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Home > Nanotechnology Columns > Pearl > Nanotech Going "Public"

Pearl Chin
Managing Director
Seraphima Ventures

There has been a trend these past 4 years, of investment bankers taking or trying to take a company public before its time to generate income for themselves. So investors should be wary that even though a company is publicly listed, that does not mean they are good investments.

January 19th, 2007

Nanotech Going "Public"

By Pearl Chin, PhD, MBA

After a hiatus from writing for almost two years, I am taking pen to paper again to celebrate a new nanotech year. Funnily enough, since mid-2005, not all that much has changed in the nanotechnology investing landscape since I have been an absent author. I do not think that is a coincidence since I have always believed the current approaches in how investments in the technology space are made are inappropriate. And to make matters more confusing for both the small and large investor, there is a proliferation of those same investment methods by investment companies in nanotechnology.

There are many nanotech companies and many large and small companies are listed publicly. This is evidenced by the slew of small nanotech companies now currently listed on the nanotechnology indices (e.g. Merrill Lynch, Punk Ziegel, Lux). Also some of you may have noticed that the companies listed on each index are not that different.

Most companies, when you think about going public, want to go IPO (Initial Public Offering). These companies trade on major stock exchanges. At this time, I want to point out that there has been a trend these past 4 years, of investment bankers taking or trying to take a company public before its time to generate income for themselves.

Going public for startup companies has been become easier with the consolidation of international stock exchanges causing much interest in listing in "Over The Counter" (OTC) type bulletin boards. This will be explained further in a follow-up article. For smaller companies, trading on OTC offers less restrictions for companies to list as a way to stimulate the investment economy. Europe has finally gotten into the swing of things and taken more of an interest in equity financing over traditional debt financing for companies. Part of the reason may be because of United States' Sarbanes Oxley Act of 2002. Due to the compliance requirements, listing on regular exchanges is becoming prohibitively expensive and reporting is much more time consuming so listing on foreign bulletin boards such as London's AIM has become very popular.

A company traditionally lists on an exchange because it believes it can expand with a public raise of money. It's valuation on the market is based on its income (Income based or Discounted Cash Flow) if it is not asset based valuation. If it is an asset based valuation, chances are for a startup company there are not many assets and the value of a patent is difficult to value if the technology has not started generating income. Unfortunately, a small startup company does not have any real cash flow since it is often not in a stage to be selling any product yet to have sales revenues coming in to do a proper income based valuation.

There are other valuation methods such as multiples but these methods are not based on a company's financials but are based on a company's industry or sector as opposed to the company itself. The Multiples method is based on someone else's opinion of how many times a company should be worth from its financials in a particular industry. This method can only be as reliable as the source and guidelines of compiling these companies' data, for the period of time for which they were calculated, and method for determining the multiples. As a very very rough approximation, multiples can be used but any serious valuation for investment or acquisition should be done on the income and asset based valuation methods.

When a company goes public or gets listed on a public stock exchange, it does so to raise money. A company does not list on an exchange because it does not need the money. At least with a company that has been around for a while and finally generating revenues, it seems like it has staying power and should be listed. For a large company, it makes sense to go for a public raise if it needs substantially large amounts of money to expand. Often a public raise keeps the shareholders of the equity dispersed so that there is no power consolidated with one or a few investors.

For a small company, why does a company raise money publicly when it can raise money privately? There are a several reasons for this. If a company goes public, it either has exhausted its private funding options because nobody else will fund it or the investment bankers who approached them want to make an easy buck on underwriting fees or it is exiting so it can pay the existing private investors who want to get out and make a return on their investment or some combination of those or all three. The last one can be understood as an investment exit strategy.

Unfortunately, or fortunately, the Nanosys IPO did not happen because the market got savvy about it not really being ready to be listed since it was not generating any revenues nor did it have a product to sell. Nanosys had plenty of intellectual property (IP) but again, valuing that IP without revenues is tricky. However, there are many companies that did not go the official IPO route but managed to get listed on some of the newer smaller less restrictive stock exchanges.

Going IPO or listing on a public exchange generates significant fees for investment bankers for underwriting the listing and distribution of shares as they take a percentage of the funding raised as part of their fees. They are less interested in actually making sure a company is appropriate for a public listing as they are more interested in whether they can make a company attractive enough as a public listing candidate and if the owners are willing or are greedy enough. The drawbacks of a public listing are that there is scrutiny from public shareholders as they will have a vote or say on anything the company does from now on.

