It looks like the nanotech space might be heating up again:
Payoff Time for Nanotech
With the first crop of startups growing up, investors dare to think about getting out.
May 22, 2006 Print Issue
When Kevin Matthews took the reins of Oxonica in 2001, the then two-year-old nanotechnology company was gunning for a highly competitive electronic display market but still had no products. It was also running on near empty, with only 12 weeks of cash left in the bank.
Four years later, the Oxford spin-off—now with £10.8 million ($20.2 million) in cash from investors such as German chemicals giant BASF—was turning out a fuel-efficient additive and performance-enhancing sunscreen compounds. Then, going public last July on the London Stock Exchange’s Alternative Investment Market (AIM), Oxonica raised another £8.3 million. And then, last December, it acquired Mountain View, California-based Nanoplex Technologies, which it hopes will lead Oxonica’s drive into the medical diagnostics market.
After a shaky start, Oxonica had transformed itself into a success story, a rare commodity in the nanotech world. At last count, there were more than 1,200 startups trying to find commercial uses for novel properties uncovered in materials parsed at the molecular level and reduced to just a few atoms in size.
Now, more than five years since the first wave of nanotech startups captured the fancy of venture capital, some VCs are wondering if some might be ready to float, or buy out given tougher and costlier market-listing rules.
IPOs by Next Year
Chances are, some companies could file for IPOs by the end of next year. Though not big in number, seeing anything listed at this point would be encouraging for an industry that has produced so few public companies to date. Out of the 143 VC-funded nanotech startups worldwide tracked by New York City-based Lux Research, only six have gone public since 1995 (Some, such as Perth, Australia-based pSividia, managed to go public without venture backing).
Eight VC-backed nanotech companies were sold during the same period. The National Venture Capital Association in Arlington, Virginia, reports that buyouts are on the rise, as IPOs fell further under the M&A shadow. In the U.S. market in 2005, there were 156 venture-backed M&As overall, including nanotech and every other sector—as against 56 IPOs.
The public market’s interest in nanotech is growing. San Francisco-based Global Crown Capital started a combined hedge-venture fund in March, after creating an index of 19 public nanotech companies last December. Global Crown, which has raised $100 million so far, plans to invest 80 percent in public nanotech companies and the balance in private ones.
“We are getting a lot of phone calls from smart investors asking to explain what nanotech is, how they can evaluate the companies, and whether the technology works,” says Rani Jarkas, managing director and chief investment officer. “We believe there should be more nanotech companies going public and more M&As later this year, and going forward,” he says.
There will almost certainly be more buyouts than IPOs, and not just because of the public’s shaky grasp of nano. The Nasdaq lost much of its once considerable lure when regulators tightened finance reporting rules, raising compliance costs. Basically, companies, tech companies as much as others, have to be bigger to get a look these days.
On the other hand, VCs are now getting better business plans. The proposals provide a sharper focus on product and manufacturing plans, says Daniel Wolfe, vice president of New York City-based Harris & Harris Group, which specializes in nanotech investments. “The technology is coming in more fully baked,” Mr. Wolfe adds.
VCs also are putting up more money. Investments rose nearly 24 percent to $508.5 million in 2005, thanks to a spike in large third and fourth rounds, according to Lux. “VCs are starting to see the funnel effect where early-stage investments are paying off in manufacturable processes and technologies,” says David Lackner, a senior analyst with Lux. “But they still require more money to get to fruition.”
The average deal size shot up 45 percent in 2005, to $11 million. Two big winners were Aspen Aerogels, which took $30 million in private equity funding (on top of $20 million in debt), and Nanosys, which picked up $48 million.
Aspen Aerogels Chief Financial Officer P.J. Piper won’t discuss a specific IPO plan, but says the company “is almost there in terms of being IPO ready.” Lux estimates that the Northborough, Massachusetts-based company, which makes lightweight thermal and acoustic insulation, generated $20 million in revenue last year and has been doubling its sales annually. “It’s an easy story to tell and understand and verify,” Mr. Piper says. “It will help when we approach the public market.
Yen for IPOs
Investors and startups are pining for large and frequent public offerings. The idea of creating nanoscale products has been around for decades, but work has been done mostly in corporate and university labs. Because it promises to bring disruptive technologies across a host of industries, from semiconductors and biotech to energy, investors began to throw money at startups in the late 1990s. Between 1995 and 2005, U.S. nanotech startups sponged up 80 percent of the roughly $2 billion in venture capital, Lux says.
Investing in tiny tech requires patience. Many entrepreneurs went to VCs with good research and novel materials but without much idea of their commercial possibilities. Some VCs who got taken in by only half the story failed. “We went through a period where people [would] say, ‘Gee, we are nano and therefore we are special,’” says Clinton Bybee, co-founder of Chicago-based Arch Venture Partners. “But it’s really the application that matters. I think both the investors and entrepreneurs are more rational about that [now].”
Quantum Dot developed light-emitting nanocrystals that enabled scientists to better monitor cell divisions and other behavior. It was sold to the public life sciences firm Invitrogen for $26 million last year—but only after taking in $39.5 million in venture capital. Thin-film developer Optiva was an unqualified disaster: it raised $35 million and last year sold its assets to Nitto Denko of Japan for $2 million.
“VCs were breaking their golden rules, which were markets and managements,” says Tim Harper, who co-founded NanoSight in the United Kingdom and is CEO of Cientifica, a nanotech consulting firm in London. “People were caught up in this over-enthusiasm for nanotech as the next industrial revolution.”
