• Apple’s breakthrough could be a godsend for 537 million people
  • Generative AI’s will be widely used in metaverses
  • Lab-grown human skin?

Dear Reader,

High growth software companies are a useful barometer for the health of the economy. 

When the public markets are in growth mode and institutional capital is allocating into growth stocks, software is one of the most popular sectors. The reasons are simple. 

Most software companies no longer manufacture any hardware or computer servers. Deployments tend to take place on generic servers on premise or in the cloud. And that means high margins, typically in the 70+% range, often above 80%.

That also means that rolling out and deploying software in the field is pretty easy to do. No need to “roll a truck” anymore. 

Just upload the software onto a server, configure it, and a business is up and running. And that means that large, double digit year-on-year growth is normal for high quality software companies.

Combining the two – large double-digit sales growth plus high gross margins – leads to gushing free cash flow for well managed businesses. And that’s why best-in-breed high growth software companies tend to command strong enterprise valuations when times are good.

It’s also why they get hit hard during times of market volatility and rising interest rates. That’s exactly what we experienced last year. 

That’s because these companies are valued on their future growth potential. And when interest rates rise to such a large extent, their future cash flows are discounted significantly, resulting in the kinds of compressed (heavily discounted) valuations that we are seeing right now.

But it raises the question, have businesses reduced their software spend? Is there a reason for us to be bearish as we look towards the second half of this year? 

Let’s have a look:

There has been a slowdown in the growth of software spending across all major market segments from large enterprises to midmarket firms. Even small and mid-sized businesses have seen a slowdown. 

It hasn’t been a straight line down, and the trend has been taking place since 2016. But with that said, software spend continues to significantly grow year-over-year, just by a smaller percentage.

The one exception was a large spike in software spending growth which happened in 2021. That was pandemic related for small and mid-sized businesses, but that has largely corrected since last year.

All things are relative. This trend might appear to be bearish. But let’s consider the relative growth.

  • Large enterprises are still growing software spend around 25% a year

  • Mid-market firms are growing software spend around 33% a year

  • Small, mid-sized businesses are growing software spend around 30% a year

These are very significant growth rates considering the modern digital transformation enabled by software advancements and cloud computing started about 15 years ago.

What’s interesting is that most software firms are still enjoying large double-digit revenue growth and high margins right now despite the current economic conditions. 

It’s just that the quality of their business is not reflected in their current valuations. This is why we’ve seen private equity step in and start acquiring some of these companies at discounted valuations.

There are always exceptions though. Cloudflare (NET), a web hosting and cybersecurity company, is trading at an enterprise-value-to-sales multiple of almost 15 right now. And companies that have strong exposure to artificial intelligence have started to run in the last few months. 

C3.AI (AI) is a perfect example. At one point in early February, the stock was up 146% year-to-date. These are bright spots in an otherwise tepid sector.

AI is a signal of what’s to come. 

Artificial intelligence is going to be the catalyst that leads the software industry out of this current economic volatility and back to high growth. This technology, capable of delivering extraordinary efficiency gains, will change the trajectory of the chart that we see above. 

AI won’t be a “want to have”, but a “need to have.” Without it, small and large enterprises alike simply won’t be able to compete.

Apple’s MedTech breakthrough…

Apple just had a major breakthrough with its wearable smart watch technology. The tech giant has developed a method to monitor blood-glucose levels in real time without the need to prick the skin and take a blood sample.

This is something that’s been talked about for years in the medical industry. And I know Apple’s been working on it for more than a decade.

The fact is, about one in ten Americans have diabetes. And globally, around 537 million adults have diabetes. This requires that they monitor their blood-glucose levels typically at least four times a day.

The problem is, right now, this requires patients to prick themselves with a needle to get a blood sample every time they need to monitor their blood sugar. It’s a tedious, somewhat painful process.

Apple may have a solution. They call it “E5”.

E5 entails tracking a person’s blood glucose levels simply with the Apple Watch. It involves using a process called optical absorption spectroscopy.

This process basically transmits a form of lasers from the watch into the wearer’s wrist. Then artificial intelligence (AI)-powered sensors on the watch determine glucose concentration levels based on the light that’s reflected back to them.

Of course, this approach allows patients to get blood sugar alerts right away. If their levels get low, the Apple Watch can prompt them to take a specified amount of insulin.

