Buying shares in companies that have no revenue and yet are valued at close to £200m is not something I would generally take an interest in. But one company that could be an exception to the rule is Cheshire-based Nanoco (LON:NANO).
Formed ten years ago to commercialise work done at the University of Manchester and Imperial College London, Nanoco moved a step closer to its ambition last week when it raised £15m through a placing of shares.
Nanoco produces something called 'quantum dots'. These are the next step up in television technology, and before long they could be used by TV manufacturers everywhere.
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Here's how it works: the dots are minute particles of semiconductor material of less than ten nanometers in diameter. When excited either by electrical energy or light, they emit light at a specific wavelength linked to their diameter. By changing the size of the dot you can change its colour emission. Smaller dots emit blue light and larger dots red light.
Quantum dots are not new, but their widespread adoption has been prevented by two things. The first is the difficulty of making them with a consistent specification, and the second is because of EU legislation.
Nanoco seems to have overcome both problems. And the way has now been cleared for it to potentially capture the market, multiplying its share price in the process.
How the way was cleared to start snapping up orders
Most other producers manufacture quantum dots via a high temperature, dual-injection process which works well for small production batches but is difficult to scale up.
Nanoco, though, grows its quantum dot structures using a seed cluster, which removes the need for a high temperature nucleation step. While this process takes around a week, it enables Nanoco to control the growth very precisely, stopping it when the frequency of the light emitted by the dots matches the required criteria.
The second hurdle has been legislation such as the EU's Restriction of Hazardous Substances directive that bans the use of cadmium in electronics. Quantum dots have historically been made of this toxic metallic element but Nanoco has come up with a way of making quantum dots that are cadmium-free.
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Much of the funding for Nanoco's research efforts has come from Japanese electronics manufacturers, which see quantum dots as the next innovation in television backlighting. Once again regulation is a driver.
In 2009 the California Energy Commission introduced new legislation to lower the permitted power consumption of televisions. One way to improve the energy consumption of televisions is to replace the traditional cathode fluorescent lamp ('CFL') backlights with LED backlights. LED TVs are now becoming popular.
The difference is, while a CFL backlight comprises a single light source that is always on, LED backlights use hundreds of LEDs (light emitting diodes) that can be selectively switched off where the related area of the screen is showing black.
Quantum dots offer a further improvement by limiting the energy that is lost through colour filtering. That is the theory. Nanoco has demonstrated it in the lab, and shown that it can produce quantum dots on a commercial scale.
Why Merrill Lynch are predicting a jump to 500p
Today quantum dots sell for $5,000 per gram. Each gram is sufficient for 60-80 LED TVs. But once Nanoco starts producing in commercial volumes it expects to be able to reduce the price to nearer $500 per gram. That's comparable to the cost of the phosphor that is used in existing solutions.
With a capacity at present to make 25kg of quantum dots per year, that implies annual revenue potential before any further investment of £12.5m. Based on this, Merrill Lynch anticipates a 70% gross profit margin. Nice!
With the cash raised last week, Nanoco is building its sales team. The big question now is the speed at which television manufacturers adopt quantum dots. Merrill Lynch has estimated that the number of LED backlit televisions sold will jump from five million in 2009 to 129m in 2012. It has assumed that Nanoco's quantum dots will be used in 10% of these TVs by the end of 2012 and 10% a year later.
Yet Nanoco is not without competition from the likes of Nanosys and QD Vision. And I agree with Merrill Lynch hen it says that 'the adoption of new technologies often takes longer than expected.' All the same, in a note last September before the latest share issue, Merrill Lynch set a price target of 140p. That's 50% higher than today's level, based on the assumption that Nanoco achieves a 20% market share in LED television backlighting in the long term.
But as it points out the actual outcome could be binary in other words Nanoco's quantum dots could capture most of the market, or none at all. In the event that it captures 50% of the LED TV market Merrill Lynch sees the shares going to 500p.
Interesting! And while I'm not buying in myself, I'll certainly be monitoring its progress over the next few months.
This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.
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