder and CEO of DSAM Consulting, which performs research and analysis on companies in the TMT and Green tech space. Prior to that, Duncan was a co-founder of Tera Capital, Canada’s first high-tech and biotech money manager, where he was responsible for managing both mutual funds and venture capital funds, and was the Canadian Technology Fund Manager of the Year in 2003. In the mid 1990s, Duncan managed a $150-million, small-cap high-tech/biotech fund at a large Canadian pension fund manager. In his years as an investor, he has deployed a cumulative $2 billion of capital into the global TMT and Life Sciences markets.

Duncan is a Chartered Financial Analyst (CFA) and holds a BA in Political Science from the University of British Columbia.

Q: What’s your take on e-books? Why didn’t they take off? Is there a more general lesson here?

A: E-books are in fact taking off; they’re doing very, very well. Part of the problem with the e-reader market, is that the original idea constituted that you wouldn’t make very much money off selling the e-books, but you could make quite a bit of money or hope to make quite a bit of money, selling millions of e-readers. The only problem is that their initial pricing of $300-400 was simply not working against tablet computers.

I can buy an e-book reader that displays black and white text extremely well and for many, many hours with a very nice form factor. But it can’t do video. It can’t do the web. It can’t do gaming. All of a sudden the extra $200 for the tablet just makes the whole stand-alone $300-400 reader market non-buyable. As you move the price point down, as we’ve seen going on, you can start treating them more as disposable devices. Not quite disposable, but you’re bringing an e-reader with you on your vacation instead of the tablet because it’s smaller, has got a longer battery life and you’re planning on taking it to the beach, that kind of market will exist. The challenge isn’t so much e-reader versus tablets. The challenge is the screen on e-readers. The technology there, because it’s black and white and doesn’t support motion, just doesn’t provide a use case that’s broad enough compared to a tablet.

Q: Chapters just launched their Kobo eReader but with the incumbents Amazon (Kindle) and Apple (iPad) controlling most of the market, do you see a winner and loser in this e-reader battle?

A: Well, it all depends on the price point, right? If you can get to a $99 e-reader, you will sell millions of units. Now, will we sell as many e-readers as we sell tablets? Almost certainly not. The tablet is a multifunction device that, even though it’s more expensive, does enough things well. The idea of a single-function electronic device that only supports text is one that is not going to have the same kind of success. Now, e-books will continue to sell very well. I’ve read books on my tablet and I’ve read them on my e-reader and they’re both wonderful. But I’m not sure I’d want to read them on my computer. Certainly e-books on tablets are going to continue to be a big thing. They already are and they will get bigger.

Q: Where is Canada’s strength when it comes to telecom and networking technology?

A: As we go forward, we are connecting more and more devices to the world networks and we are transmitting more and more data from those devices. In that kind of world, we have gone from a situation where essentially the world’s wireless networks went from running at 5-6% capacity to all of a sudden running at 50-60% capacity and getting congested. In that world, all of a sudden some of the clever bits of technological engineering that Canada is quite good at, things like policy management software and microwave back-haul, and de-pack and inspection, all of a sudden all of those technologies become quite a bit more central in a world where we have a constrained wireless spectrum. If I can use an analogy, it’s like having technology for traffic tolls and meters in downtown London, where it really matters, while doing it on a highway in Saskatchewan where there’s not a lot of traffic and it’s much less important.

One of the other things that’s fairly important in our Canadian skill set in addition to our depth in telecom and network technology being applied to network congestion, would be the application of technology in the clean tech space. When you’re using smart building technology, when you’re trying to do better energy management either inside a factory or a store, it uses a lot of the same kind of RF (Radio Frequency) technologies that historically Canadian companies have worked with. Most of these smart building technologies use various mesh architectures that are very similar to the sorts of things that the telecom companies have been working on for years. So, it’s a clean tech application of RF technology, but it’s still an important differentiation.

Q: Moore’s Law and Metcalf’s Law delineate an exponential growth in memory, processing speed, storage, and other computer capacities. Where is it all going? What is the end point? Why do we need so much computing power on our desktops? What drives what - technology the cycle-consuming applications or vice versa?

