Gerrard's Redemption: Pico Empowered by Byte

In 2022, global economic recession risks have intensified due to unstable factors such as the COVID-19 pandemic and the Russo-Ukrainian conflict. Both the global smartphone and PC markets saw nearly 10% decline in the first half of the year, directly causing weak terminal demand.

Although the current economy and stock market are relatively sluggish, investments are made based on optimism and confidence. In the context of global demand shrinkage, the VR/AR market has shown strong growth momentum and is expected to bring confidence to the market. Dolphin Analyst believes that the VR/AR market has potential for growth:

1. In the medium to long term: VR still has several times the space for growth. With the innovation and iteration of VR devices, global VR device shipments have crossed the bottleneck of 4 million units, with global shipments exceeding 10 million units for the first time in 2021. VR is gradually expanding from a niche group to the general public. Although the current usage of VR is still mainly in gaming and film, compared with the annual sales of more than 30 million game consoles worldwide, VR still has several times the space for growth. If VR expands into the social field in the future under the influence of Meta and Byte, the annual shipment volume of just over 10 million units currently and the annual shipment volume of over 1.3-1.4 billion mobile phones worldwide have more than 100 times the growth potential.

2. In the short term: VR has high growth under a sluggish market. Under the influence of unstable factors in the first half of the year, smartphones, PCs, and other products all saw significant declines, while VR achieved a high growth rate of 27%, which is a rare high-growth area outside of the new energy industry. With the release of new products from manufacturers such as Pico and Oculus in the second half of the year, the development of the VR market is expected to be further stimulated.

Overall, Dolphin Analyst believes that VR still maintains its growth characteristics in the medium to long term and in the short term, and is one of the few high-growth areas in the current market environment.

Although the overall growth rate of VR seems to have declined significantly due to Oculus's lack of new products in the past two years, Dolphin Analyst looks at the domestic and international markets separately. Oculus still dominates the overseas market, and the lack of new products has directly led to a lack of growth in VR sales in the overseas market. In contrast, Pico leads the domestic market and directly ignited the domestic VR market after being acquired by ByteDance through product improvement and promotion strategies.

Looking at the 27% growth in global VR shipments since the beginning of this year, it is mainly due to the growth of the domestic market brought by Pico. If we focus on the domestic market separately, it is expected to achieve a growth rate of more than 200% in 2022. As the core supplier of Pico, Geely Holding Group's value has increased significantly along with the sharp increase in sales volume this year. In September, Pico launched a new product NEO 4, which is expected to continue stimulating the development of the domestic VR market. With Pico's growth, it is also expected to gradually share the risk of customer concentration.

Currently, Gore still occupies the position of the core supplier of Oculus and Pico in the domestic and overseas markets. With the company's technological polishing capability and industrial chain coordination ability in the VR field, the company is expected to continue to play an important role in the supply chain of the two major players' new products and Apple's related products in the future.

Although the company's stock price has been dragged down by the US interest rate hike and the overall consumer electronics sector recently, it still continues to consolidate its leading position in the VR field and continues to grow. The Dolphin Analyst believes that when the macro environment and sectoral influence weaken, the market will also see the company's ability and value.

I. The embryonic form of VR is gradually emerging: Meta helps, ByteDance enters the game

At first, VR was only a fancy idea of device manufacturers, with more use in film and commercial purposes. With the entry of major Internet companies, VR has gradually entered people's daily lives. In 2014, Facebook (now Meta) acquired Oculus, and Sony also began to release PS VR at the same time, and the entry of giants opened the VR era.

The initial stage of VR (2014-2019): the industry is in its infancy, and the market is chaotic. Giants such as Facebook (now Meta), Sony, Google, Samsung, and HTC have successively entered the game, ushering in the first development of the VR market. This is the first time that VR products have come close to the public's vision. People have tried to buy them more out of curiosity. Although they can bring people a certain VR experience, there are also some shortcomings in the experience. The low refresh rate and resolution are easy to cause visual fatigue for consumers. As a new product, VR does not have too many games and applications to adapt to, and it is easy to cause idle time after a period of time.

