Introduction

There’s been much hype surrounding fifth-generation wireless technology, or 5G, with its promise of faster download speeds, greater data capacity, and lower latency. Over the past 10 years, advances in 4G wireless technology have driven the growth of smartphones, social media platforms, and the burgeoning digital economy.

In this issue of Strategy Insights, we take a look at wireless technology, including its history and the next steps, such as 5G, and explore the potential implications of the technology from an investment perspective, among other topics. 

Brief History of Wireless Generations

Historically, we’ve seen a new generation of wireless about every 10 years, with each new generation building upon the last to meet growing data demands. 

Mobile communication began with the first wireless generation (1G) in the 1980s that enabled mobile voice calls. This was then replaced by 2G in the early 1990s, which offered a more secure and reliable communication channel along with higher data capacity, better sound quality, and services such as caller ID and text messaging.

3G came along in the 2000s, offering improved talk and text quality, including video calling and higher data transmission speeds, allowing for wireless internet services. The capabilities of 3G wireless also spawned the Apple iPhone in 2007 and the App Store in 2008. By 2010, after significant infrastructure investment, 4G mobile networks were launched with 10 times faster download speeds, enabling all 3G services in addition to high-definition mobile TV, video streaming and conferencing, and cloud computing. Basically, cell phones went from simple devices used to make phone calls to full multimedia platforms. 

But the evolution is not complete. 5G networks are expected to bring significant enhancements to three critical areas of wireless networks: speed, capacity/bandwidth, and latency (response time). While the rollout of 5G worldwide started in 2019, adoption is expected to ramp up over the coming years as the number of connected devices significantly pressures existing network capacity. 

The App Culture

The advancement to the 3G network in the 1990s ushered in the use of applications, or apps. Apps have become easier to use with the buildout of the current 4G network and its advanced speeds. As one example, ride-share apps such as Lyft and Uber have become a way of life for many of us, but these and a host of other apps arguably would not be around without the network speeds of 4G.

So once 5G really starts coming into play, what will be the killer 5G app(s) 5 or 10 years from now? Our short answers are: we don’t know yet, and there likely won’t be just one!

As the 5G upgrade progresses, we’ll undoubtedly marvel at the faster speeds, greater data capacity, and lower latency that enable our current technologies to work even better. Remember, 4G wasn’t built for ride sharing, but rather this service came about because of the capabilities 4G offered. 

While we may not be able to envision all the killer apps that could shape the future, there are several interrelated technologies that may not be able to reach their full potential without 5G technology. Cloud computing, the internet of things (IoT), artificial intelligence, machine learning, autonomous vehicles, augmented reality, and virtual reality are just some of the current megatrends we expect will become more mainstream over the next several years with the help of 5G technology. 

Will 5G Create a Capital Spending Spike?

The rollout of 5G infrastructure might be expected to create an incremental spike in capital expenditures (capex) by companies in the 5G value chain, but the reality is this may not be the case. There seems to be a bit of a “chicken and egg” scenario playing out so far. Because the technology is relatively new, there are few handsets globally that work on a 5G network, and going too fast on the network buildout without 5G-capable handsets means the telecommunications service providers (telecoms) may not realize an appropriate return on their investments. In addition, the needs and costs of an effective nationwide network are high, thus the network roll-out so far has been slow. 

Other major industries that may be expected to increase capex include cloud computing companies, semiconductor manufacturers, and specialized real estate investment trusts (REITs), such as cell tower operators and data storage companies. However, because like prior wireless generations, the 5G network will build off of the 4G network, we do not expect the promise of 5G to lead to significant increases in capex budgets for the majority of the companies in the 5G value chain. Rather, the generation of appropriate cash flows and returns on invested capital are likely to govern the pace of capex spending. 

Potential Investment Implications of 5G 

5G promises to bring growth opportunities for companies, entrepreneurs, and investors, but it will also bring inherent risks.

There is an opportunity and a need for the telecoms, tower operators, and data center managers to build out a robust infrastructure network to make 5G a reality. However, the accompanying cost, scale, and regulatory hurdles may make some telecom carriers hesitant to be too aggressive in this buildout. They may not be fully confident they have received an appropriate return for the investments they made in upgrading the 4G network, which likely weighs on their decisions about the pace of 5G deployment.

We don’t yet know for sure how 5G will progress, so making a clear-cut investment recommendation is difficult at this point. We feel fairly confident, though, that 5G will drive huge leaps in data demand. The need to move, store, analyze, and leverage data should provide a significant long-term catalyst for the tower operators and data storage companies that comprise a majority of the weighting in the S&P 500® Real Estate sector. We expect these 5G-related companies to significantly outgrow their sector peers, and we’re actively looking for additional ways to increase our exposure to the fastest growing segments of the Real Estate sector.

Conclusion

It’s likely the buildout of 5G will be a multiyear process, and the reality of 5G may take longer than expected. Unfortunately, the worldwide COVID-19 pandemic and the resulting restrictions to contain the virus are likely to further delay the network buildout. Ironically, changes in consumers and enterprises as a result of the crisis are likely to increase the needed attributes of 5G.

From an investment perspective, we believe trying to pick any single security based on 5G alone will be difficult.

However, we see strong secular opportunities to invest in asset classes leveraged to 5G, and we currently see companies in the specialized REITs industry with 5G exposures as long-term beneficiaries of this trend.

FOR AN IN-DEPTH LOOK
Strategy Insights: Q2 2020