Get ready for nanotechnology

Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.

Get ready for a world in which cars will be lighter and more energy efficient; get ready for bandages that will heal cuts more quickly than in the past; get ready for clothes that will wear longer and be stain resistant; get ready for golf balls that will fly straighter and clubs that will strike better. This is just the beginning. Nanotechnology – put simply, the ability to manipulate atoms and molecules such that they can assume different, often superior properties – is already becoming increasingly prevalent and has the potential within the next decade to be as ubiquitous and as commonplace as the internet is today. Several commentators suggest that even by 2015, the market for nanotechnology-enabled products could be as large as $2.5 trillion. While there is some risk of ‘nano-hype’, many companies are already highly active within the space and across the value chain. Those who get it right will inevitably prosper.

The prefix ‘nano’ stems from the ancient Greek term for dwarf but in modern scientific parlance refers to that which is a billionth of a metre. To provide some context, a double-helix strand of human DNA would be around 2 nanometres (nm) in size, while the smallest cellular life form of bacteria would extend to about 200nm. Thought of from another perspective, the comparative size of a nanometre to a metre is equivalent to that of a marble relative to the size of the earth. In other words, we are dealing with incredibly small things. Indeed, the National Nanotechnology Initiative (NNI), a US federal research and development programme, defines nanotechnology as the manipulation of matter with at least one dimension sized from 1 to 100 nanometres.

Manipulation at this level is interesting since the properties of substance can differ relative to at a larger scale. This is for two main reasons: first, nano-materials have a relatively greater surface area when compared to the same mass of material produced in a larger format. This can make materials more chemically reactive and so affect their strength or electrical properties. Second, quantum effects can begin to dominate the behaviour of matter at the nano-scale, influencing the optical, electrical and magnetic behaviour of materials. As a consequence, nanotechnologies (the term is technically more accurate than thinking of one single technology or application) relate to the control of shape and size at the nanometre scale, correspondingly influencing the design, characterisation, production and application of structures, devices and systems.

In some senses, nano-science is not new. Its antecedents can be traced back to a 1959 speech by physicist Richard Feynman when he described the possibility of synthesis via the direct manipulation of atoms, while the term was first popularised in the early 1980’s by scientist Eric Drexler. Moreover, chemists have been producing polymers (effectively large molecules made up from smaller nano-units) for many years, while nanotechnologies have been used to create the miniscule features within computer chips for at least the last two decades. However, it is only in more recent times that advances in the tools that allow for atoms and molecules to be examined with greater precision – and at a lower cost – than in the past that the industry has begun to expand.

The size of the nanotechnology industry is notoriously hard to calculate given the multitude of applications to which the technologies can theoretically be applied. In addition, just as new technologies continue to emerge, older ones can suddenly become obsolete. It is easiest to start at the most basic level: Oxford Instruments, a high-tech producer of nano-tools, estimates that the market for quality tools used by researchers in their studies for nanotechnologies is worth around $4bn. The market value would then grow to $17bn if the processes and products that are developed using nanotechnology tools were included (an example being graphene, a lightweight form of carbon). Much more contentious is the scale of applications for which a substance like graphene could be used. Estimates from 11 different consultancies on the current size of the market for nanotechnology-enabled products put it at least at $400bn, but vary by a factor of two-and-a-half.

Despite this broad range, the consensus is for 30-40% compound annual growth in the market for nanotechnology-enabled products through to 2015. Even if these forecasts may appear hyperbolic, Oxford Instruments assumes a 10-15% CAGR for the nanotechnology market over the coming years. The persuasive logic behind such growth assumptions is based on the simple premise that as the world develops and populations continue to increase, nanotechnology should be seen as key to continued economic progress and growth, expanding the quality and potentially the length of human life. New materials and devices have the potential to be applied in a broad range of areas including medicine, energy production and electronics. In a nanotechnology-enabled world, there would be enhanced resource efficiency, supply chains would shorten and more become flexible, and localised manufacturing would likely grow in importance.

