Microsoft: HoloLens To Change The World - And Make Tons Of Money

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Summary

Introduction - HoloLens: can it change the world of small-scale computing?

Microsoft (MSFT) is allowing its top people on the HoloLens 2 product (and ongoing project) to say some audacious things. If they are just half right, HoloLens could be a meaningful driver of long term excess returns to MSFT shareholders. For example, Kinect inventor and now lead executive on HoloLens Alex Kipman was interviewed by Smithsonian magazine recently. Part of the article goes this way (my emphasis):

For HoloLens 2, Kipman and his team invented tiny mirrors that vibrate 12,000 times per second, generating holograms twice as wide as before. They upgraded to carbon fiber for the device’s body, which is half as heavy as aluminum and far more rigid. The carbon fiber also helps stabilize the delicate electronics in the headset, including dozens of sensors that track exactly where your head is turning or where your arms are. “And I’m talking like micron precision, right?” Kipman says. “Nanometer precision.” Engineering on that vanishingly small scale is what allows Kipman to think big. His ultimate goal: Replace every screen, from smartphone to tablet to monitor, with the HoloLens or one of the next versions of it. “Why would I have my computer if I have infinite monitors in front of me?” he says. “Why would I have a phone?”

Having been beaten in smartphones, MSFT is attacking from a different place.

A brief intro to HoloLens 2 follows.

I will call the device HL2 for the rest of the article.

What is HoloLens 2?

This is a self-contained, untethered visual headpiece that projects holographic-type images to the user, creating what MSFT calls mixed reality rather than augmented reality. Flip the visor up and normal vision resumes. The device can be worn over one's eyeglasses. The back of the device contains the two semiconductors, a CPU made by Qualcomm (QCOM) and a MSFT-designed "holographic processing unit" ("HPU 2.0") coprocessor that has AI capabilities. The front of the device contains those tiny mirrors that help create the images. Several other aspects of the system, of course, exist. Here is a picture showing what a HL2 user is seeing, using a special camera. The virtual chair and the virtual cube it is in would otherwise be invisible to the casual observer.

https://static.seekingalpha.com/uploads/2019/11/27/saupload_RE2PHcl.jpeg

MSFT describes part of the selling proposition this way:

HoloLens 2 offers the most comfortable and immersive mixed reality experience available—enhanced by the reliability, security, and scalability of cloud and AI services from Microsoft. Immersive Ergonomic Instinctual Untethered USD $3,500 per device. Available from select resellers.

This price point is far above that of Google Glass and the range for a high-end Oculus VR headset, but HL2's $3500 it is in the very rough ballpark for Magic Leap One ($2295). That device is not, however, self-contained.

MSFT provides insights into its science and marketing for HL2 in news item, The making of the HoloLens 2: How advanced AI built Microsoft’s vision for ubiquitous computing. Note that twice in the first three paragraphs, it echoes Apple's (AAPL) "it just works" theme:

The first time people don the new HoloLens 2 on their heads, the device automatically gets to know them: It measures everything from the precise shape of their hands to the exact distance between their eyes. The artificial intelligence research and development that enabled those capabilities “was astonishingly complicated” but essential to making the experience of using the device “instinctual,” said Jamie Shotton, a partner scientist who leads the HoloLens science team in Cambridge, United Kingdom. “We want you to know how to use HoloLens without having to be taught how to use it,” he said...

Please read this entire news release for many more details on HL2, as well as the first embedded video that shows off other MSFT technologies.

HL2 only connects to the Internet via Wi-Fi or Bluetooth. Cellular capability will likely arrive with HL3, and if not, I assume certainly by HL4.

Because of the cost and complexity...

The initial markets are commercial

Smithsonian summarized Kipman's vision for users this way:

He imagines an airplane mechanic in Japan using the HoloLens to summon a Rolls Royce engineer to help diagnose a busted engine, or a surgeon having hands-free, holographic access to a patient’s X-rays and medical history in the operating room.

Indeed, I found a 2017 report titled HoloLens use cases in neurosurgery - Successful prototype with the University Hospital of Berne. A current article is of interest:

Qantas preps for next phase in Microsoft HoloLens 2 trial Qantas is preparing to embark on the next phase of its trial using Microsoft’s HoloLens 2 mixed reality headset and technology to help train its engineers without putting them in harm’s way... Specifically, the proof of concept uses the HoloLens mixed reality technology to build a digital twin of a Boeing 737 flight deck, with the learner sitting in either the captain’s or first officer’s virtual chair to run through procedures and checklists. “The key purpose is to allow learners to undertake an engine ground run in a safe, simulated environment – demonstrating responses to high risk events.” group learning technology manager for Qantas Amanda El Bahou said. “What we are testing in the proof of concept is whether mixed reality will sufficiently simulate an experience that is a reliable test of competency...” While the trial appears to be still in its early stages, Qantas is already looking forward to building it out into something bigger, with the next phase set to broaden the digitisation of the initial sample of steps needed for an engine ground run the full 45-step process, including responding to an engine fire. It is understood that Qantas is also exploring how the technology could be deployed more widely across its business.