The development stage of VR (2020 to present): innovative iteration, the pattern gradually emerges. In 2020, Oculus Quest2 launched by Facebook (now Meta) became the first phenomenal product in the VR market. Oculus Quest2 has made improvements in processors, resolution, and refresh rate, and lowered the price by 100 US dollars. Good VR experience and high cost performance products directly opened up the VR market's ceiling. As of now, the cumulative shipment volume of the single product of Oculus Quest 2 has exceeded 10 million units. From the success of Oculus Quest 2, the main driving force for the sustained growth of VR is innovation and high-quality products. Brands such as Meta, Pico, Sony, and iQiyi have also begun to accelerate product iteration and product innovation in screens, resolution, optical solutions, and other aspects.

Currently, the VR market presents a "one-man show, others follow" pattern. According to WellsenXR data, in the second quarter of 2022, Meta accounted for nearly 80% of the global market share, followed by Pico with 11.3%, and the share of other manufacturers was less than 2%.

Based on the characteristics of the previous few VR manufacturers, the VR market has already moved away from the characteristics of pure hardware manufacturers and is moving towards the trend of combining software and hardware. Currently, the leading player in the VR market, Meta, already has social applications such as Facebook, and Pico, which is close behind, has already "married" ByteDance, with its parent company owning short video applications such as Douyin and TikTok. Sony and iQIYI also have their own content.

For Meta and ByteDance, although they have already built up user bases of hundreds of millions, they are still constrained by hardware entry points due to the nature of internet software companies. However, entering the VR market has given them an opportunity to occupy hardware entry points and provide them with an opportunity for software and hardware integration by equipping their original content onto the VR platform.

At the same time, the entry of major players could also drive the development of the VR industry. On the one hand, the large players bring with them the support of funds to the industry, which has more motivation to innovate and research and develop products. On the other hand, internet giants can bring more content and usage scenarios to the industry's ecosystem with their original software capabilities. For example, iQIYI integrates its own film and television resources, while ByteDance also starts adding short video and live content.

Dolphin Analyst believes that with the maturity of other brand products, Meta's high market share will decline. It is difficult for a single hardware manufacturer to enter the VR industry, and it is more likely to continue in the direction of software and hardware integration.

Innovation and iteration drive the development of VR

From the current market pattern of VR, Oculus and Pico are the most advanced, with the two together accounting for more than 90% of the market share. Therefore, product innovation in VR mainly focuses on the release of new products from these two brands, and both companies will launch new products in the second half of 2022.

2.1 New products from Pico and Oculus

In terms of the release of new VR products, the overall product is getting better and better. On the hardware side, VR products are evolving in a "lightweight and better experience" way.

1. Pico: In September 2022, Pico will release the new product Pico Neo 4, which further reduces the weight of the product to less than 300g, reducing pressure on the head. In addition, in terms of user experience, the resolution and PPI have been significantly improved, and the viewing angle has been expanded to 105 degrees.
2. Oculus: It is expected that the company will release Oculus Cambira in the second half of 2022. This is Oculus' first new product release in nearly two years and is considered an upgraded version of Quest 2. Previously, Quest 2 became a star product in the VR industry. The new product is expected to continue to improve the user experience and move towards lighter weight and a better experience.

2.2 Potential Entry of Apple

Apart from Pico and Oculus, the market is most concerned about the possible MR-related products that Apple may launch. As early as 2015, Apple acquired the German augmented reality technology company Metaio, and in the past decade, it has applied for more than 5,000 patents related to "AR" and "VR". Previously, Apple has already launched AR games, AR decoration and other related functions.

The market expects that Apple will launch its first MR product in 2023, which will potentially integrate ultra-high-definition display, eye-tracking, environmental recognition and other technologies. With the existing ecology and software and hardware capabilities of Apple, the new MR product is expected to become a new market hotspot.

2.3 Value Distribution of VR Hardware

Based on the recently released Pico Neo 4 and the innovative and hardware cost analysis of the product. The screen, SOC chip, and pancake are the three major cost components of the Pico Neo 4 hardware, with a total value ratio of more than 50%.

