Fund manager advises balancing risk, even in a micro-nano portfolio

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Jan. 7, 2005 – For an investor searching for the most likely beneficiaries of micro- and nanotechnology development, choosing companies is difficult. Should the investor focus on material suppliers, process enablers, manufacturing companies, IP powerhouses or the producers of “micro- and nano-refined” end products?

Should he focus on existing mid- and large-cap stocks, or is a tectonic shift towards new entrants with revolutionary technology likely to provide the winners?

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As it stands currently, most micro- and nanotech innovations are aiming to improve conventional products in existing markets with existing customer relationships. It is very unlikely that new entrants acting as sub-suppliers will be able to rapidly penetrate mass markets, even if they promise far superior technology and performance. It is typically a very laborious process to win customer favor and prove that you can deliver in large volume, with reliable quality and at low incremental cost.

Investors should therefore first make a careful analysis of how a company is embedded into existing value chains. Since many small micro- and nanotech companies do not have direct access to end customers, they are dependent on the success of their system-integration partners. It is, therefore, very important for micro- or nano-subsystem suppliers to choose the right partners who understand their market needs and know how to execute them flawlessly.

As far as the “right” stock valuation of a micro- or nanotech company is concerned, the common valuation criteria of other technology stocks can be applied.

Companies serving cyclical markets with high competition and low long-term visibility deserve a valuation discount. Companies with a dominant market position in high-growth markets with high barriers to entry and with non-cyclical characteristics deserve a higher valuation. This is particularly true if their process technologies might be expanded to new markets or products, thereby further increasing their growth possibilities.

It is even more difficult to analyze an early stage company. Even if the potential long-term reward could be huge if a company is successful, investors should not underestimate the technological and manufacturing hurdles. It is not a trivial task to evolve from “proof-of-principle” into a large manufacturer and supplier of a reliable, respected and cheap mass fabricated micro/nano-subsystem.

Isn’t it more likely that, at least for existing markets, established companies with proven subsystem manufacturing track records are going to eventually be the market leaders? If so, perhaps the startups could have more success applying a license and royalty-based business model. Although it would only allow access to a smaller part of total product revenues, it would liberate them from the execution risks of investing in mass production facilities.

So how should a moderately risk-tolerant investor construct a portfolio of micro- and nanotech stocks?

First, the portfolio should have a balance between companies serving different markets to mitigate the risk of being too focused on a single sub-sector. In addition, each of the companies should be a market leader.

Second, the portfolio should keep a balance between stocks of larger and smaller market cap, thereby giving a true picture of all the different micro- and nanotech activities throughout the different industries. This would also help smooth out the portfolio in case of volatile market movements.

Small-cap stocks should find a place in the portfolio if they are market leaders with an interesting growth perspective that is not well addressed by existing bigger players.

Large-cap stocks that have developed micro- and nano-processing capabilities, like high quality semiconductor companies, are also important. They already have evolved into processing powerhouses and will eventually expand into new markets like sensors, energy conversion and storage, bio-analytics and data storage.

Companies delivering the necessary tools for analytical tasks or for layer deposition should also be given a respectable weight. These equipment companies are very often the first to perceive the possibilities and opportunities of their tools, which allows them to accumulate considerable IP.

Finally, material suppliers should be part of an investment plan if the companies can show new processes by which their basic materials can be specifically arranged to meet a customer need.

In summary, investors should always be aware that success in the stock market is more likely achieved with a long-term investment horizon. This is particularly true for micro- and nanotechnologies, where the best companies will hopefully not only leverage their expertise over the next years, but over the next decades.

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