A: First of all, that’s not what Moore’s Law says. Moore’s Law, in fact, states that the number of transistors on any given size of silicone will double every 18-24 months. It’s about transistor density. Now, from an increasingly dense transistor, there are three things you can do. You can either make more and more powerful chips that use a certain amount of power at a certain price. So, in other words, I can produce a chip that uses 100 watts, costs $100, and is twice as powerful as last year’s chip. Or I can make a chip that uses the same power and the same processing power, but now costs half as much, that’s also a useful thing to do. Or I can make a chip that is exactly the same processing power and exactly the same price, but now uses half as much power. Any one of those three levers is sort of possible as a result of Moore’s law. The interesting thing is that for years what we tended to do is we worried a little bit about pricing, a little bit about power, but we spent most of our time trying to make faster and faster and faster processors. As you point out, implicit in your question, why do we need so much computing power on our desktop? The answer is we don’t, which is why the fastest growing computing devices these days are smart phones, tablet computers, and net-books, all of which in fact use less powerful chips. Now, these chips are still relying on Moore’s law. They are extremely power efficient, which is why their battery lives are so good and they are also extremely cheap. The chips that go into an atom net-book, or an iPad tablet are orders of magnitude cheaper than the classic chips you’d find inside a standard CPU or PC. So, as we are continuing to see the technology drive forward, we are taking what that progress allows us to do and applying it in different directions.

Q: What are some macro trends that you are seeing in the greentech space?

A: Smart building is a big part of it. Smart grid is another big part. Those two would be the ones that jump out. The old cliché is that the greenest electron you’ll ever make is the one that you conserve. Doing more with less, just wasting electrons out of our electric grid, just having wind or other renewable capacity lie idle because it’s not connected to the grid properly, these are inherently wasteful things. Instead of spending tens of billions of dollars on expensive mega projects, relatively small dollar amounts can result in enormous greentech savings.

Q: Mr. Stewart, in a report (free sign up required) published by the Conference Board earlier this year, the authors found that Canadian businesses have failed to seize new – or even maintain existing – opportunities to sell climate-friendly technologies globally. Furthermore, while Canadians are slowly increasing their adoption of other countries’ climate-friendly technologies, they are doing so at a much slower rate than the world average. What do are the reasons that you might attribute to this phenomenon? Does it have anything to do with the fact that we are such a resource rich country?

A: I’m not sure that’s accurate. With Deloitte we have a separate sub-program, part of our Deloitte Fast 50 that actually measures the most successful cleantech companies in Canada, it’s called our Green 15 program. There are a number of Canadian companies that are leaders. Now, I’m not saying Canada’s the biggest country in the world in greentech, we’re not even close. But I’m not sure that it would be fair to characterize us as we are slowly growing our greentech capabilities. As a matter of fact, some of the clean technologies that we’re seeing come out directly from the fact that we are a resource rich country. So, for example, some of the technologies relating to oil and gas recovery and coming up with more ways to do so, in more environmentally-friendly fashions, are being pioneered here in Canada. One of our winners in the Deloitte Fast 50 contest last year (2009) was a company called ProSep. Not only was ProSep the fastest growing company in Canada but they were also a recipient of the Green 15 award (recognizing Canada‘s leading greentech companies) and this company specializes in clean water technology as a supplier to the oil and gas industry. That’s the sort of thing that does come about because we’re a resource rich country. So, I’m not sure I agree with the conclusions drawn from that report.

Q: Investor sentiment towards the cleantech industry as a whole appears to be negative fueled mainly by the perception that cleantech companies are reliant and driven by government policy and subsidy which can change at any point in time (we all know how a government decision crippled the income trusts) and maybe even unsustainable in the long run. Do you agree with this or not - why?

A: No, that’s not true. What you’re doing is mixing two different industries - the clean energy industry and the cleantech industry.

The clean energy industry is all about subsidies and will you give me extra money for my solar power, my wind power or my bio-fuels. Those are all government mandates. Investor sentiment on that inherently is not terribly negative, but it’s also not terribly positive.

In terms of investor sentiment towards the clean technology index, there’s a thing in the U.S. called the CTI US Cleantech index. As of September 30, 2010, in Q3/10, the Cleantech index was up 11.3%, whereas the S&P was up 10.9%. Year to date performance of the Cleantech index is a little negative as it is down 2.7%, versus the S&P being up 1.6. But the point I’m trying to make is that the clean energy index (as measured by the Wilderhill Clean Energy Index) is down 10.3% year to date compared to the Cleantech index being down about 2.7%.

So, there’s certainly a lot of pressure on clean energy stocks but cleantech is not nearly as out of favor. As a matter of fact, clean technology is the single biggest recipient of venture capital dollars in the United States, ahead even of biotech. Thus, I would say that investor sentiment towards cleantech is not as in favor as it was but I certainly wouldn’t use the phrase ‘out of favor’.

Q: What are some of the macro trends that you are seeing in the life sciences space right now?

