This Once-Hot Sector Could Heat up Again

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Soon after the tech bubble burst in 2000, investors searched for a new industry that could replicate some of the massive gains seen by investors just a few years earlier. The major investment magazines helped to boost the hype into the stratosphere. The hot technology? Nanotechnology.

The premise was simple. Scientists had found ways to develop ultra-tiny particles that could be used in a range of biotech, industrial and cosmetic applications. We're talking smaller than "micro." Smaller than "milli." You have to go down below the width of a human hair, or one millionth of a meter to get a sense of just how tiny nano particles are.

Ten years on, the industry has seen limited success, and most of the major players have been vehicles to separate investors from their money. In fact, the U.S. government and the venture capital community have poured nearly $20 billion into the industry during the past 10 years, without a lot to show for it. As a result, investors have steadily drifted away from the sector.

In the last year alone, the entire industry appears to have fallen even further out of favor, with many stocks off -30% or -40%. Don't fault the industry completely on this one. These companies remain unprofitable and speculative and that's precisely the type of company that investors are shunning in this troubled economic environment. Conversely, speculative stocks can post out-sized gains when markets rebound, as investors move further out on the risk curve. With shares in a funk, let's take a look if any long-term value may still be created in this former highflying industry.

Company Name (Ticker) Recent Price Market Cap. 52-Week Change 2009 Sales ($M) 2010 P/E 2010 Sales Growth Price/Sales Ratio
Altair Nanotech. (Nasdaq: ALTI) $0.58 $63M -43% $4.4 Neg. +236% 14.3
FEI Company (Nasdaq: FEIC) $17.52 $668M -33% $577.3 17.7 +6% 1.2
Flamel Tech. (Nasdaq: FLML) $22.76 $178M -24% $42.1 Neg. -5% 4.2
Nanosphere (Nasdaq: NSPH) $3.09 $88M -60% $2.2 Neg. +31% 40.0
Harris & Harris (Nasdaq: TINY) $4.14 $128M -32% N/A N/A N/A N/A


Unfulfilled promise
Most nanotechnology companies have scant revenue bases, as they have yet to effectively commercialize their technologies. And even though some of these companies will never see their technology get out of the R&D labs, some companies are making an impressive go of it. For example, Altair Nanotechnologies (Nasdaq: ALTI) uses nano-sized materials to improve the electricity flow in lithium-ion batteries -- the kind that are finding their way into many new electric and hybrid vehicles.

Altair's battery technology provides high power rates, fast charge and discharge rates (within 10 minutes), longer life cycles (12,000+ charges), wider temperature operating ranges (-40 degrees C to 55 degrees C) and improved safety compared to other chemical approaches. The electric utility market has also been looking at Altair's approach. But Altair's revenue base is still too small to generate profits, so the company routinely burns through $20 million a year and any potential profits are likely several years away.

Biotech promises
The use of nanotechnology has always held a great deal of promise among biotech and drug makers. By using super small molecules, drugs could theoretically be more effectively distributed in precise targeted dosages. Flamel Technologies (Nasdaq: FLML) had been an investor favorite in this area, as the company looked poised to boost sales sharply as major drug makers licensed its technology.

But shares have fallen from $35 in early 2007 to a recent $7 as sales growth has slowed and stubbornly high losses remain in place. But it's not fair to completely disregard the company's progress to date. Partners such as Merck ( MRK ) , Pfizer ( PFE ) and Baxter ( BAX ) continue to pour research dollars into Flamel's novel approach. And if any of those efforts bear fruit, then licensing revenue could prove to be significant and shares would post a nice rebound.

An industry bright spot
There is one company that has arguably delivered on its nano-tech promises: FEI Company (Nasdaq: FEIC) . Research scientists at universities, government agencies and corporate labs use the company's imaging equipment to analyze materials at the nano-size level. Trouble is, demand for the company's equipment isn't growing and sales remain stuck at around $600 million. Analysts expect sales to grow just +6% to +7% both this year and next, due solely to improving budgets at key customers, and not because the company's nano-focused approach is finding many new applications.

The fund approach
Investors can avoid the risks associated with particular companies by investing in holding companies that have stakes in a range of nanotech players. For example, Harris & Harris (Nasdaq: TINY) owns stakes in more than 30 companies that are using nanotechnology as part of their manufacturing process. The value of those stakes is currently valued at around $4.60 a share, more than +10% higher than the current share price, and management notes that some of its holdings are being valued at less than they are likely worth, which means that the net asset value ( NAV ) of its holdings is likely closer to $5. To the extent that some of these nanotech holdings hit pay dirt, then Harris & Harris could rebound nicely.

Shares had occasionally moved up to the $15 to $20 mark in the first half of the last decade when investors had been focused on this sector. But they've been steadily falling in the past few years and now trade close to five-year lows.

Action to Take --> Despite a reputation for unfulfilled promises, the nanotechnology industry could still take off. The slow and frustrating development should have been expected from such a completely new technology approach. Yet most of these companies are likely to keep burning cash, issuing more shares, and staying in a funk -- until sales really take off.

Harris & Harris' diversified approach makes a lot more sense, especially since the investment firm can strike promising deals for company stakes that individual investors never could. This may be the safest way for individual investors to play the sector.

As with all speculative plays, these investments should only be a small part of your portfolio. But as is also the case with speculative stocks, a strengthening stock market could easily push these stocks back up by a hefty margin , erasing the big drops they've seen in the past 12 months.


-- David Sterman

David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More...

P.S. When you get in on the ground floor of a promising new trend or technology, the profits that can follow can change your life forever. Andy Obermueller's Game-Changing Stocks is entirely devoted to finding the next big, life-changing investing idea. See his latest report, The Hottest Investment Opportunities of 2011, for more ground-breaking investment plays.

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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This article appears in: Investing , Investing Ideas


David Sterman

David Sterman

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