Nanotech: Picks and Shovels

05/14/2004 12:00 am EST

Focus:

Michael Murphy

Former Editor, New World Investor

"Nanotechnology has applications across many, many industries; in fact, there are at least 500 major government, university, and private R&D programs under way," says Mike Murphy. His "pick" in the sector is a maker of nanotech "picks and shovels."

"It’s too early to know what will be the killer products coming out of nanotechnology. There probably will be hundreds of thousands of them. So instead of trying to pick a nanotech applications winner at this early stage, we are better off in a company selling nanotechnology instruments for research—that’s where the big funding is right now. That’s why we have recommended Veeco Instruments (VECO NASDAQ).

"What products do Veeco’s tools enable? Here’s a good example: IBM should introduce the Millipede data storage system this year. It can hold one terabit (trillion bits) of data per square inch, almost 20 times the density of hard disk drives, and uses less battery power in a laptop. You could store 25 DVD movies or 25 million printed textbook pages in an area the size of a postage stamp. Numerous new materials are under development with exact combinations of strength, weight and, other properties—chemical, electronic, or optical. Atomic-force microscopes are having a major impact in biotechnology, both in discovering drugs and delivering them to where they need to go in the body. I also think dramatic new medical devices are on the way. In the next decade, nanotechnology should allow us to build chips with design features smaller than the wavelength of light.

"Veeco is the big dog in this business with a 70% share of the atomic-force microscope market. Over $3 billion was spent in 2003 on nanotechnology research, at hundreds of government, university and private centers. The ability to sell and support globally gives Veeco a tremendous competitive advantage. In addition to its nanotech research products, Veeco sells process and measuring equipment to the data storage, semiconductor, telecommunications, and wireless industries.

"Valuing this stock is tricky. It’s selling for 279 times last 12 months’ earnings, but 39 times this year’s estimate—pricey for a 17% grower. However, in just a few months Wall Street will be looking at 2005 earnings, and if I’m right about the $1.45 estimate, the stock is only selling for only 21 times that. But in addition to enabling others’ research, Veeco spends a bundle on its own R&D—17% of sales or a current rate of $53 million a year, equal to $1.80 a share. They spend much more on R&D than they report in earnings, and that means there will be a steady flow of new products to maintain their lead, all of which will have good profit margins and keep up the growth rate. The stock is cheap because Wall Street punishes companies for making heavy investments in R&D. That gives us an opportunity. My target is $38 by the end of this year. I expect to hold Veeco for at least 12 months, and quite possibly longer as nanotech helps drive the next technology wave."

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