Augmented reality starts to liven up the VR/AR market

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1 Global: Technology Augmented reality starts to liven up the VR/AR market Equity Research Refining our framework as AR comes more into focus Revise up VR/AR market size by $15bn to $95bn for 2025E Since we published Profiles in Innovation: Virtual & Augmented Reality six months ago, in which we laid out the case for virtual reality (VR) and augmented reality (AR) to become the next big computing platform, this nascent market has seen interest and uptake in R&D grow daily. After incorporating the latest information like pricing, timing of new product launches and wider use cases, we now forecast a 2025 VR/AR market of $95bn ($50bn hardware, $45bn software) vs. our prior forecast of $80bn ($45bn hardware, $35bn software). Put in context, this compares to the current $111bn hardware market for notebooks and $63bn for desktops. Refining VR estimates by product; expanding our AR view Changes to AR. We expand our forecasts to include consumer use and broader enterprise adoption (such as the field technician use case and mobile computing for the office professional), beyond the healthcare, engineering and education vertical use cases in our prior forecast. In the long-run, we believe AR has the potential to be as ubiquitous as smartphones and forecast the broader adoption of AR by applying a penetration rate to the high-end smartphone market. Early success of Pokémon GO, the first mass adopted AR game, helps prove the potential of AR, and we see similar ideas spreading to other content quickly. We now forecast a 2025 AR market of $36bn (vs. $10bn prior). Changes to VR. Looking out to 2025, we lower our VR shipment forecasts by 11% as we now see AR playing a bigger role for both consumers and enterprises. Further, we reduce our ASP assumptions for VR hardware as we expect price points will need to decline to drive adoption, with evidence of this already playing out in the market. We now forecast a 2025 VR market of $59bn (vs. $69bn prior). Wei Chen +886(2) wei.chen@gs.com Goldman Sachs (Asia) L.L.C., Taipei Branch Masaru Sugiyama +81(3) masaru.sugiyama@gs.com Goldman Sachs Japan Co., Ltd. Heather Bellini, CFA (212) heather.bellini@gs.com Goldman, Sachs & Co. Marcus Shin +82(2) marcus.shin@gs.com Goldman Sachs (Asia) L.L.C., Seoul Branch READ THE ORIGINAL Profiles in Innovation: Virtual & Augmented Reality (January 13, 2016) In the first report of our Profiles in Innovation series, we examine what VR/AR could become, the evolving use cases and the markets that could be created and disrupted. Competitive landscape and value of the VR platform With additional product details out, we look at the opportunity created by the major VR products and their competitive edge PlayStation VR (favorable cost of ownership and game content), Oculus Rift (first mover advantage with VR platform), and HTC Vive ( room scale capability). Who are the VR/AR enablers? In terms of tech stocks, we continue to highlight Buy-rated firms that are positioning ahead of the VR/AR trend, including Alphabet, Facebook, Goertek, HTC, Largan Precision, Nvidia, Qualcomm, and Sony. Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-us affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research

2 Table of contents Virtual and augmented reality in 6 charts: An update 3 PM Summary: Evolving our views on the next big computing platform 4 Evolving our VR/AR forecasts, up $15bn to $95bn for 2025E 8 Augmented reality to become as ubiquitous as smartphones 10 Continued bullishness on VR, but lowering hardware ASPs 14 Exploring the opportunity within each key segment/product Vive hardware significant revenue opportunity PlayStation VR strong installed base to drive near-term share Oculus first mover advantage and high awareness via Samsung GearVR adding VR functions to Samsung smartphone Other VR HMD sizing the market for smaller VR brands 23 Appendices 24 Appendix 1: VR/AR software and hardware market forecast detail 25 Appendix 2: Competitive dynamics of the three major VR platforms 26 Disclosure Appendix 29 Analyst contributors Wei Chen +886(2) wei.chen@gs.com Masaru Sugiyama +81(3) masaru.sugiyama@gs.com Heather Bellini, CFA (212) heather.bellini@gs.com Marcus Shin +82(2) marcus.shin@gs.com Toshiya Hari (646) toshiya.hari@gs.com Ricky Lee +886(2) ricky.lee@gs.com Daiki Takayama +81(3) daiki.takayama@gs.com Shateel Alam (212) shateel.alam@gs.com Giuni Lee +82(2) giuni.lee@gs.com Lingling Hu +86(10) lingling.hu@ghsl.cn Jim Liu jim.liu@gs.com Yusuke Noguchi +81(3) yusuke.noguchi@gs.com Jack Kilgallen, CFA (212) jack.kilgallen@gs.com Simona Jankowski, CFA (415) simona.jankowski@gs.com Goldman Sachs Global Investment Research 2

3 Virtual and augmented reality in 6 charts: An update Exhibit 1: VR/AR unit shipments could initially ramp close to smartphones Exhibit 2: VR/AR could create a large hardware market by 2025E 800,000 Base case Accelerated uptake Delayed uptake 350 Unit shipments (000's) 700, , , , , , ,000 Tablet shipments from Smartphone shipments from PC shipments from Accelerated uptake Base case Shipment (mn) VR/AR Accelerated $89bn Tablet PC $65bn VR/AR Base Case $50bn Game Console $16bn TV $99bn Notebook PC $111bn VR/AR Delayed $22bn Desktop PC $63bn E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Notes: For additional detail on our accelerated uptake and delayed uptake scenarios please see Appendix 1. IDC data for smartphone, tablet and PC. Source: IDC, Goldman Sachs Global Investment Research. Delayed uptake Exhibit 3: We revise our VR/AR hardware and software market size forecast up by $15bn in 2025E ASP($) Notes: IDC data for smartphone, tablet and PC. Source: IDC, Goldman Sachs Global Investment Research. Exhibit 4: Breakdown of our new VR and AR shipment forecasts to 2025E VR/AR HW&SW market ($bn) $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 $95 New Old $82 $80 $72 $70 $59 $61 $49 $49 $38 $37 $27 $28 $20 $18 $13 $7 $6 $3 $0 $2 $ E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E VR/AR shipment (mn units) VR AR E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Exhibit 5: Our new 2025E base case VR/AR forecasts AR hardware, $18.6bn AR software, $17.7bn $95bn VR/AR market VR market: $59bn AR market: $36bn VR hardware, $31.1bn VR software, $27.7bn Exhibit 6: Our 2025E VR/AR hardware and software scenarios $200bn $180bn $160bn $140bn $120bn $100bn $80bn $60bn $40bn $20bn $0bn $11bn $22bn $45bn $50bn $85bn $89bn Delayed uptake Base case Accelerated uptake Hardware Software Goldman Sachs Global Investment Research 3