The tech downturn sobered up VCs. And entrepreneurs. Investors say they are seeing better business proposals submitted by more experienced management teams. Gert Kohler, co-founder of Creathor Ventures, says he redirected Blue Membranes’ market focus after he and G.K. Beteiligung bought the nearly bankrupt German startup from a previous set of investors in 2003.
Blue Membranes initially marketed its carbon compounds for separating oxygen from other elements in the air. To what end? “You have a higher density of oxygen in your room and you live longer,” Mr. Kohler says. “It was a foolish idea.” Blue Membranes now targets the medical device coating market and recently signed licensing contracts with device makers in Japan and India.
Risky Business
Successful moves by these maturing startups have fueled talk of IPOs. Palo Alto, California-based Nanosys, which has raised $102 million to date, is definitely on investors’ wish list. It tried to go public two years ago, but canceled its scheduled August 2004 IPO that aimed to raise up to $122 million, with management and backers blaming a bear market for the pullout.
But analysts say there was more to the retreat: while Nanosys had a broad intellectual property portfolio, it had no tangible products in hand and what revenue it had—$3.31 million—largely derived from government grants and some outsourced company research projects.
Nanosys Chairman Larry Bock says the company has no plans to raise money this year. Currently, it is working with Sharp to develop flexible display, and with Intel on memory devices. Mr. Bock dismisses the suggestion, made by some financial analysts, that Nanosys is looking to IPO to validate its share value ahead of a buyout. “There has been a lot of market validation of Nanosys’ value, from the prices investors pay to corporate partnerships,” he asserts.
Without many successful exits, however, many public and private investors don’t know how to bet on the sector. Governments and corporate research labs spend 18 times more money on nanotech than VCs, Lux says. Nanotech startups often require hefty capital to find new materials, develop products, and manufacture them. “You’ve got to have validation in the public sphere for public investors to look at you,” says John Roy, senior analyst with WR Hambrecht. “They can’t go in and do a thorough patent analysis and technology comparison.”
New York City-based Apax Partners, for example, still considers many nanotech startups too early-stage. It passed on Nanosys and Nano-Tex, another possible IPO candidate. “When we look for late-stage investments, we look for profitable companies with high growth,” says general partner Paul Vais. “We are not looking for large dollars and risky investments.”
Still Waiting
Although some companies have gone public, VCs say they are still too small to “move anyone’s needle,” as one VC puts it. They are looking for the Netscape and Google of the nanotech world, he says, and that looks a long way off.
“There haven’t been some huge IPOs or acquisitions that would get everyone thinking this is going to be the next great gold rush,” says Charlie Harris, CEO and chairman of publicly traded Harris & Harris. The group has 22 nanotech investments now and so far has managed exits with five firms—including Nanophase, which raised $32 million in its Nasdaq IPO in 1997, and NanoGram Devices, which left the Haris & Harris portfolio in a $45-million trade sale last year.
Despite the slim pickings in the public market, some investment houses have assembled stock indices to educate curious investors. The problem is the stocks, which include Harris & Harris and a slew of chemical, microscope/equipment/device, and pharmaceutical companies, are a jumble of companies with components outside nanotech and are too diverse to move up and down as a group. In 2004, Punk Ziegel created its index that now includes 19 companies. Lux, which introduced its own index in March 2005, launched a nanotech exchange-traded fund on the American Stock Exchange last October.
The U.S. Sarbanes-Oxley Act isn’t helping. As mentioned above, stiffer compliance rules introduced with the 2002 law have dulled the old zest for the Nasdaq, and raised the cost of entry. “SOX has had a major and negative effect on small, emerging companies,” says Keith Blakely, CEO of NanoDynamics in Buffalo, New York.
Despite getting most of the money, venture-backed U.S. startups have not outpaced their peers elsewhere in the IPO and M&A worlds. Only two American startups have gone public since 1995. (Lux doesn’t include a third, Nanophase, because it received VC money long before 1995.) In addition, two British startups, along with two Australian firms, have succeeded down that route, Lux says. There have been other American IPOs, including NUCRYST Pharmaceuticals—but only off the back of corporate spin-offs.
Markets such as the London Stock Exchange’s AIM and Deutsche Borse’s Entry Standard board in Frankfurt have become more attractive. Cap-XX, an Australian maker of energy-storing devices for mobile electronics, floated on the AIM last month, raising £17.1 million and putting its market cap at £45.2 million. “Five years ago a lot of people in Europe thought about going to the Nasdaq and most regret it today,” Creathor Ventures’ Mr. Kohler says.
VCs say they’ve seen few business plans from Asia, but take some encouragement from some strong government and corporate R&D initiatives in that part of the world (see “Metal Foam,” p. 40). The Singapore government, for example, has aggressively courted nanotech investments. BASF, in fact, just opened a research center there with plans to spend $16.4 million in research over the next two years.
Although the bet is on some good IPOs in the next year and half, the sizzling M&A market looks likely to take the spotlight. Ten venture-backed companies netted $540.8 million through U.S. IPOs in the first quarter, says Thomson Venture Economics and the National Venture Capital Association. M&A deals generated $4.8 billion in that time, in 95 deals.
Whether through IPOs or trade sales, nanotech looks like it’s turning a corner—and none too soon.
Contact the writer: UWang@RedHerring.com
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