Initial analysis from J. M. Dutton Associates:
jmdutton.com
SI Diamond Technology, Inc. Randall D. Lewis, CFA
April 30, 2002
Symbol (OTCBB): SIDT Fiscal Year Ending:
December 31
Recent Price: $0.62 Year EPS P/E
REV's PSR
Price Range: $0.45-$1.65 1999A $- -
$6.75 6.2x
Avg. Daily Vol. (30 day): 86,000 2000A $(0.14) -
$2.72 15.4x
Industry: Nanotechnology 2001A $(0.08) -
$3.08 13.6x
12 Month Target Price: $2.00 2002E $(0.04) -
$7.53 5.6x
Market Capitalization (000): $41,969 2003E $0.05 12.4x
$30.20 1.4x
Capitalization (000): 12/31/01 Estimated 2001- 2005 Annualized
Shares O/S: 67,692 Growth Rate: -
Cash & Equiv.: $262 Dividend: -
Net Working Capital: $(1,523) Yield: -
Long-Term Debt: $40 Inside Ownership: 2%
Shareholders Equity: $(946)
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Recommendation: Buy
Basis for Recommendation
SI Diamond Technology, Inc. is engaged in the development of uses for carbon nanotube field emission technology. We believe the Company's patent portfolio to be worth at least $40 million, and as much as $80 million, providing a solid valuation base.
Nanotechnology is one of today's hottest fields. Nanotech has already gained favor with a number of venture capital firms and could likely be their darling this year too. Government spending on research is expected to take a huge leap, and many industry observers see nanotech as the next major driver of innovation, the economy and the stock market, similar to the Internet boom of the 1990s.
As a leader in the development of practical applications for nanotechnology, in an industry with the potential for explosive growth, the Company has an opportunity to leverage its market-leading position to achieve its targets: revenue growth of over 113% and positive earnings results.
We believe the Company's management team is poised to take SI Diamond to the next level. Dr. Zvi Yaniv (President, Chief Operating Officer, Director) is a nationally renowned, reputable figure in the display and nanotech fields. CEO and investment banker Marc Eller is also the Company's largest investor. Jake Schroepfer (President & CEO of the Company's subsidiary, Electronic Billboard Technology) is a seasoned advertising professional, serving as President & CEO of the Dallas office of DDB Worldwide, the largest advertising agency in the U.S. and third largest in the world, prior to joining the Company.
Company Profile
Texas-based SI Diamond Technology, Inc. ("the Company" or "SI Diamond"), founded in 1987, is engaged in the development of uses for carbon nanotube field emission technology; research at the Company's subsidiaries is focused on identifying key applications of this technology. Currently, the Company's primary growth drivers are the development and marketing of electronic display products, including electronic billboards, that utilize the Company's patent portfolio, which we believe to be worth $40 to $80 million. The second growth driver is the research and ultimate application of its technology to the medical, X-ray, and wireless communications industries. Operations are conducted through subsidiaries, including Electronic Billboard Technology, Inc. ("EBT"), Applied Nanotech Inc. ("ANI"), and Sign Builders of America, Inc. ("SBOA"). In addition to its sign manufacturing facility, SI Diamond intends to establish manufacturing partnerships, joint ventures, and outsourcing arrangements to satisfy its manufacturing needs. Currently, the Company has installed electronic displays at customer test sites and has received an order from McDonald's restaurants of Hawaii to install electronic displays at 80 locations, which are expected to be installed during this summer. As of April, the Company employed 54 people on a full-time basis, including five executive officers.
Products
SI Diamond has two leading potential carbon nanotube field emission products. These products are being developed jointly with others based on SI Diamond technology. Upon successful completion of the development process, the Company's development partners will be required to license its technology to produce and sell specific products and services. Development partners retain all rights to any intellectual property that they develop in the process. Consequently, it may not be possible for others to produce these products without obtaining licenses from both SI Diamond and its development partners.
Picture Element Tube (PET). This first product being developed is intended for use initially as large indoor displays. If the PET is successful, SI Diamond expects to enhance it for outdoor use. This product is being jointly developed with Futaba Corporation. Although SI Diamond is overseeing the product development, to this point Futaba has provided $1.1 million to cover the majority of the expenses, and will continue to provide further developmental costs. An example of this is the recent announcement of the demonstration of a 14-inch diagonal carbon nanotube display. Any jointly developed intellectual property will be jointly owned by the two parties; however, any intellectual property would be based on underlying patented technology owned by SI Diamond and would require Futaba to license the technology.
