In Search of Profits From Nanotechnology

New technology is revolutionizing industry

A fascinating and exciting new technology is revolutionizing industry, and it's happening in places invisible to the human eye.

Nanotechnology, which involves the development, manufacture and application of products at the molecular level, will have a profound impact on virtually every business if implemented successfully, from consumer electronics to textiles, automobiles, pharmaceuticals, and everything in between. On this ultra-small scale, matter can be manipulated with molecular precision.

To understand the dimensions, consider that one nanometer is equal to about one one-billionth of a meter, or 1/75,000th of the diameter of a single human hair. At this level, materials exhibit properties that reflect quantum physics. Many "nano-scaled" products, from tiny robots or micro-machines to nano-particles that could help clean the environment, may have unprecedented positive effects on human activity.

Indeed, the growing importance of nanotechnology was underscored by President George W. Bush in his State of the Union address in January. He proposed to double the Federal commitment to the most "critical basic research programs in the physical sciences over the next ten years," including nanotechnology. In March, the U.S. Secretary of Commerce Carlos M. Gutierrez announced the launch of a state-of-the-art center for collaborative nanotechnology research at the National Institute of Standards and Technology in Gaithersburg, Md.

But will this "nanotech revolution" translate into tangible investment opportunities for stock pickers anytime soon?

Lux Research Inc., a nanotechnology research and advisory firm, estimates that revenues from products using nanotechnology will rise from $13 billion in 2004 to $2.6 trillion in 2014, equaling about 15% of global manufacturing output at that time. By then, the firm believes, nanotechnology will be a routine part of everyday living.

All Things Great and Small

Jack Uldrich, president of NanoVeritas Group, a consultancy, and author of two books on nanotechnology, estimates that corporations around the world will spend more than $10 billion on nanotechnology in 2006. He closely follows about 100 U.S.-based nanotech firms, of which 60% are privately held. Of those 100, roughly 60 have commercial products currently on the market and about 22 are profitable. "These firms are supplying nano-scale equipment to the nanotech industry, as well as to big companies like International Business Machines (IBM) and Intel Corp. (INTC)," Uldrich notes. He believes the number of 'nanotech' companies, profitable or otherwise, will continue to increase.

Late last year, Lux Research, in tandem with PowerShares Capital Management, launched an exchange-traded fund, the PowerShares Lux Nanotech Portfolio (PXN), for investors seeking to invest in nanotechnology. The tiny $93-million fund invests in stocks of the Lux Nanotech index, which consists of 26 publicly held companies. It is the first investment vehicle dedicated to this emerging technology, and the index is designed to be representative of the "overall space," says Peter Hebert, chief executive officer of Lux Research. Year-to-date through March 31, the ETF gained 12.0%, versus a 4.2% rise by the S&P 500-stock index. The portfolio is too new to be ranked by Standard & Poor's.

The Lux index consists of companies developing or manufacturing tools used to develop nanotechnology, and well-established firms integrating nanotechnology into their existing products. Components are broken down into two basic types of stocks: "nanotech specialists" and "end-use incumbents." The specialists are small- and mid-size companies that focus specifically on developing or funding nanotechnology applications. The end-use incumbents are large-cap companies applying nanotech to existing product lines. The two groups are then equally weighted with 75% applied to the nanotech specialist components and 25% for the end-use incumbents.

The first group, nanotech specialists, includes companies such as FEI Co. (FEIC), which is "essentially a toolmaker, manufacturing the 'metaphorical picks and axes' of the nano gold rush," Hebert explained. The firm makes electron microscopes used by nanotech researchers since regular optical microscopes aren't powerful enough to see nanometer-sized material. He noted that large corporations like BASF AG (BF) are buying FEI's equipment. Hebert said that while FEI is traditionally known by Wall Street as a semiconductor company or a data storage tool provider, about 50% of the company's business is now based on nanotech.

Another nanotech specialist, Flamel Technologies (FLML), uses nanotechnology to improve drug-delivery systems, which it licenses to big pharmaceutical companies. Other nano-specialists include Symyx Technologies (SMMX), which has a technology that accelerates the process for creating new materials, and Accelrys Inc. (ACCL), which develops molecular modeling and software simulation to facilitate new product design and drug discovery for the life sciences industry. Both these companies have licensing arrangements with big corporations.

While some see the ETF as a good vehicle for those who want to invest in nanotechnology, others point to its drawbacks, such as holdings that are not yet profitable and the extreme volatility associated with industry-specific funds that seem gimmicky. Srikant Dash, index strategist at Standard & Poor's, notes that narrow sector ETFs have two legitimate uses. "First, money managers who have a view on a narrow industry, but do not have a view on individual stocks within that narrow sector, can use these ETFs to implement their views," he said. "The second user group consists of trading desks and active traders who trade frequently on news about a narrow industry, or want to manage their risk exposure to a narrow industry."

Big Blue Chips Go Tiny

Another way investors can play nanotech initially is by investing in large-cap companies applying the technology to their existing product lines, thereby avoiding unstable and unprofitable start-ups. Nanotech is expected to have a powerful impact on three major industries initially: information technology/semiconductors, life sciences and energy.

Many well-known firms like 3M Co. (MMM) are already integrating nanotechnology, Hebert noted. American Pharmaceutical Partners Inc. (APPX), he cited, "has a new cancer drug, Abraxane, that is enabled by nanotech. It is on the marketplace as we speak." Big pharma companies are using new nano-particles to reformulate existing drugs to make them more effective and potent, and therefore extend the patent, which leads to bigger revenues, experts say.

Among other end-use incumbents, Japanese carmaker Toyota Motor (TM) has long been involved in nanotechnology research, which includes the development of automotive fuel cells that have nano-structured components. Semiconductor giant Intel produces transistors with nano-scale features and is increasingly focusing on new innovations like carbon nanotube-based electronics.

The bluest-chip company of them all, General Electric (GE), has said that nanotech is one of its three top priorities, and that it will invest up to $50 million annually in this technology. The giant German conglomerate BASF will invest $200 million over the next three years in nanotech research & development. Within four years, it expects, between $60-$75-billion in revenues will be attributable to nano-enabled products.

Uldrich is especially excited by nanotechnology's potential impact on the energy industry. "Among other innovations, nanotech will make coal a cleaner energy source, and make the transmission of electricity produced from coal more efficient and cleaner," he said. "In addition, we will see more efficient solar energy cells." Uldrich added that Chevron Corp. (CVX) and Exxon Mobil (XOM) are "investing heavily in nanotechnology."

While some observers remain skeptical about nanotech's near-term future as a viable investment vehicle, Uldrich is confident it is not an overblown "fad," like many dot.coms were. "There will initially be some excessive hype surrounding nanotech and some fraudulent companies trying to exploit investor excitement," he said. "But what distinguishes nanotech from things like the dot.com craze is that legitimate nanotech companies have to have a strong scientific and technical background and foundation. This will limit the number of companies that enter the field."

The applications of nanotech are so complex and varied as to render the term somewhat nebulous. That's because experts see it as an enabling technology that becomes part of the value chain. "You can't group it as one lump industry," noted one observer. "There is nano in health care, semiconductors, and basic materials." Uldrich says he compares the potential of nanotech to something as basic as electricity, which revolutionized society in the early 20th century, and then became something people took for granted in their daily lives. "You're not investing in a specific race horse... nano-science is the race course."

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