Judging by my recent conversations with clients, it seems that IoT (and more broadly, Industrial Tech) is a focus for both corporate and PE investors right now.

The appeal of the sector is clear: a combination of rapid growth, high customer willingness to pay (for the best solutions) and the potential for recurring, service-based revenue drives a compelling financial profile for many assets.

However, there are challenges:

1. The small scale of many targets means that the total cheque size isn’t suitable for all investors
2. Multiples are very high (and processes are extremely short and competitive)
3. Not every investor is comfortable underwriting the technology risk

In response, we’re seeing some clients take an alternative approach.

Rather than investing in companies that develop technology, they instead seek to identify the businesses which will benefit from deployment of the technology. In other words:

If the technology has the potential to create radical customer value, why not buy the customer that stands to reap the rewards?

Take the construction sector as one example:

It’s well known that productivity in construction has stagnated over the past two decades – growing at less than 1% per annum. Increasing regulation, the uniqueness of each job site, the complexity of managing major projects, and an ageing workforce have all caused problems.

Now, a wave of technologies appear to have the potential to drive major gains. From new AR design tools and new surveying technologies to automated, hybrid equipment – the list of technologies that are at the point of early adoption is long. In that context, the potential for changes to the industry cost structure – and hence radically improved performance for the winning firms – is significant.

Of course, construction is just one example. A range of other “old economy” sectors could equally be upended by companies which fully grasp tech-enabled change.

When a sector is subject to disruption, not all the participants will benefit equally. The key is to identify the niches or the specific targets that – with the stimulus of a skilled investor – can creatively and aggressively deploy new technologies to transform their economics.

Developing a sound investment thesis requires early investigation to assess the likelihood of change, the magnitude of impact and to identify the specific companies that can best capture the new value. Here are some of the questions that we’ve seen people address early on, as they begin to craft and refine their thesis:

1. Which activities in the value chain will be affected by IoT?
2. What other structural challenges might restrict the sector’s ability to fully benefit from new technology?
3. How much capital will be required to acquire and deploy new technology, and what does that imply about the overall funding requirement for the business?
4. Does cyclicality amplify or restrict the ability to take advantage of new technology? Where in the cycle are we?
5. What factors best position a company to deploy the technology – i.e. a strong reputation for trust and integrity, strong customer service?
6. What might the sector’s structure look like after the disruption? Will it be more consolidated or more fragmented?
7. Does the disruption present an opportunity to establish strong pricing and margins in the sector?
8. What are the “early warning signals” that industry change is gathering pace – so that we can best time our investment?

Winning with this kind of investment requires much more than a sound thesis. Even having found a great target, success often requires skills and appetite to drive a new management agenda and to reinvent the value-gen plan.

But given the level of competition in the more obvious deals, it seems that more and more investors see this as a valuable – and viable – path.

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