4 PM Summary: Evolving our views on the next big computing platform Since our initial Profiles in Innovation report in January 2016, where we put forward our view that virtual reality (VR) and augmented reality (AR) have the potential to become the next big computing platform, we have seen multiple positive developments and have gained greater insights on the use cases. As such, in this follow-up report we refine our framework to incorporate the availability of new information (pricing, launch timing, etc.) and better insight into software use cases. Virtual reality vs. augmented reality VR uses an opaque headset (which you cannot see through) to completely immerse the user in a virtual world whereas AR enables users can see the real world and overlay information and imagery onto it. While acknowledging that there is some hype around VR/AR, our January report identified nine use cases for VR/AR technology which we see currently emerging (videogames, live events, video entertainment, retail, real estate, education, healthcare, engineering, and military) and looking beyond videogames our analysis showed that real estate, retail, and healthcare are likely to be among the first markets that VR/AR disrupts. Throughout this year, we have not only seen the interest level in VR/AR continue to rise, but also the level of R&D companies are investing to enable the technology. Popular mobile and PC games have been announced on VR platforms, such as Fruit Ninja, Alternative Girls and Fallout 4. Recently, rapid adoption of the Pokémon GO AR game, with over 20mn downloads in its first week of launch (without promotion), is a perfect example of how content innovation on a new medium (i.e. augmented reality) can quickly have a widespread effect. To provide further insights on this phenomenon, we include a Case Study of Pokémon GO on page 13. In aggregate, we raise our 2025 VR/AR industry forecast from $80bn to $95bn as we expand our view of the AR market and incorporate new use cases in enterprise and consumer, primarily offset by lower VR hardware ASPs (average selling prices) which we see as necessary to drive adoption. Exhibit 7: Our prior 2025 base case VR/AR forecasts Our prior forecast only included limited vertical-specific use cases for AR Exhibit 8: Our new 2025 base case VR/AR forecasts Our raised forecast is driven primarily by the inclusion of new AR use cases, but somewhat offset by VR ASPs AR hardware, $1.6bn AR software, $8.6bn VR market: $69.3bn AR market: $10.2bn AR software, $17.7bn VR market: $58.8bn AR market: $36.3bn VR hardware, $31.1bn VR hardware, $42.9bn VR software, $26.4bn AR hardware, $18.6bn $80bn VR/AR market $95bn VR/AR market VR software, $27.7bn Goldman Sachs Global Investment Research 4

5 Expanding the application set for AR We now forecast a global AR market size (hardware and software) in 2025 of $36bn (versus our prior estimate of $10bn). Our changed assumptions as discussed below result in an AR market that is roughly evenly split between hardware and software at c.$18bn each. 1. Expanding our use cases of AR. In our prior model, we only included AR shipments for vertical-specific enterprise use cases in engineering, healthcare, and education. We now expand this to include consumer use and broader enterprise adoption. We believe consumers have the potential to begin using AR devices as a supplement or even replacement to the smartphone for day-to-day tasks. We have also broadened our enterprise view to include use cases like field technicians communicating with the home office or office professionals using AR for mobile computing (i.e. using a headset that puts s into the field of vision rather than using a smartphone). Incorporating these use cases takes our 2025 AR shipment forecast from 3mn vertical-specific shipments, adds 13mn shipments for broader enterprise use and 16mn for consumer use, leading to total shipments of 32mn. For comparison, 2015 had ~250mn high-end smartphone shipments and 1.9bn total mobile phone shipments. 2. Applying a penetration rate to high-end smartphones. In the long-run, we believe AR could be as ubiquitous as smartphones and forecast broader adoption of AR with a penetration rate linked to the high-end smartphone market. While we are bullish on the prospects for AR, we believe we are tempered on the ramp of adoption, estimating that AR penetrates just 15% of high-end smartphone shipments in Lower software price points for non-specialized use cases. We note that the consumer and expanded enterprise use cases of AR we now factor in have lower software price points versus the vertical-specific use cases already included in our forecasts (as we expect areas like healthcare and engineering will require specialized software), hence the disproportionate increase in our AR hardware (up $17bn to $19bn) vs. software estimates (up $9bn to $18bn for 2025). Continued bullishness on VR, but lowering hardware ASPs After updating our long term forecasts as discussed below we now expect the global VR market size (hardware and software) in 2025 to be $59bn versus our prior estimate of $69bn. 1. Accelerating hardware ASP declines. The decrease in our global VR revenue forecast for 2025 has primarily been driven by lower hardware estimates (down $12bn to $31bn) as we now assume a lower ASP for VR HMD (head mounted devices) of $286 by 2025E (vs. prior $352). The lowered ASP assumption reflects a faster pricing decline which we believe is needed to drive higher adoption and lower mix of the integrated form factor which carries a higher ASP. We have seen evidence of this playing out in the market already with 50 of the non-branded VR hardware devices currently for sale on Amazon.com showing prices discounted on average by 43%. 2. VR/AR overlap leads to slight reduction in VR shipment forecast. Although we have expanded our AR shipment forecast for 2025 by ~29mn units, we decrease our VR shipment forecast from 122mn units to 109mn units, with the reduction mainly reflecting the rise in AR applications in consumer and enterprise which we believe could cannibalize some of the VR demand. 3. Expanding usage within the installed base. On VR software, we slightly increase our global revenue estimate from $26bn to $28bn for 2025, mainly driven by our view that users will engage in a greater number of VR use cases, in particular to justify the high price points of the product. Goldman Sachs Global Investment Research 5