In terms of device-side innovation, these three components are also the most important focus. The Pico Neo 4 SOC chip still uses the most widely used Qualcomm XR2 chip in the market, the screen uses JDI/BOE's fast-LCD panel, and the pancake optical module comes from GOERTEK. The impact of other devices on the overall cost is relatively small.

As can be seen from the changes in weight and resolution of the new product mentioned earlier, they mainly come from the improvement of the screen and optical solutions.

1. Screen Development Trend: It is developing from backlit LCD to mini-LED. Due to the self-luminous properties of mini-LED, the overall brightness and resolution of the screen will be higher than LCD, but it will also raise the cost item of the screen;
2. Optical Scheme Trend: "Traditional Lens-Fresnel Lens-Folding Optical Path (Pancake) Scheme". Pancake mainly shortens the imaging working distance between the screen and the lens by allowing the light path to bounce back and forth between the lenses multiple times, and the overall length of the optical module can also be reduced, achieving thinness and lightness of the head-mounted display. According to data from Skyworth, the thickness of the entire optical module is reduced from 39mm to 17mm with the use of pancake, and the reduction rate is over 50%. Pancake can reduce the weight of the host while thinning it.

Dolphin Analyst believes that the VR industry is still in its early stages and still needs to rely on innovation. The release of new products such as Meta, Pico, and Apple is expected to continue to stimulate the development of the VR industry. In the development of the VR industry, the most benefited are brand manufacturers and core supply chain. From the perspective of VR hardware value splitting, the three most benefited components in the industry are screen, SOC chips, and pancake optical modules.

Three, industry trends and individual stock opportunities

VR has growth attributes in both the short and medium term. So who will benefit the most from this VR industry wave? Dolphin Analyst believes that the development of the VR industry is similar to that of smartphones, and the ultimate beneficiaries are brand manufacturers and core supply chain companies.

3.1 Brand manufacturer perspective:

If VR can successfully expand downstream in the future, when the industry's annual shipment reaches 50 million or 100 million units, there will also be terminal brands in the industry, similar to the more influential Apple in the smartphone market. In the development and mature period of the industry, terminal brand manufacturers are expected to earn more profits.

From the comparison of domestic and foreign VR markets, overseas growth is slowing down, while China is showing strong growth.

1. Overseas VR market: In the past, it was led by Oculus, and in 2020, Quest 2 directly ignited the entire overseas market. However, as Oculus has not launched a new product from 2020 to the present, the overall overseas VR market shipment growth has begun to stagnate and has stabilized at a quarterly shipment level of about 2 million units. The market expects Oculus to launch Oculus Cambria this year, which may have a certain stimulating effect on the market;
2. Chinese VR market: In the past, because Oculus devices require a Facebook account in China, the ignition of Oculus Quest 2 did not bring much change to the domestic VR market due to usage restrictions. After ByteDance acquired Pico in the second half of 2021, the domestic VR industry began to grow rapidly. The entry of internet giants brought funds and confidence to the domestic VR industry. At the same time, Pico's overall good new products and promotions directly drove a high growth of 300% + in the domestic VR market.

Dolphin Analyst believes that the growth of overseas VR market still needs to pay attention to the new products of Oculus and Apple, while the domestic VR market is expected to usher in a wave of outbreaks in advance. Previously, due to usage restrictions and the shortage of domestic products, the domestic VR industry has always been lukewarm. After adopting Pico, ByteDance's "good product features and promotional activities" have directly stimulated the high growth of the domestic VR market. The Dolphin Analyst expects that in the future, the domestic VR market may be similar to new energy vehicles, and with the improvement of domestic product features and content richness, it is expected to continue the pattern dominated by domestic brands. The domestic VR market is expected to exceed 1 million units in 2022 for the first time, an increase of over 200% year-on-year.

3.2 Industry Chain Perspective:

By analyzing the cost breakdown of VR hardware, screen, SOC chip, and pancake are the three main cost items in mainstream VR, and they are also major innovation points for new VR products. Grasping the opportunities of the industry chain also focuses on the part with the highest value.

