Forget Google — This Is The Best Stock For The Internet’s Next Big Thing

You have to have some sympathy for the executives at San Jose, Calif.-based Echelon Corp. (Nasdaq: ELON).

They’ve been trying to explain the appeal of adding wireless communications and intelligence to a range of “dumb” machines and devices for more than two decades, yet industries and consumers never quite grasped the company’s vision.

Indeed, Echelon’s market value recently fell to an all-time low of just $ 100 million as investors grew tired of open-ended losses.

So you can imagine the company’s shock when Google (Nasdaq: GOOG) announced plans in January to acquire Nest Labs for $ 3.2 billion. Nest has made quick inroads in the consumer market by adding wireless intelligence to thermostats and other “dumb” devices. Echelon’s executives can at least take solace in the fact that investors have pushed its stock up 50% in hopes of a Google-style buyout. 

Why would Google pay so much money for a company that reportedly had just a $ 300 million revenue run rate? Because Nest, along with many other firms, are in the forefront of an emerging industry niche that could be worth $ 44 billion a year by 2017, according to research group GSMA. That firm solely estimates how much money will be spent by consumers to develop a “connected home.” But the use of such technology in industrial applications may create another market just as large, if not larger.

By now, you’ve probably read at least something of this technology, which is increasingly referred to as the Internet of Things. It’s a concept that is simple and straightforward. Any device that can be programmed or monitored, can be done so remotely. Right now, Google and Nest are thinking about items such as carbon monoxide detectors, but when you think about it, there are dozens of devices in your homes that could be improved with an Internet connection.

For example, your next washing machine may be able to notify the manufacturer when a breakdown is imminent. A repairman may call you about the problem before you even knew about it. How about a toothbrush that sends information on your brushing habits to your smartphone? Gigaom’s Stacey Higganbotham recently predicted that “we’re just at the beginning of seeing a bunch of really ridiculous products that tie pretty much anything to a smartphone.”

Yet beyond any early wave of silly ideas, the long-term outlook of Web-enabled devices is shaping to up to be huge. Companies big and small are angling for a piece of the pie, and while Google seems to have captured a lot of initial buzz around the concept, investors should really consider another tech titan that stands to be a clear beneficiary.

Cisco Systems (Nasdaq: CSCO), whose stock has been flat since the summer of 2010 while share of Google have risen 250%, is squaring up for its own major push into the Internet of Things. Simply based on Cisco’s legacy business divisions and solid cash flow generation, this stock already holds solid appeal to value investors. For growth investors, the Internet of Things holds the promise of reinvigorating the top and bottom lines.

Large Numbers
Maciej Kranz, vice president for corporate of Cisco’s corporate technology group, recently told an investment conference that Cisco has already invested more than $ 1 billion in pursuit of the Internet of Things, and expects to roll out more than 700 products targeted at this niche. Though some of these products will be aimed at consumers, Cisco appears more intent on targeting the industrial market, where wireless connectivity can boost productivity in a variety of ways.

Andrew Obin, who follows industrial technology for Merrill Lynch, suggests that 1% to 2% efficiency gains can be reached on factory floors through the deployment of the Internet of Things. The current $ 32 trillion annually spent globally in manufacturing could yield savings in the range of $ 300 billion to $ 600 billion, according to Obin.

These are very large numbers, and it will likely be a decade before such gains are fully reaped. The key point is that the Internet of Things isn’t a future technology — it already exists. By this time next year, Cisco will likely have already launched a wide variety of products targeting the opportunity.

Merrill Lynch’s Tal Liani, who follows Cisco and other networking stocks, cites several potential industrial uses for the Internet of Things (IoT):

• “In manufacturing, IoT would increase production up time.”
• “In energy, IoT would improve safety of operation.”
• “In logistics, IoT would lower downtime for trucks and increase equipment utilization.”

Perhaps the greatest appeal for Cisco is not the chance to sell millions of low-priced wireless widgets that are wired into a machine’s control panel. Instead, the advent of the Internet of Things brings the need for a much more robust computer network to manage and direct the ever-growing streams of data these machines will produce.

Cisco would likely be willing to swallow its profit margins in exchange for robust orders for its high-ticket network equipment. Cisco has developed an operating system geared toward the Internet of Things, called Cisco IOx, which you can read about here.

Risks to Consider: Emerging technologies can sometimes take a while to play out, so expectations for a fast-growing Internet of Things ecosphere in 2014 may be pushed out a year or two.

Action to Take –> As the Internet of Things takes off, a number of small, private companies may look to go public. The $ 3.2 billion buyout of Nest may have primed the pump for a flurry of deals. Some of those IPOs will soar in price as investors start to ponder the ultimate size of the Internet of Things.

Yet an investment in Cisco, while offering lesser upside than the small companies, offers a chance to latch on to this growth trend while still owning a company that generates solid cash flows. Indeed, Cisco has generated at least $ 8 billion in free cash flow in each of the past seven years, a point which is often overlooked when investors suggest that the company is no longer vital. Cisco remains an out-of-favor stock, though the Internet of Things may just be the catalyst to get this stock moving higher.