6 Exhibit 9: Summary of our global VR/AR unit shipment and ASP changes 2025E (unit shipments in millions, ASPs in $) 2025 Prior New % change $ change VR shipments (mns) % Vertical-specific enterprise shipments % General-use enterprise shipments Consumer shipments AR shipments (mns) % 29.2 Total VR/AR shipments (mns) % 16.1 VR ASPs ($) $352 $286-19% -$66 AR hardware ASPs ($) $581 $581 0% $0 Exhibit 10: Summary of our global VR/AR revenue changes 2025E ($ in billions) 2025 Prior New % change $ change VR hardware $42.9 $ % -$11.8 VR software $26.4 $27.7 5% $1.3 Total VR $69.3 $ % -$ Vertical-specific enterprise AR hardware $1.6 $1.7 4% $0.1 - General-use enterprise AR hardware -- $ Consumer AR hardware -- $ AR hardware $1.6 $ % $ Vertical-specific enterprise software $8.6 $9.5 11% $0.9 - General-use enterprise software -- $ Consumer software -- $ AR software $8.6 $ % $9.1 Total AR $10.2 $ % $26.0 Total VR/AR $79.6 $ % $15.5 Goldman Sachs Global Investment Research 6

7 Goldman Sachs Global Investment Research 7 Exhibit 11: Virtual reality and augmented reality enablers (Buy-rated) Company Ticker Rating CCY Alphabet GOOGL Buy* US$ Facebook FB Buy US$ Goertek SZ Buy RMB HTC 2498.TW Buy NT$ Largan Precision 3008.TW Buy NT$ 3,430 Nvidia NVDA Buy US$ Qualcomm QCOM Buy US$ Sony 6758.T Buy* JPY 3,179 Last Close Company profile Exposure to VR/AR The opportunity Alphabet is an online advertising pioneer with $75bn in 2015 revenues (+13% yoy), of which 90% is online advertising (referred to as Google) and 10% non-core revenue. Alphabet is investing in both AR and VR platforms. Facebook runs the leading social platform with over 1.5bn monthly active users (MAU) and 2015 revenues of $17bn (+39% yoy) of which 95% is advertising. In 2014, Facebook acquired VR hardware/software vendor Oculus for $2bn. Global leader in acoustic components and core supplier to Apple. Design manufacturer for Oculus and Sony PlayStation VR headsets, exclusive supplier in A rising VR platform company with legacy smartphone hardware business based on Android ecosystem. Global leader in miniature camera lens technology used primarily in smartphones and tablets. Largan s major clients include Apple (73% of 2015E sales), as well as major Android phone and notebook PC brands. Leader in GPUs used for gaming/vr, deep learning/ai, automotive, and high performance computing applications. Leading smartphone cellular chipset and application processor provider. Customers include most major handset and tablet companies, and many emerging handset vendors. Owning most of the IP behind CDMA/WCDMA and much of LTE, Qualcomm gets a royalty from every device that uses its technology. Has been investing in VR/AR for over five years, and in the past year it launched a reference design platform specifically designed for advanced cameras. One of world's largest technology conglomerates with annual revenue of $68bn in Portfolio includes leading console platform PlayStation, Hollywood film/tv studios, a media network, music business, TV sets, smartphones, etc. Sony plans to launch PlayStation VR (PSVR) in October Currently immaterial. Currently immaterial. We expect revenue from VR headsets to contribute c.20%-30% of GoerTek's overall revenue in 2016E-18E. We estimate revenue from VR headsets to contribute 13%/21% of HTC's overall revenue in 2016E/2017E. HTC is building a VR ecosystem including VR headset, software and application store. Dual-camera design on smartphone supporting AR applications (i.e. project Tango from Google). We expect VR-related GPU revenue to contribute 5%/8%/17% of Nvidia's overall revenue in 2016E/2017E/2018E. Nvidia manufactures GPUs, which are used to render graphics in VR programs. Qualcomm stands to benefit from the proliferation of connected devices. Snapdragon 820 (introduced in March 2016) supports immersive VR, and Qualcomm introduced Snapdragon VR SDK in 2Q16. Games and Network Services business is one of the most profitable divisions of Sony and we estimate it will contribute 36% to consolidated earnings (pre-elimination) in 2016E. We expect 1.5mn PSVR shipments in 2016, rising to 3mn in AR and VR hardware and software sales. In the long-run, we view AR and VR as new platforms on which Alphabet can advertise. VR gaming with both hardware and software sales. In the long-run, we view VR as new platform on which Facebook can advertise. VR revenue from VR headsets by top global brands as well as the emerging Chinese VR platform. VR revenue from hardware sales (VR headset) and services (VR content distribution, customization and support). VR revenue opportunities include both consumer and commercial applications. Camera lens on VR/AR headsets for computer vision or user vision pass through. Lens use in 360 degree cameras for usergenerated VR and/or professional VR content creation. Lens use in dual camera in smartphones to support AR applications. VR revenue from hardware sales (GPUs). VR revenue opportunities include both consumer and commercial applications. VR and image capture devices could become an adjacent market opportunity. We expect Qualcomm to remain focused on chipset processors and connectivity. We expect VR to help Qualcomm's market share and ASPs in the core smartphone chipset market. PSVR could become a major differentiator of the PlayStation platform vs. its competitors. Exclusive content such as Gran Turismo and Star Wars also key. We expect game business OP to remain at peak level despite reaching mid-cycle for the console. Notes: *Denotes stock is on our regional Conviction List. AI = artificial intelligence; CDMA = code division multiple access; GPU = graphics processing unit; IP = intellectual property; LTE = long-term evolution; WCDMA = wideband code division multiple access. Prices as of close on July 15, Source: Datastream, Company data, Goldman Sachs Global Investment Research. July 18, 2016

