I  have been doing a lot of work around IoT (the Internet of Things) lately. It is a subject of near universal interest among the kinds of people I hang out with. Hardware, software and component makers are all trying to find some way to tap into the market. Bankers and investors are constantly looking for IoT ideas. Whenever I meet a company that has sensors or a field crew or sells $0.10 components into cars or machines, I suggest they rebrand themselves as an IoT company if they want to give their valuation a boost.

All joking aside, the reality is that almost no one has an actual ‘IoT business’ yet. There are barely a handful of public companies that can credibly make this claim, and their valuations are priced for that scarcity. Most public investors know this, and tend to be very skeptical about anyone making IoT claims. This reality was the idea that sparked my big report two months ago laying out what the IoT hardware landscape would look like. I am not saying that all IoT businesses are hot air, there are some real businesses emerging, especially in the software domain. However, the industry is in very early stages relative to where some people think it can go. I saw a book today called “The Zero Marginal Cost Society”, with the alluring sub-title “The Internet of Things, the Collaborative Economy and the Eclipse of Capitalism”. That last bit about capitalism stuck with me long enough to inspire this post. I think it is premature to say IoT can spark that sort of change. Maybe, someday. But we have several more cycles to go through before that can even be attempted.

As I said, I think most public investors are aware of the hype cycle surrounding IoT. However, there is one category of investors who view things very differently – private equity. I have heard this from many different bankers. Last year, there were several ‘IoT companies’ on the auction block, and they were sold for healthy multiples. Multiple sources have told me that those auctions attracted a huge amount of interest from ‘financial buyers’, as opposed to ‘strategic buyers’ or actual companies. There is a sense that IoT is going to spark a drastic change in the operations of non-tech companies, and private equity buyers want to participate in that. If you start with the premise that IoT is coming in a big way in the next five years, then I suppose there is appeal in owning a company that will enable that wave. These companies also tend to be relatively low-tech – in the sense that they are focused on the problem of retrofitting industrial infrastructure like delivery trucks and factory machinery. This area has a lot less technology risk.  As I noted in my report in June, all the technical building blocks for IoT are largely mature – Wi-Fi and micro-controllers are well-established technologies. These kinds of companies have cash flow from service contracts and the like, which appeals to private equity buyers. By contrast, venture investors who want to take on technology risk seem to be much more focussed on the software side of IoT

What really stands out to me is the depth of private equity interest in IoT, with some of last year’s auction attracting twenty bidders, and people calling in favors just be on the shortlist. Public market investors now tend to be very choosy about assigning IoT valuations to companies. By contrast, the businesses that are attracting private equity buyers attract a lot of bidders, even when these businesses have been around for years doing things far more mundane than eclipsing capitalism.

I am not going to say there is some kind of IoT Bubble. There are definitely reasons for private equity buyers to want to participate in this field. Nonetheless, I can not wholly reconcile the different levels of interest between the public and private markets. One interpretation could be that private equity buyers have a longer time horizon than the average hedge fund manager. I am not so sure about that. Another could be that there are many companies today which need to re-tool for future IoT businesses, and the best way to do that is with private equity capital. This thesis seems to be supported by the news yesterday morning that Motorola Solutions sold a stake in itself to the arch-Tech Private Equity firm Silver Lake specifically to ‘transform’ its business. On the other hand, it could just as easily be argued that this has nothing to do with IoT, and is all about smart financial engineering, a thesis borne out by the fact that Motorola will use some of the Silver Lake funds to increase share buy backs and the like.

When it comes right down to it, maybe the answer to all this depends on what we expect from the Internet of Things. The name alone conveys some lofty hopes. For people looking to transform or disrupt the whole economy, IoT carries much promise but is also a distant goal. By contrast, for those looking to help old-style industry re-tool for a digitally-enabled world, there are some nice cash flow streams out there which can support some big investments for growth in a few years. If the goal is to enable some Big New Idea, it is hard to find good investment opportunities. On the other hand, if the goal is to supply investment capital for a business that attaches wireless modules to cement mixers, maybe there are some good deals out there.