HyFED(TM). This product combines properties of a cathode ray tube (CRT) and carbon nanotube field emission technology. SI Diamond plans to license its HyFED technology for use in the production of flat-screen TV applications that are cost-competitive with CRTs. This product is under joint development with a consortium that includes a variety of other companies. SI Diamond is overseeing this consortium and expects to incur approximately 50% of the total costs over the life of the project. Each member of the consortium is responsible for its own costs. SI Diamond expects to incur in excess of $200,000 in costs during 2002 and expects project completion by the end of 2002. No terms have been negotiated for any potential license agreements with consortium members.
Cathodes. In addition to the above products under development, SI Diamond supplies cathodes (the negative electrode from which current flows, and whose rays produce X-rays when they strike solid matter) that use its carbon nanotube field emission technology to Oxford Instruments, Inc., which in turn uses it in that company's portable X-ray product.
Nanotechnology
While the average investor might not know what nanotechnology is, one thing is clear: it is big business. Nanotech has already gained favor with a number of venture capital firms and could likely be in fashion this year too. Government spending on research is expected to take a huge leap, and many industry observers see nanotech as the next major driver of innovation, the economy and the stock market, similar to the Internet boom of the 1990s. Government spending on nanotech began in 1998, with about $115 million invested. Now the Bush administration has asked Congress to appropriate $679 million for 2003 to help the U.S. catch up to technology development efforts of other countries in this field. Already, European governments have spent $164 million on nanotechnology in 2000; for 2002-2006 they have allocated $1.2 billion.
Nanotechnology is an emerging technology that utilizes matter at the scale of one-billionth of a meter (1 nanometer), or 1/75,000th the size of a human hair. Because there were no tools that existed to allow scientists to observe, let alone manipulate, individual atoms, nanotech did not emerge as an experimental science until the early 1980s, with the invention by IBM researchers of new microscopy techniques. It has been defined as the precision placement, measurement, manipulation and modeling of sub-100 nanometer scale matter, somewhere from 4 to 400 individual atoms. The advantage of this technology is that at this level of matter, laws of physics allow us to manipulate atoms, which combine to form molecules, the building blocks of our natural world; this allows scientists to produce new and better materials. In other words, through the utilization of nanotechnology, we can make new, artificial materials with predetermined properties. The technology is already being used in areas ranging from sophisticated medical purposes to simple household goods.
Branches of Nanotech
Though research and development and potential applications of nanotech are extremely vast, it is typically segmented into five markets: biological; instrumentation (the tool makers); physical (better, faster products ñ such as computer hardware); materials development; and futuristic (which includes advertising). Although nanotech labs today focus primarily on basic research, it is hoped that discoveries will soon apply to nearly all branches of technology. It has been predicted that nanotech will lead to new scientific advances, including mundane items such as scratch-proof glass, precision drug delivery systems, and computers the size of a sugar cube that could hold the entire Library of Congress. Already, research points to revolutionary advances in materials, pharmaceuticals and information technology.
Nanoscale approaches to computing: Molecular computing, which uses single molecule switches to process data and quantum computing, offers the potential that the speed of integrated circuits will continue to double every 18 months, in accordance with Moore's Law. Already, using semiconductor nanotubes, researchers have assembled several basic electronic components, including transistors, the electronic logic gate at the heart of all computing. Labs have also reported success with other nanomaterials, such as silicon nanowires. This offers promise to the semiconductor industry, which expects to hit the theoretical limit of photolithography within a decade.
Biology and natural sciences: Other research groups are exploring the intersection of nanotechnology and biology. Nanotechnology offers the potential to recognize and control the bio-molecules that govern normal as well as diseased cell activity. Implantable, intracellular sensing systems, together with custom DNA chips and smarter drugs hold the potential to transform biomedicine into a much more precise discipline that it is today. While these companies have no real product yet, their valuations are skyrocketing commensurate with the perceived value that nanotech will bring.
Developmental Hurdles
To be practical in the real world, nanotechnology must scale up. Today researchers assemble nanodevices one molecule at a time. However, to be useful, a device would have to incorporate millions of molecules, precisely arranged. Researchers are exploring this type of "self-assembly". DNA has been called the perfect example of a self-assembling machine: a single molecule that, under the right conditions, creates not only replicas of itself, but incredibly complex organisms.