8 Evolving our VR/AR forecasts, up $15bn to $95bn for 2025E In aggregate, changes to our global VR/AR industry model in this report (raising 2025 from $80bn to $95bn) are mainly driven by an expanded AR market view (updating shipment forecasts) and a deeper understanding of the installed base by use cases (new use cases in enterprise and consumer), but partly offset by lower VR hardware ASPs which we see as necessary to drive adoption. Hardware: We have extended our bottom-up analysis of the VR hardware market to 2025 (rather than top-down from previously). Overall, we revise up our global VR/AR hardware market revenue forecast for 2025 from $45bn to $50bn (+12%), driven by an upward revision in our hardware shipment assumptions (2025 up by 13% to 141mn) after incorporating our expanded view of AR and an upward revision in our GearVR shipment estimates (due to limited-time free bundling with Galaxy S7 smartphones and the fact that it is one of the first mobile VR products in the market). Software: We revise up our global VR/AR software market revenue forecast for 2025 from $35bn to $45bn (+30%), primarily driven by our inclusion of expanded AR user cases in consumer and enterprise. By 2025, we expect the VR software market size to reach $28bn, with video games, live events, and video entertainment making up ~75% of the mix. We estimate the AR software market size will be $18bn in 2025, with enterprise, healthcare, and engineering as the major components. Exhibit 12: An expanded AR view boosts our hardware market estimates Hardware: Revision to market size (base case in $bn) Exhibit 13: We expect software market revenues to reach $45bn in 2025 Software: Revision to our market size (base case in $bn) VR/AR hardware market(usd bn) $60 $50 $40 $30 $20 $10 $22 $15 $50 $45 VR/AR software market(usd bn) $50 $45 $40 $35 $30 $25 $20 $15 $10 $5 $15 $13 $45 $35 $ E2017E2018E2019E2020E2021E2022E2023E2024E2025E $ E2017E2018E2019E2020E2021E2022E2023E2024E2025E In our accelerated uptake case, VR/AR could track like smartphones The following chart lays out our new base, accelerated uptake, and delayed uptake cases for VR/AR shipments vs. the adoption curve for smartphones from 2004, tablets from 2010, and PCs from 1995 (see Appendix 1 for full details of the revisions to our VR/AR software and hardware market forecasts). Our new accelerated uptake scenario in the initial ramp stage is close to the adoption curve of smartphones and PCs. Goldman Sachs Global Investment Research 8

9 Exhibit 14: Putting our global VR/AR shipment estimates into context Comparing our new VR/AR estimates to the penetration of smartphones/tablets/pc during their ramp up 800,000 Base case Accelerated uptake Delayed uptake 700,000 Smartphone shipments from ,000 Unit shipments (000's) 500, , , ,000 Tablet shipments from PC shipments from Accelerated uptake 100,000 Base case Delayed uptake E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Notes: Our accelerated uptake scenario predicts VR/AR technology evolving from a niche device to a broader computing platform. Our delayed uptake scenario assumes VR/AR sees challenges in latency, display, safety and privacy, and the technology is used primarily for videogames. IDC data for smartphone, tablet and PC. Source: IDC, Goldman Sachs Global Investment Research. Exhibit 15: We expect VR/AR to become one of the major hardware markets by 2025 VR/AR hardware market scenarios for 2025E compared to other hardware market sizes currently 350 Shipment (mn) VR/AR Accelerated $89bn Tablet PC $65bn VR/AR Base Case $50bn TV $99bn Notebook PC $111bn Desktop PC $63bn 50 Game Console $16bn VR/AR Delayed $22bn ASP($) Notes: IDC data for smartphone, tablet and PC. Source: IDC, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 9

10 Augmented reality to become as ubiquitous as smartphones Augmented reality technology is en route to incorporating all the functions of a smartphone (voice calls, text messaging, , internet, and video) except the interface will be viewed through glasses and controlled with gestures versus the smartphone that is held and controlled with your hands. Across both personal and professional settings, there are considerable advantages of a computing device that doesn t require your hands to be occupied. Further, the size of the display of an AR device would essentially be infinite versus the physical display screens of a desktop computer or phone that are confined. As such, we believe AR devices have the potential to be as ubiquitous as smartphones in the long-run and that an independent framework is needed (separately to VR) to understand this market opportunity. Refining our AR framework Applying a penetration rate to high-end smartphones To forecast potential unit shipments of AR devices, we rely on high-end smartphone shipments ($600+) as an input. While it could be more ubiquitous, we believe the demographic that currently purchases high-end smartphones would be the mostly likely to consider AR devices as they come to market. When considering the pace of adoption of AR devices, we look at the adoption rate of smartphones as consumers transitioned away from feature phones (Exhibit 16). What we believe keeps our AR unit forecasts conservative relative to smartphone volumes is that high-end smartphones (the market we use for our AR penetration rate) currently represent only 16% of the total mobile phone market. By 2025, in our base case we assume that the shipment of AR devices reaches a level equivalent to 15% of high-end smartphone shipments, 30% in our accelerated uptake case, and 7% in our delayed uptake case. As such, Exhibit 17 shows that our base case AR shipment forecasts pale in comparison to the past trajectory of smartphones and tablets. Exhibit 16: The AR adoption curve could be similar to feature phones transitioning to smartphones The early adoption of smartphones was slow at first but accelerated due in part to the 2007 launch of the iphone Exhibit 17: Our AR shipment forecasts relative to the penetration of high-end smartphones We expect AR to penetrate the high-end smartphone market which is currently only 16% of total mobile phone shipments Units shipped (000s) The first 15% early adopters and innovators The next 68% the majority The last 16% the laggards % smartphone penetration 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% % of smartphone shipments vs total mobile shipments Accelerated uptake Base case 19,357 76, ,190 Delayed uptake E2017E 0 Smartphones Feature phones Smartphone penetration (% of total handset shipments) Source: IDC, Goldman Sachs Global Investment Research. Source: IDC, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 10