This is a remarkable breakthrough for both the Apple Watch and the medical industry. Presuming this gets to market, it will be an incredible breakthrough for a very large percentage of the world’s population.

And if Apple gets approval to implement this tech, it’s only going to differentiate the Apple Watch even more from its competitors. And we should keep in mind that the Apple Watch is already the best-selling watch in history.

Apple sold 53 million Apple Watches last year, and the company has a 34% market share in the smartwatch market. In other words, the Apple Watch is the giant in this space. It’s far larger than any traditional watch manufacturer. That’s ironic considering that its origin is in computing, and more recently smartphones.

So this is absolutely something to keep an eye on.

Apple will need to get FDA approval to implement its new non-invasive glucose sensing technology into its smartwatch… but doing so would be a major boon for diabetics everywhere. 

It’s not hard to imagine that any diabetic with the means to purchase an Apple Watch would do so just to avoid the multiple pricks of the finger every day. And it’s not a stretch to think that at least part of the purchase would be covered by insurance eventually.

After all, accurate glucose readings could be shared in real-time with physicians to monitor health and affect better health outcomes.

I doubt we’ll see this in the market this year, but I suspect it will be likely, presuming FDA approval, sometime in 2024.

I’d be curious to hear what subscribers think. For any of us living with diabetes, would this impact our decision to purchase an Apple watch? Feel free to share your thoughts right here.

Roblox is just the first of many to follow…

We have to talk about yet another exciting application for generative AI today. It’s going to be an incredible tool for building metaverses.

In fact, Roblox is gearing up to launch a generative AI tool specifically to help players create things in the game. And if we remember, Roblox was one of the world’ most popular metaverses well before the term had become widespread.

Here’s a look at their generative AI in action:

Generative AI Applied to the Roblox Metaverse

Source: Roblox

Notice the captions in the top corners in this video. Those are the text prompts that tell the AI exactly what to do within the game.

And as we can see, these prompts enable users to change colors and patterns for objects in the game on the fly. And they even enable some powerful graphics, such as turning the car’s lights on upon command.

The benefit here is that users don’t need to manually write code line by line to implement these changes. They can create, build, and iterate on the spot, all using basic text prompts. That’s the power of generative AI as applied to metaverses.

This is going to be a massive application for gaming, especially in these kinds of metaverses that empower players/users to create in these online worlds. Roblox will roll out this functionality soon. And I’m sure all popular metaverses will have to follow suit.

If we think about it, the is the next generation of gaming.

Historically, games have been a “sandbox,” so to speak. They consist of worlds that developers created. Players simply interact in those worlds.

Well, with generative AI, that’s all going to change. Games will become dynamic environments that players build and change on the fly.

And as I often say, the video game market is larger than the motion picture industry. It was estimated to be a $200 billion market last year, and it’s only going higher. As investors, it’s important for us to stay updated on new breakthroughs in this space.

A breakthrough in “growing” skin grafts…

We’ll wrap up today with another potential breakthrough in medical technology (medtech).

New scientific research was just published demonstrating an effective way to grow human skin in a lab. As strange as this may be, it will be a game-changer for patients who need skin grafts.

Skin grafts are complex and difficult to apply. Today’s therapeutic approach is painful and time consuming for the patients.

They involve taking skin from one part of the body and grafting onto a different part of the body that’s been burned or damaged.

With this new technique, skin grafts can be accomplished with just a small biopsy of skin from a healthy part of the body. With that as a raw input, the remainder of the skin graft can be “grown” in a lab. Here’s what that looks like:

Lab-Grown Human Skin

Source: Wired

Here we can see skin that was grown in a lab over top of an example hand mold. The shape was chosen given the complexity of the contours of a human hand. After the graft has been grown, it is simply peeled off the hand mold in preparation for eventual grafting onto a damaged human hand.

The skin itself is grown using extracted skin cells taken from a patient. In the case of an adult hand, all it takes is a four millimeter sample of skin cells in order to grow an entire graft for the hand.

This is exciting because the technology used for skin grafts really hasn’t changed in several decades. There had been a lot of hope around 3D printing of organs several years back, but unfortunately not much progress has been made.

To me, this approach has better potential.

Now the question is – will a company spin out to commercialize this technology? That’s something we’ll be watching for later this year.


Jeff Brown
Editor, The Bleeding Edge