Competitive Strategy
Management has developed a business strategy designed to grow the Company and maximize return on invested capital. Components of this strategy include the following (according to business segment):
Electronic Billboard Technology, Inc. (EBT)
While current revenues from EBT consist of limited product sales, we feel the potential from this business segment has perhaps the greatest potential. EBT focuses on the digital delivery of visual content through a network of displays in an out-of-home setting, one that is centrally managed and controlled (also termed "narrowcasting").
The U.S. narrowcasting industry is poised for substantial growth over the next five years. This growth will arrive in conjunction with macro- and micro-level changes that are now occurring: one is already evident in the improvement of the overall U.S. advertising market; the other is the growing experience and sophistication of narrowcast vendors.
CAP Ventures projects the total narrowcasting industry revenue from displays, control/management software, integration, and advertising/network operations will approach/grow from $388 million in 2002 to $2 billion in 2006. By 2006, it is estimated that over 26,000 firms will use narrowcasting systems, with over 92,000 sites having at least one networked display. This would project to a base of over 387,000 displays.
Despite this rapid growth, it is important to note that by 2006, only 1.6% of the more then 1.6 million available firms in key target markets will have implemented narrowcasting systems. Narrowcasting will also source volume from other key marketing communication's disciplines as the rate of adoption escalates and marketers begin to shift marketing dollars from "broadcast" to "narrowcast." EBT, through narrowcasting, intends to penetrate the following established marketing communications disciplines that already represent significant volumes. According to Promo Magazine, these include:
Point-of-purchase: $17 billion (+18% from 2000 to 2001)
Sales promotion: $100 billion (+8% from 2000 to 2001)
Advertising $94 billion (-10%)
In our opinion, it makes sense for SI Diamond spin off EBT within the next 12-18 months. The Company is focusing its efforts on sales of its E-Window and E-Banner products, which allow retailers to automatically display and manage indoor advertising. E-Window projects images ñ both video and still - on a piece of glass, such as the storefront of a mall retailer. In pursuing these sales, SI Diamond plans to implement two different models:
Straight Sale/Management - This model entails sale of the hardware (projector, networking, screen, etc.) as well as creating and managing the advertising content. Creating includes both conversion of existing content and creative design. Once the content is ready, the Company's technology includes methods of automatic rotation of advertisements that can be managed on site or remotely.
Revenue Share - Under this model, the Company will take a piece of the revenue earned through customers' sales of advertised products. Generally, 50% of the advertising will need to be pre-sold (if the customer is allowing outside advertisers as well using the product for internal use) and these agreements will have a two-year minimum duration.
The Company's sale of 80 installations in Hawaiian McDonald's restaurants serve as a springboard for these types of sales. Management states that use of its advertising systems have resulted in a 38% increase in sales for the retailers using them, at a much lower cost and increased efficiency compared to other forms of advertising. Interestingly, retailers such as Macy's spend about $250,000 a week changing their in-store displays. That fact alone is incentive enough for the Company's target market to embrace new technologies.
Applied Nanotech Inc. (ANI)
The primary focus of ANI is to: 1) perpetuate the sale of HyFED, PET and cathodes; and 2) the research and development of new nanotech applications--particularly in the fields of display, X-ray, decontamination and wireless applications, among others. R&D starts with anywhere there is an emission of electrons from a carbon base. (Incidentally, diamonds are extremely high in carbon, thus the Company's name). Next, the Company's researchers prove a principal to potential users of a particular application, much as it did in 1999, when it landed a $5.6 million licensing deal from Canon, Inc.
Currently, ANI's revenues come from sales of cathodes to Oxford Instruments, and R&D grants and advances from various sources, including Futaba, a large Japanese display manufacturer ($1.1 million), and NASA ($582k). Future revenue will likely come from licensing existing and future technologies, and/or royalty payments as a percentage of customers' revenue derived from the use of such technologies.
In addition, ANI has signed a licensing agreement option with the University of Massachusetts, Amherst (UMass) for a new nanotechnology that can create ultra-high density metallic nanowire arrays grown in self-assembled die-block copolymer templates. This structure has potential applications in the display industry as well as other fields including ultra-high density storage media, multi-layered device fabrication, and the creation of new artificial materials with pre-designed properties. For FY 2002, we have assumed one major royalty agreement in Q3, though timing and amounts of such agreements are nearly impossible to predict.
