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Jan. 5, 2005 – As nanotechnology companies move into public markets, early stage companies may lack the revenue visibility usually accompanying startups in more established industries.
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It is arguable that a platform technology-based nanotechnology company — what we’ll call pluripotent — deserves a premium valuation: one that exceeds the value of its visible product line. But as shown by the withdrawn IPO of Nanosys — an example of this type of company — public investors may not see it this way.
Valuation begins by separating nano companies into two groups: single-focus companies and pluripotent companies.
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Single-focus nanotechnology companies have products and strategies focused on single-industry penetration. Their valuation follows an approach similar to that used for existing companies in a specific industry, albeit with allowance for early stage dynamics.
Established valuations methodologies should therefore be used that are founded upon the company’s long-term product and earnings growth potential (discounted cash-flow models and models focusing on earnings before interest and taxes, price-to-earnings, price-to-revenues, etc.).
For nanotechnology companies, these figures may be particularly difficult to forecast due to greater technical complexity and product uncertainty.
On the other hand, pluripotent companies — those with a platform technology business model — have the potential to impact multiple sectors. In this group, we find a range of companies, from those with products already in advanced stages of development, to others whose products are too early in development to allow investors to define specific products.
Valuation of such companies must incorporate the value of the firm’s future development (valued like an option) and the diversification benefit of entry into multiple markets, while still considering the risk of uncertain product development.
The valuation received by these companies should be based on the following factors:
Management and scientific personnel: Does the company have a management team that truly understands the technology and can make the appropriate investment decisions as information becomes available? Does management maintain constant access to the inventors and to in-house scientific personnel to ensure the program’s proper development?
The technology’s transformational potential: What is the firm’s ability to generate products with a disruptive impact? What are the hurdles to achieving market penetration in the face of established competitors?
The technology’s multi-faceted potential: What is its robustness for multiple applications? Where are those particular industries in their own respective lifecycles and what kind of margins do they generate?
The scope of the intellectual property (IP) position: Does the company have a defensible portfolio of patents? Does it have the resources to defend its IP estate?
The company’s business model: Will the development of emerging products require licensing, partners, spinoffs, or can it be accomplished internally?
Now, for the challenges.
A steep learning curve: The average investor will be challenged to assess the scientific foundations behind these companies. This may give rise to arbitrage opportunities as incomplete information affects stock prices.
Diversity’s ups and downs: Comparisons to existing stocks will be limited. The relevance of a one-size-fits-all valuation method disappears when wide-ranging applications reach across differentiated industries.
Impatience ruins the day: Nanotechnology companies may follow a modified biotech business model with long development programs and corporate partnerships for commercialization. Nano differs from biotech in a couple of key areas.
It has less regulatory oversight (and lacks the kind of development benchmarks that FDA approval provide) and greater uncertainty in market size and product revenue. Whereas investors do not currently seem amenable to the biotech model, it has been successful in the past and could return.
Elemental influences: Aggregate market conditions and investor receptivity to new issues and ideas will always be unpredictable. Nanotechnology will go through technology and market cycles. Investors should also consider issues that define the environment in which nanotechnology companies grow — for example, concern over safety and the resulting uncertainty of future regulatory conditions.
Valuation requires the assessment of disparate forces — from technology and talent to market and uncertainty — that will ultimately shape a company’s prospects. Investors will benefit from embracing option pricing techniques as a complement to more traditional approaches. As more nanotech companies go public, investors will gradually learn to focus on the most appropriate factors drawing from all available alternatives.