This is exactly what is going on with small nanotech companies that have listed on exchanges in the last 5 years. Those companies list because they need money, your money, not because they are becoming stable in generating regular revenues. Companies that should be listing on public exchanges should be more mature companies with revenues and want to expand and grow, not companies in startup or still in product development stage that need easy cash to fund their next development stage. Valuations of those companies which stock prices are linked are supposed to take into account that growth and expansion.

If a small nanotech company takes the easy way out and does a public raise to get past its product development issues, it will have to raise additional funding soon anyway for the next stage. If a company cannot raise private funding to get it past its development stage to prototype to the point of making some revenues to sustain itself as some point, it probably does not have the staying power to become a mature company. Then it has no right to be a public company in the eyes of the market yet. However, the public does not realize yet that this is going on and small, and also some large investors, assume that since a company is publicly listed, that somehow it is more credible. In some sense it is more credible or more reliable because its financials are public. Sarbanes Oxley can discourage misleading accounting practices of small companies who list their government research funding income as sales revenues when they do not have a product or a prototype yet. This practice is misleading and may be borderline fraudulent from a SOX accounting perspective but the SOX reporting can help deter that type of practice. However, if the financials are bad, no amount of disclosure is going to make them good and so then there is no compelling reason to invest in them even if they are publicly bad.

So where exactly is the big money going to be in nanotechnology investing if it is not in the publicly listed companies or indices? It is in private investment. The most obvious answer is in the private companies that no one really knows about yet. Those are the companies who are developing their technology stealthily and with aggressively raising private money so they can maintain the quality control and control of their development processes. A small company does not need the public scrutiny of a public raise to help get it through its next stage. In fact, public input and remarks by those who are ignorant of the technology but influential in the markets can make or break a company, deservingly or not.

So who knows about those companies if it is private investment? It is most certainly not the investment bankers. This is why venture capital can be so lucrative but can be an art form. You have the latitude and discipline to do your research and your due diligence and you have to know what you are looking for to recognize the potential of a small nanotech company and its technology. Of course, it helps to really understand what nanotechnology means in the first place, not just what industries it affects, because it is a research and development mentality, not an industry or sector, although it affects all industries and sectors. For the answer to that, you have to have at the least a PhD in the physics or materials sciences or engineering and even that may not be enough. Once you have that, then you have to understand the business side of technology development and the commercialization hurdles to be able to craft a successful commercialization strategy as opposed to a mediocre commercialization strategy.

My point is that investing in nanotechnology is a lot more difficult than investing in publicly viewable nanotechnology indices. If it were that easy, we'd all be making money right now investing in them. However, they are currently underperforming the S&P 500 and it will be some time before they outperform it if ever. It will not be easy money and it will not be made tomorrow because those small companies (IBM excluded) listed on the indices are immature. It is like grapes that were picked before they were ready to be made wine. That wine from immature grapes, no matter how long it sits around and ages will never age properly to be as good as the wine where the mature grape was used, because the development was arrested. You can only make as good a wine as what that grape had and no more. Of course you can add sugars but there is more to grapes and wine than just the sugar content just like there is more to making a company successful than just throwing money at it. The ones who will be making money on nanotechnology are not the people investing in those nanotechnology mutual funds or according to those indices. That money has already been made. Those early private investors have just dumped that stock as a public listing on the unsuspecting public sucker so they can make a return on their investment.

There are so many good technologies out there, more than you can imagine, because there are a lot of bright and creative scientists out there and tons of government research money out there paying for these graduate students and research scientists to think of great ideas. Often there is more than one researcher or research teams working on a similar problem. Even Alexander Graham Bell had competition.

What makes one technology successful is a combination of factors that often have little to do with how great or unique that technology is or how public that information is. What makes a technology and its company successful has less to do with the actual technology and more to do with the commercialization strategy. This commercialization strategy incorporates product development strategy, management strategy, and marketing strategy and superior tactical implementation thereof. In a nutshell, it has to do with making sure all those factors hit together and are orchestrated properly. This is much like a general does when he is at war and must deploy his forces in a strategic and tactical manner to win the war. There is also a little luck involved as nobody has complete control over all outcomes, no matter how well they are planned.

2007 Pearl Chin - All rights reserved.

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