1. Screen: Currently the largest cost item in VR devices, and may still be the largest cost item in the future. Similar to smartphones, the cost of screens in phones is also high. The screens used in VR devices were previously mainly backlit LCD screens, but because resolution and brightness will affect user experience and usage time. In terms of product innovation, there is currently a trend towards mini-LED and OLED from LCD. LCD is mainly used due to cost considerations at this stage. The value of screens in VR devices is expected to continue to increase in the future.
2. SOC chip: Currently, mainstream VR devices generally use Qualcomm XR2 chips with a 7nm process. SOC chip directly affects the processing and computing power of VR devices, and low-performance chips are more prone to stuttering phenomena when VR devices often need to process 3D images. Like mobile processors, SOC chips will gradually evolve towards higher performance in the future. Domestic manufacturers still have some gaps.
3. Pancake optical module: In recent years, the optical module of VR devices has gradually shifted from Fresnel lenses in the past to pancake optical modules. The biggest advantage of this is to thin the host and reduce the overall weight. Although the use of the Pancake optical module will increase the cost factor by 8 times, it can better improve the comfort of user wear. In the future, optical modules are also expected to evolve towards lighter and better imaging effects. Some domestic manufacturers have already mastered Pancake.

3.3 Selected stocks:

Applied to individual stocks, the Dolphin Analyst still believes that GoerTek is the best leading stock on the VR track, from three dimensions:

1. Two leading core suppliers at home and abroad: As a to-C product, whether the supply chain company is good or not depends on whether the customer's product can be sold well.

From the perspective of splitting the domestic and foreign markets, Oculus holds more than 90% of the overseas market share, while Pico holds 80% of the domestic market share. Due to the special nature of the VR market, the domestic and foreign markets are relatively independent. However, the overall pattern is that Oculus in overseas markets is firmly in the lead, while Pico in the domestic market is also far ahead. And both major brands are the company's major customers, and the company is also their main core supplier. Whether Oculus develops overseas markets or Pico increases dramatically in domestic markets, the company will benefit;

2) Domestic major customers are expected to erupt: Since ByteDance acquired Pico, the domestic VR market has shown a dramatic increase. In September 2022, Pico will release its new product, neo 4, which is expected to continue to stimulate the growth of the domestic market. Whether Oculus can once again bring explosive products and other product releases, but Longbridge will directly benefit from the high growth of Pico in China;

3) The value of Longbridge to Pico exceeds that of Qualcomm: From Fresnel lens to pancake optical solution, Longbridge is its supplier, and this solution directly increases the value by 8 times. In addition, Longbridge also provides Pico with ODM, acoustic modules, etc. The overall unit value is $76, accounting for 21% of the overall hardware cost. From Pico's choice of Longbridge's pancake solution, Longbridge has won the recognition of the manufacturer. As various manufacturers switch from Fresnel to pancake, Longbridge is expected to continue to improve its value in the VR industry chain.

Dolphin Analyst believes that the overseas VR industry will still focus on the new product releases of Oculus and Apple, while the domestic VR industry is expected to continue to show high growth under the drive of brands such as Pico. Longbridge, with its position as the core supply chain of the largest brands of Oculus and Pico at home and abroad, is expected to benefit from the growth of VR. From the latest Pico teardown, Longbridge's value continues to increase to more than 20%, surpassing Qualcomm. Although the company's stock price has been dragged down by the US interest rate hikes and the overall consumer electronics sector in the near future, the company continues to consolidate its leading position in the VR field and continues to grow.

Dolphin Analyst's research on the VR industry and Longbridge includes:

August 30, 2022 financial report evaluation "Longbridge: VR growth that doubles based on why it has pressed the pause button?"

April 27, 2022 financial report evaluation "VR high growth, Longbridge again submitted a strong guide against the trend"

March 30, 2022 financial report evaluation "Longbridge: "Laid-off" is just now, the future is still VR"

August 27, 2021 financial report evaluation "Longbridge: "VR light" covers the "loneliness" of TWS earphones invite-code=032064)"

On August 20, 2021, "Geely Share (Part 2): The Metaverse Is Too Far Away, VR Game Consoles Are Already "HOT"" and on July 23, 2021, "Geely Share (Part 1): What Has Happened to The Fruit Chain Leader Who Experienced Another Sharp Drop?"

Risk Disclosure and Statement of this Article: Disclaimer and General Disclosure of Dolphin Research