Sign Builders of America, Inc. (SBOA)
While the production of billboards is currently SI Diamond's main source of revenue, we expect SBOA's contribution to overall company revenue to decline dramatically in the coming years. Granted, there could be some overlap with the Company's electronic billboard initiatives, but for the most part, the growth catalysts are EBT and ANI. We have forecast only modest growth in sales for this division.
Competition
SI Diamond faces competition in both the development and application of its nanotechnology from universities and several companies, both privately owned and well-known public companies. Given the number of potential applications for nano-technology is far reaching, it is not surprising that there is significant interest in this field. Future breakthroughs by these companies are likely to bring about more investor excitement regarding the prospects of the industry as a whole and result in higher valuations for the entire group. Some of the more well-known companies developing nanotechnology include General Electric (NYSE:GE), Agilent Technologies (NYSE:A), IBM (NYSE:IBM), Hewlett-Packard (NYSE:HWP), and Veeco Instruments (Nasdaq:VECO). Other companies in this space include:
Nanosys (privately owned), which has corralled key intellectual property that will be the foundation of future developments. A Harvard University spin-off, they have received $1.7 million in funds from various sources.
Ntera (privately owned), probably the Company's closest competitor on the display side. Ntera's first product, NanoChromics, is a ultra-thin display that looks like regular paper but can change what it displays, just like a computer screen or LCD.
Symyx Technologies, Inc. (Nasdaq:SMMX), which is producing nanoscale materials with novel properties that have applications across a wide range of industries.
Pharmacopeia, Inc. (Nasdaq:PCOP) is developing software to visualize, model and simulate matter and activity at the nanoscale.
Additional Comparables Table (click here)
In addition, we are likely to see start-up companies emerge as a result of successful research efforts at universities. Joining the ranks of nanotech R&D are the University of Virginia, MIT, University of Michigan, each of which has received over $5 million from the National Science Foundation to create centers for nanoscale research.
Financial Information
Revenue and Earnings
Currently, the only revenue that SI Diamond receives related to its carbon nanotube field emission technology is related to reimbursed research and development expenditures and the cathode sales to Oxford Instruments. Over the last year, revenues continued to grow but net profits have remained negative due to the research-intensive nature of its current operations. Now that EBT has significant, market-ready product, however, this trend could begin to reverse itself this year. In 2001, the Company had $3,084,196 in revenues compared with $2,724,830 during 2000. While the majority of sales were due to non-governmental contracts, government-funded projects totaled $352,341 in 2000 and $466,680 in 2001. The Company may seek additional research grants in the future if they are directly related to projects already in progress. Net loss was $5,166,559 in 2001 and $7,761,342 in 2000 or $(0.08) and $(0.14) on a per share basis. Company-sponsored research and development expenses contributed to the majority of these losses. While these losses are significant, they represent an investment in the development of novel applications for nanotech, which is an emerging and potentially high growth industry.
Working Capital and Funding
SI Diamond expects its cash needs to for 2002 to be approximately $4.8 million. The Company expects to raise funds through a combination of SBOA sales, reimbursements for research, license agreements, and issuance of debt and equity securities. Successful introduction of electronic display products may result in cash needs that exceed current estimates; however, an increase in customer orders will also serve to validate the Company's product strategy and are likely to result in an increased availability of funding.
Although management expects to incur substantial additional R&D activities in 2002, SI Diamond expects these expenditures to be substantially reduced from '01 levels for two reasons. First, external funding of research at ANI is expected to grow. Second, EBT's display products are market ready and will require much lower levels of ongoing research and development expenditures. In 2002, the Company expects to spend approximately $1,500,000 on unreimbursed research and development.
Key Risk Factors / Concerns
Product development is in its early stages and the outcome is uncertain: The utilization of nanotechnology is largely in the research stage. While current applications may produce revenues and profits for the industry, the biggest growth drivers are likely to be developed in future years. Given the uncertainty involved in determining the success of individual companies, this is a high-risk industry; at this stage of industry development, it is difficult to predict which companies will successfully develop profitable applications and the magnitude of those profits. With any new technology, there is the risk that the market may not appreciate or recognize the potential applications of a technology.
Need for cash resources: Given that the industry is still heavily involved in R&D, funding from investors will be a requirement for many companies. The ability to raise significant levels of funds will be critical to SI Diamond's success.
Operational risk: SI Diamond expects a very large increase in signed contracts over the next few years; effective execution of strategy and the ability to maintain a high level of customer service are critical to gaining further investment funding and maintaining and strengthening brand image.
Valuation / Outlook
SI Diamond is a player in one of the most exciting development stage industries of our time and has strong growth prospects, many of which will be discovered as research progresses. As a leader in the development of practical applications for nanotechnology, in an industry with the potential for explosive growth, the Company has an opportunity to leverage its market leading position to achieve its targets for revenue growth of over 113% and positive earnings results. Although there are several key factors that will drive the stock price, the ability to secure additional client contracts, development of its technology, and investor sentiment towards the industry in general will be the primary stock drivers in the near term. As both the industry and SI Diamond prove they can move beyond the development stage and begin to produce meaningful earnings and revenues, investors can expect the stock to appreciate significantly.
Arriving at a fair valuation and building a corresponding case for either under or over-valuation of the stock is naturally difficult and highly theoretical at this stage of its development. Because financial results will be greatly affected by the pace of technological developments which is always uncertain, actual revenue and earnings numbers are likely to significantly deviate from expected results ñboth in terms estimates being met or exceeded. In addition, strong visibility into our estimates is tenuous at best because we cannot establish direct relationship with end-market demand on the basis of customer commitments, contracts, etc. for 2002 and beyond. We are unable to make a thorough comparison of our estimates for SI Diamond to its competitors because much of the industry is either private or a research division of a much larger company or university. Consequently, a valuation based on a relative comparison of near term estimates relative to competition is highly theoretical and subject to a high degree of subjective judgment, largely based on favorable industry trends and a projection of short-term company results into the future.
With the caveats said, however, several facts remain clear. First, SI Diamond is a player in an industry that is receiving a lot of attention and whose stocks are being afforded lofty valuations, as evidenced by our comparables table. In fact, we feel that if the Company had "nano" in its name, it would be receiving a much higher valuation. But fads often die hard; sales and earnings don't. Second, many of these highly valued stocks do not even have a marketable product; they are simply functioning as research labs in the hopes of discovering something innovative. Lastly, not only does the Company have several viable products, it has test-marketed and proven the efficiency of them.
Right now, the Company is selling at 5.76x our 2002 revenue estimate of $7.5 million. Maintaining that multiple next year would equate to a stock price of roughly $2.00 a share based on our estimates. While basing a valuation on such a significant, uncertain jump in revenue might not be prudent, we feel that the multiple is low when comparable companies are taken into account. A revenue multiple of 10.5x 2002 sales (more in line with the comps) gives a price of $1.17. Therefore, we feel comfortable in assigning a short-term price target of $1.20, with a 12-month value of $2.00 ("value" because the EBT spin-off could effectively cut the stock in half though shareholder value is unchanged). An outstanding private placement will create an additional 9.1 million shares, and thus might apply some pressure on the stock in the near term, but overall the prospects for SI Diamond look very promising. We look to the execution of the EBT business model as the primary reason for a future rating upgrade. And as stated earlier, we believe the Company's patent portfolio to be worth at least $40 million, and as much as $80 million, providing a solid valuation base. For now, however, we are assigning the shares of SI Diamond Technology, Inc. a Buy recommendation with a 12-month price target of $2.00 a share.
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Analyst:
Randall D. Lewis, CFA, MBA
Mr. Lewis has more than ten years experience in security and portfolio analysis, and served as an equity analyst at SSI Investment Management, Inc., financial analyst for Griffin Financial Services, and research and market analyst for Eneric Financial Services. He has published several articles, most recently HFR Journal of Hedge Fund Research, on the subject of merger arbitrage. He has a BA degree in finance from California State University, Fullerton, an MBA from the Anderson School at UCLA, and is a Chartered Financial Analyst (CFA).
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Contact:
SI Diamond Technology, Inc. 3006 Longhorn Blvd., Suite 107, Austin, TX 78758; Phone: (512) 339-5020, Fax: (512) 339-5021. Contact: Brad Arburg, Dir. Corporate Development; e-mail: arberg@attbi.com.
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J.M.Dutton & Associates, LLC. John M. Dutton, President and Supervisory Analyst, 1129 Manning Drive, Suite 310, El Dorado Hills, CA 95762 Phone (916) 941-4985, Fax (978) 418-6422 Email: JMDutton@JMDutton.com Web site: www.JMDutton.com |