11 Expanding the application set for AR Across the three buckets of AR use cases (vertical-specific enterprise, general use enterprise, and consumer) we maintain our hardware ASPs, with a starting point of $1,500 for an integrated head mounted device, declining at a 10% CAGR through 2025 to $581. We note there is currently a wide price range for AR HMD in the market, from $400 for consumer use cases to $4,000 for vertical specific-use cases. Widely expected consumer product launches from Microsoft HoloLens and Google Glass could also lead to our assumptions being refined. In our prior model, we only included AR shipments for vertical-specific enterprise use cases in engineering, healthcare, and education. We now expand this to include broader enterprise adoption as well as consumer use. The tables below outline the unit assumptions we incorporate to arrive at our 2025 AR hardware ($19bn) and software ($18bn) revenue forecasts, followed by a discussion of our framework for the three buckets of AR use cases. Exhibit 18: Summary of AR shipment and ASP changes 2025E (units in millions, ASPs in $) Exhibit 19: Summary of AR hardware and software revenue changes 2025E ($ in billions) 2025 Prior New % change $ change - Vertical-specific enterprise shipments % General-use enterprise shipments Consumer shipments AR shipments (mns) % 29.2 AR hardware ASPs ($) $581 $581 0% $ Prior New % change $ change - Vertical-specific enterprise AR hardware $1.6 $1.7 4% $0.1 - General-use enterprise AR hardware -- $ Consumer AR hardware -- $ AR hardware $1.6 $ % $ Vertical-specific enterprise software $8.6 $9.5 11% $0.9 - General-use enterprise software -- $ Consumer software -- $ AR software $8.6 $ % $9.1 Total AR $10.2 $ % $26.0 Total VR/AR $79.6 $ % $15.5 Vertical-specific enterprise use cases. With our new forecasts, there is little change to our vertical-specific AR assumptions. For 2025, we model 2.9mn AR device shipments (prior 2.8mn) driven by the healthcare, engineering, and education verticals. We forecast that specialized AR software for healthcare and engineering will be similar to specialized software we see today and note that computer-aided design (CAD) software for architects and engineers can range from $1,000-$5,000 per year. For 2025, we estimate healthcare and engineering AR software at $1,500 per seat and educational software at $50 per seat versus an ipad K-12 curriculum currently priced at $70. Our assumptions result in 2025E vertical-specific AR hardware of $2bn and software of $10bn. Broader enterprise use cases. In updating our AR forecast we now add expanded use cases in enterprise, driven by our view that AR devices can be used in a similar way to how PCs and smartphones are used now and as such we model AR unit shipments as a function of high-end smartphone shipments. Our broadened view of enterprise use cases includes field technicians communicating with the home office or office professionals using AR for mobile computing. For enterprise AR software costs, we anticipate the use cases will be similar to productivity suites as we know them today and estimate annual software costs of $200, similar to the current price of the Microsoft Office 365 professional edition. Our assumptions result in 2025E general enterprise use AR hardware of $8bn and software of $6bn. Goldman Sachs Global Investment Research 11

12 Consumer use cases. In the long-run, we envision consumers adopting AR devices for a use case similar to smartphones today. However, we believe our assumptions are conservative as we forecast just 13mn consumer AR shipments in 2025 (8% of highend smartphones) versus 2015 high-end smartphone shipments of ~240mn. We note that in FY15 Apple generated $31bn in software/services revenue from installed-base related purchases (of its 1bn user installed base our Hardware team estimates 500mn are iphones). Using this as a proxy, we forecast consumer AR software revenue of $50 per user. Our assumptions result in 2025E consumer AR hardware of $9bn and software of $2bn. Goldman Sachs Global Investment Research 12

13 Case Study: How Pokémon GO s catapult launch proves the case for AR gaming On July 6, 2016, The Pokémon Company and Niantic launched the smartphone game Pokémon GO in the US and Australian markets. We identify this game as the first mass adopted augmented reality game. Since its launch, the app has seen very high levels of downloads (over 20mn in the US as of July 13) and in-app purchases, putting it at the top of the ranking in both markets where it was launched. The game extensively uses GPS functions to overlay standard features of Pokémon catch, battle, and possibly exchange into real life (augmented reality). Also, using a phone s camera, the game allows users to catch and battle Pokémon depicted in real life. Some of the publicly available information relating to Pokémon GO: 10.5% of Android devices in the US have the app downloaded as of July 13 (Source: Similar Web), suggesting an installed base of over 20mn in the US alone. Daily revenue of $1.6mn (Sources: Sensor Tower, Thinkgaming.com) in the US ios devices. 3% of US Android devices were actively using Pokémon GO on July 8, with average daily use of 43 minutes per user (Source: Similar Web). Niantic commented that restaurants and retail chains could sponsor PokéStops and gyms (locations inside the app where a wild Pokémon appears and battles take place). We believe revenues would likely be on a cost per visit basis. Technological hurdles cleared for the first mass market ready AR game The background for Pokémon GO s success includes the clearance of some technological hurdles. Pokémon GO is not the first augmented reality app using the mobile camera. Apps like Sekai Camera have been around since 2009, attempting the first try at mobile AR long before Pokémon. Although those apps caught some attention, slow processing speed meant the app could not be used easily. High smartphone penetration, greater computing power (the iphone 6S is 3x faster and has 15x more memory than the iphone 3G), and a willingness to pay for in-game purchases have all helped lead to the successful launch of Pokémon GO. Dual camera, AR glasses, more IPs AR gaming is getting started We believe there is more to come for AR gaming. Although AR glasses may take a while to penetrate the gaming business, technologies like dual camera allow greater depth recognition, which should enhance the AR rendering inside games. Now that Pokémon GO has become successful, we believe there will be more console franchises willing to try the new concept. In terms of similar explore and catch type games, we point to Yokai Watch from Level 5 and Nintendo, as well as Monster Hunter from Capcom. Pokémon GO looks to have opened new doors to the next generation of mobile gaming, and just as the game industry has proven repeatedly in the past, adaptation of new technology is the first step of proliferation. Please see Pokémon Go impact diluted, but boosts expectations for next titles, July 12, 2016 for additional detail. Exhibit 20: Pokémon is among Nintendo s most popular franchises Nintendo s major franchises and maximum package units sold in one edition (as of July 2016) Exhibit 21: Getting hooked on Pokémon GO: DAU reached similar levels to Twitter in the US, and average usage time exceeds that of Whatsapp Daily average usage time for apps (min, as of July 8) Maximum packages sold (mn) Mario Kart 34.3 New Super Mario Bros Brain Age 20.1 Pokémon 18.1 Super Smash Bros. Brawl 12.0 Animal Crossing 12.0 Mario Party 8.8 The Legend of Zelda 6.9 Donkey Kong 6.1 Kirby 2.9 Total Pokemon WhatsApp Instagram Snapchat Messenger Source: Company data, VGChartz, Goldman Sachs Global Investment Research. Source: Similar Web. Goldman Sachs Global Investment Research 13

14 Continued bullishness on VR, but lowering hardware ASPs Recent developments in the VR space We continue to be bullish on the outlook for VR technology to become the next big computing platform, as laid out in our January 2016 Profiles in Innovation report. Since then we have seen more VR content being created, significantly higher consumer interest and media coverage, and ongoing venture capital activities. During the Game Developers Conference in San Francisco in March 2016, Sony revealed the consumer edition of PlayStation VR, as well as the launch date of October 2016 with a retail price of $399. During the conference a number of major content companies also revealed intent to launch VR versions of their content, such as Electronic Arts planning to make Star Wars Battlefront compatible with PlayStation VR. However, recent announcements have not just focused on upcoming new launches (Exhibit 22), as shown by a February 29 release from HTC Vive stating it had sold 15,000 units within the first ten minutes of the product going on sale for pre-order. More recently, during E3 (the largest Games Expo) in mid-june, a number of popular mobile and PC games were announced on VR platforms, such as Fruit Ninja and Fallout 4. Exhibit 22: New product announcements launched and coming soon Recent VR headset announcements Product name Company Launch Price PlayStation VR Sony October 2016 $399 Oculus Rift Facebook / Oculus March 2016 $599 HTC Vive HTC / Valve April 2016 $799 Galaxy Gear VR Samsung Electronics November 2015 (consumer edition) $99 Source: Company data. Consumer interest and media coverage on virtual reality have both increased significantly since the start of the year. As evidence of the increasing consumer interest, Exhibits show that interest over time in virtual reality has grown exponentially since 2H Exhibit 23: The interest level in virtual reality is rising according to Google Trends Exhibit 24: Rising media attention on virtual reality Google trends index /2012 4/2012 7/ /2012 1/2013 4/2013 7/ /2013 1/2014 4/2014 7/ /2014 Virtual Reality Augmented Reality 1/2015 4/2015 7/ /2015 1/2016 4/2016 7/2016 Number of results per 3 months /2011 9/ /2011 3/2012 6/2012 9/ /2012 3/2013 6/2013 9/ /2013 3/2014 6/2014 9/ /2014 3/2015 6/2015 9/ /2015 3/2016 Note: Numbers in the chart represent search interest relative to the highest point on the chart, not absolute search volume. Source: Google Trends. Notes: Data shown is the number of virtual reality mentions in the news (Japan, per three months). Source: Nikkei. Goldman Sachs Global Investment Research 14

15 VC investment in VR/AR is gaining momentum Investments in companies innovating in virtual and augmented reality has been robust since our January 2016 report, with quarterly venture capital (VC) funding for startups in the industry above $150mn in each of the past three quarters. 1Q16 saw a 27% qoq uptick to an all-time high of $279mn, excluding the ~$800mn round for Magic Leap (a company which has raised as much money as all other VR/AR startups combined since its first capital raise in 3Q12) for a more meaningful funding trend. As shown in Exhibit 26, we also note continued investment in the space from large tech/media players. Exhibit 25: Funding for VR/AR startups continues on an upward trajectory Global VC investments in virtual and augmented reality startups Capital invested in mn $1,200 $1,000 $800 $600 $400 $ # of deals $0 3/31/2010 6/30/2010 9/30/ /31/2010 3/31/2011 6/30/2011 9/30/ /31/2011 3/31/2012 6/30/2012 9/30/ /31/2012 3/31/2013 6/30/2013 9/30/ /31/2013 3/31/2014 6/30/2014 9/30/ /31/2014 3/31/2015 6/30/2015 9/30/ /31/2015 3/31/2016 Capital Invested, ex-magic Leap (LHS) Deal Count (RHS) Capital Invested in Magic Leap (LHS) Source: PitchBook, Goldman Sachs Global Investment Research. Exhibit 26: Recent involvement in virtual reality by large technology and media companies Company Date Details Qualcomm Jan-12 Raised seed funding for the mobile augmented reality startup, Blippar Google Apr-12 Introduced the augmented reality glasses, Google Glass, to the public Sony Sep-13 Announced its HMZ-T3, new head-mounted display HP Mar-14 Launched Aurasma 3.0, its augmented reality platform that it acquired through Autonomy Facebook Mar-14 Acquired Oculus, a virtual reality startup, for $2bn Samsung Sep-14 Revealed its own head-mounted display, Samsung GearVR, partnering with Oculus Google Oct-14 Invested $542mn in the startup, Magic Leap Intel Apr-15 Invested in Series A funding for the virtual reality startup, WorldViz Apple May-15 Reportedly acquired Metaio, the augmented reality software maker Disney Sep-15 Led a $65mn funding round in Jaunt, a VR content startup Microsoft Oct-15 Microsoft acquires Havok, a 3D physics engine used for videogames Comcast & Time Warner Nov-15 Participated in a $30.5mn funding round for NextVR, which captures live events in VR Apple Nov-15 Acquires Faceshift, a facial recognition capture and animation company Fox Jan-16 Acquires minority stake in Osterhout Design Group, a VR/AR HMD maker HBO, Discovery & Liberty Media Apr-16 Invested in Otoy, a cloud gaphics company developing entertainment experiences including VR and AR AOL Apr-16 Acquired RYOT, a publisher of immersive media content using 360 degree and VR video production HTC Apr-16 Launched Vive X, its $100mn VR accelerator program Source: News sources, compiled by Goldman Sachs Global Investments Research. Goldman Sachs Global Investment Research 15

16 Refining our VR long term forecast We make the following refinements to our global VR forecasts up to 2025 versus the January 2016 note: 1. Extending the bottom-up hardware units forecast by major categories (PSVR, HTC Vive, Oculus, GearVR, Other VR HMD) for the period (prior bottom-up estimates only covered ); 2. Adding a new category Others VR HMD to capture the non-branded VR market; 3. Improving our forecast methodology for HTC Vive and Oculus Rift by adding a framework to capture general consumers and commercial market demand (prior methodology only captured core gamer demand); and 4. Incorporating replacement cycle and churn assumptions for each of the HMD categories in our industry model. Overall, we now forecast a global VR market size (hardware and software) in 2025 of $59bn versus our prior estimate of $69bn. The decrease in our global VR revenue forecast is primarily driven by lower hardware estimates (down $12bn to $31bn) after incorporating faster pricing decline, lower mix of integrated form factor and potential cannibalization from the rise of AR HMD. We expect price points will need to decline to drive adoption, with evidence of this playing out in the market already with 50 non-branded VR hardware devices currently for sale on Amazon.com with prices discounted on average by 43%. Historical price reductions on major product cycles Price declines have traditionally been the key catalyst for hardware adoption. Similar to previous major technology cycles, we believe the cost of VR HMD could decline over time as price elasticity impacts end demand. We draw on the historical pattern of price declines from major end devices like desktops, TVs, tablets, notebooks and smartphones as a proxy of how VR/AR HMD could see price declines in future. We use the past pricing decline rates of existing hardware devices and incorporate these in our long term HMD growth rates as we believe they could resemble similar volume growth curves. We have seen major hardware devices experience pricing declines in the range of 5%-13% annually over the past 20 years. Exhibit 27: HMD price declines could resemble the historical pattern of desktops, notebooks or smartphones Historical price decline of major computing platforms Goldman Sachs Global Investment Research 16

17 Although we have expanded our AR shipment forecast for 2025 by 29mn units, we decrease our VR shipment forecast from 122mn units to 109mn units, with the reduction of 13mn units mainly reflecting the rise in AR applications in consumer and enterprise which we believe could cannibalize some of the VR demand. Exhibit 28: Summary of VR shipment and ASP changes 2025E (unit shipments in millions, ASPs in $) 2025 Prior New % change $ change VR shipments (mns) % VR ASPs ($) $352 $286-19% -$66 Updates to our VR software revenue forecast On VR software, we slightly revise up our global revenue estimate from $26bn to $28bn for 2025, mainly driven by our view that users will engage in a greater number of VR use cases, in particular to justify the high price points of the product. For example, we believe more gamers will adopt multiple consumer use cases of VR and now expect that 35% of the installed base will view VR live events by 2025 (versus our prior assumption of 30%). Thus, while we temper our overall VR shipment forecasts, we do expect VR users to engage in a greater number of use cases to make their investment in the product worthwhile. Exhibit 29: Summary of VR revenue changes 2025E ($ in billions) 2025 Prior New % change $ change VR hardware $42.9 $ % -$11.8 VR software $26.4 $27.7 5% $1.3 Total VR $69.3 $ % -$10.5 Extending the bottom-up hardware units forecast to 2025 By deepening our understanding of the go-to-market strategy, price point, launch schedule and content availability of major VR brands (PlayStation, Oculus and HTC), we have extended our bottom-up shipment forecast to 2025 (prior forecast period covered ). As such, we are able to indicate potential market share progression of the major VR brands (Exhibit 30). Exhibit 30: Market share progression for major VR brands Market Share Base case E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E PSVR 0% 18% 17% 22% 20% 19% 18% 18% 18% 18% 17% HTC Vive 0% 5% 6% 10% 12% 13% 14% 15% 16% 16% 16% Oculus 0% 5% 6% 10% 13% 16% 16% 16% 16% 17% 17% GearVR 100% 48% 48% 38% 35% 36% 35% 38% 38% 39% 41% Other HMDs 0% 23% 23% 20% 20% 17% 17% 12% 11% 10% 9% Total shipments 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Source: Company data, Goldman Sachs Global Investment Research. Goldman Sachs Global Investment Research 17

18 Adding a new category: Other VR HMD Outside of PlayStation, Oculus, HTC Vive, and Gear VR, there are a large number of smaller VR brands producing headsets. Given the sophisticated nature of the content required, and the integrated nature of hardware and content platforms, we believe smaller brands are likely to face business challenges and growth restraints. We estimate the size of this category by looking at the trends of the PC and smartphone markets, which saw the shrinking of smaller players as the industry matured. In the PC market, we have seen smaller players market share decline from c.50% to just c.20% in the course of the past decade. Since we view the barriers of entry as higher for VR, our base case estimates Other VR HMD starting with 30% market share but falling to 10% by In terms of price, we believe the ASP of the smaller players is likely to drop much faster than for the major VR brands given their lower product quality. Having searched through pricing for 50 of the non-branded VR devices online, on average the current selling price is 43% below the original price. Additionally, the average ASP of $245 for discrete devices and $29 for slide-on devices is markedly lower than that of major VR brands PlayStation VR at $399 and Gear VR at $99, respectively. Exhibit 31: Non-branded VR hardware products are currently discounted by 43% on average Summary of 50 non-branded VR hardware products on Amazon.com (as of May 2016) Category Selling price Original price Discount Overall $36.42 $ % Slide on $28.92 $ % Discrete $ $ % Cardboard $9.89 $ % Source: Amazon.com, complied by Goldman Sachs Global Investment Research. Improving our forecast methodology for HTC Vive and Oculus Rift In our previous forecast methodology for HTC Vive and Oculus Rift, we accounted for the demand from core gamers but didn t explicitly consider demand from general consumer and commercial users. Hence, we enhance our framework by adding consumer and commercial segments for both. Moreover, we previously assumed that both Vive and Rift would address the user base of the Steam installed base. We now modify this assumption as we believe Oculus Rift can draw from the installed bases of not only Steam but also Xbox and PlayStation and essentially develop its own ecosystem. We expect HTC to capture the majority of the VR opportunity from Steam (as a partner of Valve, which owns Steam). Exhibit 32: Key assumptions for HTC Vive s total addressable market HTC Vive 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 12/ / / / / / / / / /2025 Assumptions 1) Steam game active users (000s) 146, , , , , , , , , ,959 YoY 4% 4% 4% 4% 3% 3% 3% 3% 3% 3% 2) PC annual shipment (000s) 261, , , , , , , , , ,038 High-end consumer mix 5% 10% 15% 20% 25% 27% 28% 29% 30% 30% High-end consumer PC shipments (000s 13,091 25,396 36,951 47,790 57,945 60,703 61,063 61,346 61,558 59,711 YoY -5% 94% 46% 29% 21% 5% 1% 0% 0% -3% 3) Commerical VR shipments (000s) ,425 2,375 3,826 4,620 4,961 5,840 6,064 6,026 YoY 349% 55% 67% 61% 21% 7% 18% 4% -1% 86% 66% 71% 64% 51% 52% 55% 54% 53% 56% Goldman Sachs Global Investment Research 18

19 Exhibit 33: Key assumptions for Oculus Rift s total addressable market Oculus 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 12/ / / / / / / / / / Assumptions 1) Steam game active users (000s) 146, , , , , , , , , ,959 YoY 4% 4% 4% 4% 3% 3% 3% 3% 3% 3% Active Playstation User base (000s) 53,934 71,862 85,988 97, , , , , , ,063 YoY 55% 33% 20% 13% 5% 5% 5% 5% 5% 5% Xbox user base 89,765 92,457 95,231 97,136 99, , , , , ,132 YoY 3% 3% 3% 2% 2% 1% 1% 1% 1% 1% Gaming users 290, , , , , , , , , ,155 Hardcore gamers (30%) 87,102 95, , , , , , , , ,346 YoY 10% 9% 7% 6% 3% 3% 3% 3% 3% 3% 2) PC annual shipment (000s) 261, , , , , , , , , ,038 High-end consumer mix 5% 10% 15% 20% 25% 27% 28% 29% 30% 30% High-end consumer PC shipments (000s) 13,091 25,396 36,951 47,790 57,945 60,703 61,063 61,346 61,558 59,711 YoY -5% 94% 46% 29% 21% 5% 1% 0% 0% -3% 3) Commerical VR shipments (000s) ,248 2,070 2,415 2,537 3,045 3,027 2,921 YoY 268% 58% 73% 66% 17% 5% 20% -1% -3% 75% 55% 65% 58% 51% 53% 52% 50% 52% 56% VR software market estimates broadly unchanged On VR software, our estimates are largely unchanged with 2025 going from $26bn to $28bn, driven by a slight increase in entertainment use cases (i.e., expanded use cases in consumer markets on top of the core gamer market). Exhibit 34: We expect ~75% of the $28bn VR software market to be driven by consumer entertainment in 2025E Breakdown of VR software market Engineering 7% Retail 3% Education 2% Healthcare 4% Military 2% Real estate 7% Videogames 46% Video entertainment 14% Live events 15% Goldman Sachs Global Investment Research 19