A: Part of the problem is that what’s going on in Canada and what’s going on around the world. So, here in Canada, we for some period of time were massively punching above our weight. We had QLT, Biovail, Angiotech Pharmaceuticals, BioChem Pharma and these were all companies selling drugs that were $500 million - 1 billion dollar per year drugs. Those are blockbusters. At one point Canada had four or five blockbuster companies and we were thinking ‘wow, we’re really good at this’. Then today we don’t have any public companies that are of that kind of size. So there’s a couple things going on: One, we feel like ‘wow, we are good at this’ and the answer is a little more mixed than that. Based on kind of a nation of thirty-some million people and the size of our industry, we should at any given moment have about one really big life science company, bio-tech company, and the fact is that we have zero. The problem is that there are not a lot of places between zero and one, it’s kind of binary.

So although we are feeling like we are punching slightly below our weight, the reality is that when we had four or five of these companies, we were doing ridiculously well and that was not to be expected, nor should it have been seen as sustainable. The money in life sciences and biotech comes from new products, new drugs, new devices and not so much diagnostics. It’s hard making a lot of money off of diagnostics. The challenge is that with devices and therapeutics, the regulatory pathway has been getting longer and more complicated. We have the FDA justifiably saying, “You need to really, really prove your point. We’re much more worried about small, possibly dangerous effects of medicine.”

As a result of all this, the time to market has been elongated. It takes more money to discover a drug. It takes longer and there are more failures. So therefore, the sector is not as in favor as it was 10 years ago. 10 years ago with pharmacogenomics, we had these dreams that we’d be able to invent a drug for $5 million instead of it costing $50 million. The reality is that has not happened. The promise of biotech, the promise of genomics, have not yet come to fruition. It costs a lot of money, it takes a lot of time, and it doesn’t seem like that’s going to be changing anytime soon. Because of that the sector is not out of favor, but it’s not as popular as it would have been a few years ago or a decade ago. Also, part of the problem is that breakthrough drugs are extremely hard to create. We have spent I don’t know how much money working on Alzheimer’s drugs and so far none of them have had any kind of success. That’s just an example of one of the areas that has been extremely challenging to have any success in.

Q: Who will win the smart phone versus net-book war and/or the war between various smart phones?

A: I think I have an opinion on both. When you look at the PC ecosystem, one company controls the operating systems for almost all computers. In our view, we’re going to continue to have a highly fragmented smart phone ecosystem, and you’re not going to see any one company own 90% of the smart phone market. That’s really important to understand.

Smartphones versus net-books or smartphones versus tablets, those aren’t real battles. People don’t buy an iPad or a net-book instead of a smartphone. They usually have a smartphone and they have a PC, and they’re filling in the gaps. They’re not really competitive. Now to some extent, people did buy net-books instead of laptops, but even that wasn’t a huge market. What I think is much more interesting is the interaction of tablets versus net-books and we already have the data on that. Many, many people are saying ‘I prefer the tablet format versus the net-book format’ and we already have data that shows that cannibalization occurring.

We also have data from the United States that shows that tablets are actually cannibalizing, not just the smartphone market but also the laptop market. I have a laptop computer and I use it a lot but there are times like when I’m making a business trip up and down to Ottawa in one day that don’t necessitate me carrying my laptop. So having a tablet computer is proving to be a pretty useful case. Similarly in a lot of environments if you’re using it in retail, for example or in a board of directors meeting, it’s a lot less intrusive to have a flat tablet on the table than to have everybody sheltering behind their laptops. So in our view, we continue to see tablets and net-books co-existing, but tablets taking a bigger share than probably we would have thought a year ago. But together that form factor is significantly cutting into the full-size laptop market.

Q: Can you extend that conclusion to the PC market? Are tablets and net-books sales cutting into the sales of desktops at all?

A: No. Desktops seem to be a very stable business. People don’t buy a tablet instead of a desktop. They buy a tablet instead of a laptop.

Q: How about the iPad versus any other net-book or tablet?

A: Apple is a very, very early leader and they’re doing enormously well. However it’s so early that really we don’t have enough data yet. If you look at the early days of the PC industry, there were all kinds of winners who aren’t even around anymore. So, it’s very hard to extrapolate. Using a baseball analogy, we’re at the top of the first inning, we don’t really know who is going to win the game. Certainly in our view, it is unlikely that the tablet market will continue to be owned 90% by any one company. It’s likely to be something like the smart phone market where you’ve got three or four players representing the bulk of them at the OS level. Manufacturing could be different. You could have somebody with an Android tablet and somebody else with an Android tablet. Together, Android will have a big share. RIM is in there. At this point, I think it’s really early to say but in our view, it’s likely that the tablet market will have a number of different players.

Thank You, Mr. Stewart!

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