The implication of the above is that the sales ramp for HL2 will be slow. A lot of code is going to be written and tested before numerous large orders will arrive. But, that's OK assuming that MSFT continues to improve the prodict line.

Let's look at the future in MSFT's eyes.

What the HL franchise may look like

Back to Smithsonian, which writes that Kipman:

figures it’ll be as compact as a normal pair of horn-rimmed glasses. By then, perhaps its sheer ubiquity in the workplace will make it seem acceptable in social life. “You wear them all day,” he says.

Presumably there will be competition, and until corrective lenses receive the HL treatment, this vision of the future appears overstated, but you get the point. MSFT's point man on the HL is thinking very big.

But the vision to replace screened devices with HL working with Azure and other MSFT software goes beyond the obvious commercial and then consumer use cases. A transcript of a podcast interview from April with one of MSFT's key scientists involved with the HL project provides a vision of holograms everywhere. Here are some quotes regarding future possibilities:

I can, for example, put on HoloLens and place a hologram somewhere in the world, and then you could come by with your mobile phone and use ARKit or ARCore to find back this hologram and see it at the same place where I placed it in the world... you can start thinking of applications where, for example, I can put virtual breadcrumbs in the world, and allow you to navigate, so these are for more consumer-ended applications... there’s things that we call digital twins. This means that you have, for a real machine in the real world, you also have somewhere a digital representation of it in your servers in the cloud. That information that is available in the cloud, you would like to be able to align it also in the real world, so that if you walk around with your holographic computer with your HoloLens on, you can actually see, on top of the real world, on top of the real machine, you can actually also access, in context, all of the information that relates to it... There’s a lot of things we still have to work out. But the basics are there...

This is wild stuff. I am sure I do not understand all of MSFT's ideas for this franchise. Please read the interview in full if interested.

Implications for MSFT stock

As AAPL after Steve Jobs returned, and Amazon (AMZN) throughout its life delivered one new product after another, changing their business reality for the better, the companies gained significant enterprise value. The same may occur with MSFT if HL2 at least meets its expectations. I think it's important that MSFT evolve beyond its move to the cloud, a SaaS business model, and in general defending its old turf and absorbing LinkedIn. The HL project offers investors in MSFT, trading at 30X TTM EPS, a very big picture opportunity.

How big? Well, MSFT is suggesting that HL and competitors can replace smartphones, the PC and I suppose even TVs. That's a very, very big total available market. And of course, if even moderately successful, there are vertical and horizontal ancillary profit drivers galore.

One of the things I like about HL is that it is not being hyped. Perhaps by a HL4 (consumer version), say in 2023, there could be an iPhone-like buzz to HL. So I'm hoping that this is a very cheap option on a large profit opportunity for MSFT that could grow well into the 2030s.

MSFT has at least one other potentially very large opportunity, namely quantum computing, for which it is quietly growing an ecosystem. This too has competition, but if the field is to become commercially viable, I think it has plenty of room for several innovators.

Summary and concluding thoughts

HL2 is a much-improved version of the original HL. Among other things, it is more comfortable, has a wider field of vision, and is easier to use. The technical problems that MSFT has solved to get to this stage are notable in my layman's view. They surpass what its large-cap tech competitors. MSFT also has a guiding vision for a HL ecosystem that would rely upon Azure and certain MSFT software services. That MSFT has a comprehensive vision for HL reminds me of the ramps of AAPL, AMZN, Facebook (FB) and Alphabet (GOOGL) the past 10-20 years.

I'm hopeful that the HL franchise can expand in a timely fashion in the commercial sphere. From there, the goal is to miniaturize HL, have a stripped-down consumer version, and move toward making it and its competitors much more ubiquitous. It is not necessary for HL (and its ilk) to replace screened devices to become a major profit driver even for MSFT, already obviously a giant.

While growing the existing businesse at an impressive pace, Satya Nadella's MSFT is moving forward with new concepts that could turn out to be major future growth drivers. HoloLens, quantum computing and perhaps other products and projects just might allow MSFT to grow and change, i.e. reinvent itself, in unforeseen high-profit ways.

In a generously-valued tech sector, I continue to like MSFT a good deal on a risk-adjusted, price:earnings:growth rate basis without contributions from HL, quantum computing and other greenfield efforts. But success in one of them could make the company a faster-growing enterprise with greater visibility many years hence.

In summary, I see MSFT as nicely balancing growth from current products with innovative R&D, while maintaining strong P&L results and a strong balance sheet. HoloLens 2 is a rounding error to MSFT today, but perhaps in 5 and 10 years, it could be a very different story.

Thanks for reading. Please share any knowledge you have on the mixed reality/AR/VR space you think is relevant, as well as comments on MSFT in general. Also please note, this is a best-efforts article, given the technical nature of the new HoloLens 2 story. Please do your own research.

Submitted Wednesday morning. MSFT $151.77.

Disclosure: I am/we are long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser.