Tech Predictions for 2017

By Simon Erickson and Dylan Lewis Markets Fool.com

On our last 2016 episode of Industry Focus: Tech,Motley Fool analysts Dylan Lewis and Simon Erickson preview what investors can expect in the tech space in 2017.

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Find out why they think wearable technology will enjoy some new growth avenues, what will probably happen with smart home devices, why M&A might die down from its peak in 2015.

A full transcript follows the video.

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This podcast was recorded on Dec. 23, 2016.

Dylan Lewis:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, December 23rd, and we're looking forward to what 2017 has in store for tech. I'm your host, Dylan Lewis, and I'm joined in studio by Motley Fool premium analyst Simon Erickson. Simon, how's it going?

Simon Erickson:Great, Dylan. Thanks very much for having me.

Lewis:What are your holiday plans?

Erickson:Heading back down to my home state of Texas, where it will be much warmer than up here in Alexandria.

Lewis:I'm doing the opposite. I'm going further north where it will be colder, in New Jersey.

Erickson:I wish you the best of luck.

Lewis:It's going to be a little rough. This is our last show for 2016. Next week, we're actually going to be reairing some of our favorite episodes from the past year, to fill the gap between Christmas and the New Year's holiday. Simon,I was tempted to do the show where we surprised John Rotonti with your posed listenerquestion, ultimately wound up going with something I shot with David Kretzmann about stock-based compensation. It seemed a little bit more relevant. But that was a good time. We should do that again.

Erickson:I'm pretty sure my accent completely gave me away. It was really a terrible accent I tried for John, and I think he was on to me.

Lewis:Because he couldn't see you, he could only hear this wild, hackneyed accent asking him a question about why it's wrong, about value investing, I think?

Erickson:I think so.

Lewis:But, yeah, since this is our last new show of the year, I thought maybe we would look forward to 2017, give listeners an idea of some of the things that we're watching in tech for this upcoming year. I know one thing that you're really hot on is wearable technology, and it possibly morphing beyond the traditional consumer electronics market, right?

Erickson:I think that my first prediction is that wearable devices are going to look much more like medical devices in the coming year or two. We've gotten accustomed toFitbitstracking our steps, maybe telling us a little bit about how we sleep, and a lot of fitness tracking that is kind of interesting and useful. But they're expanding how these can be used beyond just fitness. I think we're going to start seeing that more, because the real money for this is going to be coming from insurers. Insurers are going to want to see more functionality than just how many steps you're taking or what they're doing today.

And we're starting to see some of that already. We've seen nowFitbit (NYSE: FIT)work withMedtronicfor type 2 diabetesto monitor blood sugar and things like this. I think that's going to be my first prediction -- you're going to start seeing a lot more of that where it's more specific applications, but it's going to be tied to insurance reimbursements.

Lewis:Because really, for the insurers, more data is better. They want as much as they can to help build out some of the actuarial tables and some of the pricing for a lot of the plans they're going to be offering. In terms of better understanding patient outcomes and best treatments, there's a lot of applications there as well.

Erickson:We just went to theConnectedHealthconference here in D.C. just a couple of weeks ago and found out that about 40% of your health is based on behavior, which is very interesting, what are you eating, how active are you, what are you doing out there? And I think that plays into the wearable technology trend. You just have to get to where the money is in this industry. I think that really is from the insurers.

Lewis:I think very often, people can be blind to things that are automated and rote for them because they're just humming in the background. It's a decision that they don't even realize they're making. You have some of these wearables that can help identify that in a big data step back type of way, and that can be very compelling for the insurance and healthcare market.

Erickson:Absolutely.

Lewis:Another area I know you're watching is how some big tech titans will be focusing on the cloud, and it sounds like the smart home market as well.

Erickson:We have Alexa in our home right now --

Lewis:And actually, our podcasts have an integration with Alexa.

Erickson:You can actually ask them to play our podcasts, right?

Lewis:Yeah, if you feel like doing that some time.

Erickson:Getting smarter, right? TheAmazonEcho, which is what we refer to as Alexa here, is already a hardware device that was launched in 2015, collecting data for Amazon (NASDAQ: AMZN) to facilitate more e-commerce transactions. Now, this last year, we sawGoogleHome introduce their own hardware competing product, so they can get more information on what you're searching for and what you're wanting to do, which, of course, can drive advertising. We've seen that Jeff Bezos has said he has 1,000 employees working on Amazon Echo right now.

Lewis:That's insane.

Erickson:It's really crazy to think about. They've sold 5 million of these already earlier this year. So, this is a really big project for a really big company, and an innovative visionary leader that's not afraid to put money behind some of his best ideas. I really think that not only Amazon but also Google, alsoMicrosoft, alsoFacebook, are wanting to collect more and more data that you're giving it in your living room, so that they can supplement and improve their businesses.

Lewis:And it seems like a lot of these hardware solutions are really reducing the friction that users have with getting whatever it is that they're searching for, whether it be a podcast, like one of The Motley Fool podcasts, or maybe it's an answer on what the weather is like, or something like that. But, a lot of time, it's ease of use. You look at something like Google's original search algorithm and how that brought the entire tech landscape and navigating the web into something that is simple and easy to find. A lot of what these smart home and more integrated solutions we're seeing from big tech names are doing is something similar, is a next layer on top of that, as I'm seeing at least.

Erickson:Yeah,I completely agree with you. We've seen them launch the product first and then optimize it over time second, basically strategy model of these. Amazon wanted to get the Echo out, get it in your home. Andit's not going to be able to do everything up front. In fact, it was very limitedwhen they first launched it, but it'sgetting smarter. It's able to do more and more things. And I think in the future, we're going to see that more and more beingbased on transactions, rather than just playing music orasking what the temperature is, "Book me an Uber" or "Reorder mesomething on Amazon." I think that's the next wave thatAmazon is going forward, and Google is going after a lot of data as well.

Lewis: One of the thingsI thought was really interesting.I was talking with Fool.com writer Daniel Kline about this. He's a gadget head,loves everything, owns everything. He'll buy itso he can write an article about it -- he's that kind of guy. He saidAmazon was very smart with what they've done with Echo,because they have started out with very limited functionality, and they nailed theexecution on that functionality. Rather than maybe what we've seen withApple(NASDAQ: AAPL)and Siri and some of those other assistant-style things,where the execution was wonkybecause it tried to do too much. So, it'll be interesting to see how these different tech companies, from a functionality perspective, and all the features they allow here,continue to develop that,because it seems like Amazon has been smart there in slowly rolling it out and building a ton ofconfidence in the capabilities of the device and theunderlying software and then adding things as they're able to execute for users.

Erickson:Yeah, and it's a race right now. Do you really need to have Alexa and Google Home and everything else in your home? You probably don't. Maybe you could have them talk to each other and have an interesting conversation. But really, this is almost a winner-takes-all for your living room, which I think is very beneficial for whoever sells the most hardware devices. They're really going to win the data prize at the end.

Lewis: Switching gears here, I know one thing that we're both very interested in is tech mergers and acquisitions, and what that might look like in 2017. There are a couple different factors that I think might play into this. Some numbers fromDealogic: According to their estimates,global technology targeted M&A in 2014 was around $300 billion. In 2015, it was nearly $700 billion. Year to date in 2016, it's around $530 billion. Forcontext, 2006 to 2013, total M&A wasn't above $300 billion once. My projection here is that we will see tech M&A be more or less flat from 2016, maybe even go down. I don't think we're going to revisit that huge peak we had in 2015. A couple different factors here on my end. Do you have any thoughts on that?

Erickson:Money's cheap.

Lewis: Money's cheap.

Erickson:What's the interest rate looked like the last several years, you know?

Lewis: Exactly. Last week, the Fed announced it was raising rates for the second time in 10 years. Now, the federal funds rate, which is the baseline rate for overnight bank borrowing, is at 75 basis points (0.75%), which is up from 50 basis points. Fed officials indicated that they would be possibly interested in making up to three increases next year, which would obviously be more aggressive than they'd originally forecast. The market wasn't quite expecting that. Also, they project three hikes in 2018 and 2019. All of this is to say, it will probably get more expensive to borrow. Capital is not going to be as cheap as it has been in the past. I think that will make some of these acquisitions a little tougher, because very often they're financed by debt by some of these big companies.

Erickson:It's aninteresting dynamic. I would say, right now if you go back to the early 2000s,it was all about getting a website. First, we had pets.com and every other dot-com thatyou could possibly get out there because the internet was blossoming. Then, you look maybe seven or eight years after that, and it was all about mobile, andeverybody wanted to be an app that was on your smartphone that you could access, andthat was just completely the new business model. I think now we'reactually kind of slowing down on producing new things, because we have kind of overwhelmed what consumers can reliably handle,as far as websites and apps.I think it's going to be much more about,how are they useful, and who's consolidating that data? I think that's the third phase of the internet we'reabout to start experiencing.

Lewis:I think one of the other things thatmight play into what we see with M&A moving forward is, a lot of peoplelook at the market right now and they see that it's fairly expensive, in historical terms. Youlook at the S&P 500's trailing P/E, it's in the mid to upper mid-20s. That's on the higher end when you look backover the past 90 years. Historically, it's high single digits to low 20s, with some outliers here and there. Obviously, these are all broad-stroke macro factors, andnone of this scares me away from buying any individual companies. Butit's good to be awareof the general atmosphere surrounding the market.I don't think you will continue to see the consolidation that you've seen, particularly in spaces like thesemiconductor industryand things like that,simply because it's going to be more expensive to borrow, and valuations have already beenpushed up because it's been so inexpensive to borrow for such a long time. There is a wrench, possibly, that could get thrown into this thought process.

Erickson:Here we go.

Lewis: Youwant to deliver it? This is your theory. Thepotential for a tax holiday could be a little bit disruptive with this line of thinking, right?

Erickson:That'sthe wrench that gets thrown into the plan. The gloves are off, what's going to happen, if all of the sudden you can repatriate these billions of dollars that tech companies have had overseas into the U.S. for a reduced rate? That could change the entire dynamic, probably.

Lewis:You wouldn't need the debtto be able to finance these types of acquisitions. Not thatit would be a problem for a company likeApple or Microsoft to do that. But these are two companies thatI believe 90% of their cash hoard is held overseas. For them to bring that back under current tax law, they would be taking a huge haircut to do it. So, they've beenharvesting that money overseas,and basically just letting it sit in marketable securities. But, if they are granted a one-time special tax holiday by president elect Trump,obviously that would make it a lot easier for more deals to go through.

Erickson:Would that make America great again?

Lewis: It might. I don't know. It'shard for me to know. I am no politico. I am just a guy they decided to give a weekly podcast to.

Erickson:Well, I'm glad that you started the reckless predictions for this. I do think the interesting part is, obviously, Trump has campaigned a lot about establishing jobs in America. Of course, tech is a huge source of jobs in this country. So, a tax holiday could theoretically provide a lot of that for him.

Lewis: Yeah. And, I mean, to show his emphasis on the tech industry, they had that tech summit, was that last week? A lot of execs were there. I know Tim Cook was there. So, he's clearly appealing to that group of executives and that industry. It will be interesting to see what the follow-through is there. Obviously, like we said, it's something that could disrupt that process, and that line of thinking with M&A trajectories. But, something we won't know for sure, and just have to watch.

Erickson:Indeed.

Lewis: Any other things to watch for 2017? Anything on your dashboard?

Erickson:Well, I have two reckless predictions for M&A.

Lewis: Love it!

Erickson:This is the crystal that is always cloudy. We never know where it's actually going to hit or not. But just for the show, for you, Dylan,I came up with to reckless predictions of M&Aacquisition that I could see happening in the future.

Lewis: I appreciate that. And emphasis on reckless.

Erickson:Yes. And any hate mail from our listeners,directly to your inbox, right?

Lewis: Yes. That's dlewis@fool.com. Or industryfocus@fool.com,if you feel like hitting all of us!

Erickson:These are, again,highly speculative. I don'trecommend anybody go out and buy these based on this. But two things that I do see that are very interesting out there: My first reckless prediction in the tech M&A space isIBM(NYSE: IBM) acquiringSplunk. The reason being, IBM has been a company that has shown it's willing to change its business model so many times. It's reinvented itself so many times over the decades, successfully. And it recognizes in the healthcare space, in all of the spaces that Watson is playing in right now, it has to look at unstructured data. It has to look at the fullercontext of what's going on in the datathat we're trying to figure out X outcome to come out of. The leader right now, far and away, in unstructured data, is Splunk. IBM istrying to use Watson to improve the outcomes of the healthcare space. So,I would make that reckless prediction No. 1 in the M&A space.

Lewis: All right, what's reckless prediction No. 2?

Erickson:No. 2 isSalesforce(NYSE: CRM) buysVeeva Systems. Again,you have a non-compete clause here with Veeva having exclusive rights to the life sciences and healthcare industry, whereas Salesforce isfocused on almost everything else for software as a service,improving sales efficiencies, and actually, Veeva's CEO came from Salesforce.com, has a great relationship with those guys, and is actually using Salesforce to power along the back-end architecture for that company. I think they've carved out a very profitable niche, and they've kept that great relationship with Salesforce.I think that's a natural fit, potentially, for the future.

Lewis: I love that those were your two, because two that came to mind for me,these are companies we have discussed fairly recently on the Tech podcast,TwitterandPandora. Verycurious to see what happens with them in 2017, because Twitter,of course, went through that flurry of headlines about potentially being suited by,Salesforce was one of them,Marc Benioff, their CEO, seemedenamored with Twitter. But I knowDisneywasin the conversation at some point,I believe Microsoft was in the conversation at some point. It seemed likeanyone with a decent amount of cash on hand was in the conversation. And Pandora recently in chats, potentially, withSirius.I know there has been some speculation there, too. David Kretzmann and I did a show on thema couple weeks ago. So,I'm glad to see that you're bringing some fresh perspectives, those are truly reckless predictions, and ones that maybe a lot ofpeople aren't thinking about right now.

Erickson:Sure.

Lewis: Glad to have you on. Anything elsebefore I let you go, Simon?

Erickson:I think that's it. We're obviously keeping a very close eye on the tech space in Motley Fool Explorer, and also MDP and Rule Breakers. It's aninteresting time to be a tech investor. We've seen the valuations a lot higher than we've been used to. On the other side, these companies are doing somepretty innovative stuff out there. Continues to make our jobs veryinteresting and a lot of fun.

Lewis: It'sa lot of fun to talk about. I'm sure I'll have you on the show plenty of times in 2017.

Erickson:Thanks for having me today, Dylan.

Lewis: Well,listeners, that does it for this episode of Industry Focus. Just a note before we sign off: I wanted to let our listeners know about our holiday philanthropy drive. This year, we've partnered with Growing Powerto bring sustainable food and employment to at-riskcommunities around the United States. One in sevenAmericans are food insecure. Your donation can make a difference to a community in need. To learn more about Growing Power's mission, and to donate, visit give.fool.com.

If you'relike the show and you're looking for more of our stuff, you can subscribe on iTunesor check out the Fool's family of shows at fool.com/podcasts. As always,people on the program may own companies discussed on the show, and The Motley Fool may haveformal recommendations for or againststocks mentioned, so don't buy or sell anything based solely on what you hear. For Simon Erickson, I'm Dylan Lewis. Thanks for listening and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Dylan Lewis owns shares of Alphabet (A shares), Apple, Pandora Media, and Walt Disney. Simon Erickson owns shares of Amazon.com, Apple, Facebook, Splunk, Veeva Systems, and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, Apple, Facebook, Fitbit, Pandora Media, Splunk, Twitter, Veeva Systems, and Walt Disney. The Motley Fool owns shares of Medtronic and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.