The ways in which nanotechnologies can be applied are multifarious, potentially indefinite, but it is easiest to break them into three broad sub-groups: nano-materials, electronics and nano-medicine. The largest of these three areas is nano (or ‘smart’ – the currently popular alternative expression) materials, and countless examples of applications abound. One of the most notable relates to the car industry, where a shift towards lightweight substances such as high-strength steel and carbon fibre can help improve auto efficiency and reduce pollution. Consultants as McKinsey estimate that the lightweight market (also including aviation and wind turbines) is already worth €70bn and could reach €300bn by 2030. Elsewhere researchers have, for example, developed a nano-fabric paper towel woven from tiny wires of potassium manganese oxide, which is able to absorb 20 times its weight in oil. Such a product would be particularly effective in clean-up operations such as disasters. Consumers may also find zinc oxide nano-particles within sun cream (making it more resistant) and silver nano-particles in food packaging (increasing durability) and plasters among other commonplace products. Within the medical arena, nanotechnologies could help enable drug-delivery targeted at specific sites within the body, and enhance molecular imaging (such as MRI scans), while embedded sensors within the body could allow both patients and practitioners to monitor temperature, heart rate and blood pressure more effectively.

While the potential is clear, how quickly the nanotechnology industry ultimately grows will largely be a function of the funding environment, both from the public and the private sector. The Project for Emerging Nanotechnologies, a charitably funded collaboration and educational group, lists around 2,000 manufacturer-identified research projects, with around 3-4 new ones hitting the market each week. In terms of country of origin, the US leads the way (with around 50% of all projects), followed by Europe (c30%) and then Asia (c20%). The NNI has received around $20bn of cumulative funding since its inception in 2001 and although it has applied for $1.7bn of funding for 2014, the impact of sequestration is slowing the process. Nonetheless, the environment has recently begun to improve in Japan, while some industry experts assert that China has become the largest state spender within the nanotechnology arena.

The industry’s development may, however, not be impacted just by funding, and other concerns relate to the overlapping areas of safety, regulatory and ethical issues. Taking the former, little research has thus far been conducted on the environmental impact of how different nano-particles behave in the air, water, soil and subsequently also within the food chain. Where there have been studies, scientists did discover that when rats and mice inhale and/or consume certain nano-elements, their rates of cancer, heart disease and ageing did increase. Meanwhile, a major report recently published in Nature Nanotechnology, a peer reviewed scientific journal, suggested that some forms of carbon nano-tubes may emit substances as harmful as asbestos. These concerns naturally lead on to the issue of regulation. While there may be broader moral issues such as who has the right to control the uses of nanotechnologies and who benefits most from their uses, the more practical debates relate not only to health and safety, but also to questions over whether atomic/ molecular structures can be patented and should perhaps be taxed. There are no simple answers and some also suggest that excessive intervention in the near-term may stifle a still-nascent industry’s development.

From an investor’s perspective, nano-hype is also an important consideration. Not only will many companies seek to benefit from (or at least capitalise upon) this likely inexorable trend, but it is also worth noting that there are a very few successful pure-play businesses on this theme of a meaningful size. A useful warning is provided by the performance of the PowerShares LUX Nanotech ETF Product, which was launched in 2005, but has delivered negative annualised shareholder returns both since inception and over the last five years. Some of this reflects the challenges associated with investing in start-up businesses, and our preferred strategy is to focus on the more established nano-tool manufacturers and smart-materials producers.

Within the first category, US-listed FEI, with a market cap of over $3bn is a leading producer of focused ion-beam workstations and transmission electronic microscopes that are critical for viewing and manipulating atomic level material. Yearly bookings have grown at a rate of over 10% annualised over the last decade, and the company points to an installed base of more than 8,000 instruments, currently growing at a rate of at least 500 new systems a year. With these retailing for between $750,000 and $6m, FEI sees a $4bn opportunity for its products by 2016. Also successful within the nano-tool area is smaller Oxford Instruments (capitalised at c$1.3bn). Founded in 1959 and spun out of Oxford University, the company produces advanced instrumentation equipment used for scientific research, chemical analysis, patient monitoring and other similar fields. Oxford estimates that it has around a 7% share of the nano-tool market. Companies with a strong presence within smart materials include Hexcel (carbon-fibre reinforcement products), Polypore (speciality chemicals) and recently-listed Evonik (also speciality chemicals). In terms of the former, Hexcel has 65 years of operating history within the advanced composites market and has patented over 700 products. 60% of its revenues derive from the aerospace industry, with the defence industry and broader market for industrial products (including autos) comprising the remainder. FEI and Oxford have both delivered five-year annualised shareholder returns of over 20%, while those from Hexcel and Polypore have been closer to 10%. The potential for further returns is clear.

Alexander Gunz, Fund Manager