As we enter 2013, the outlook for Harris & Harris Group (TINY) pivots around three key dynamics: 1) accelerating nanotech innovation and commercialization, 2) the growing likelihood of additional liquidity events, several of which could provide attractive venture-type returns, and 3) prospects for enhanced investment capabilities through the successful acquisition of non-dilutive, third-party capital. Viewed together, these three items paint an encouraging picture for TINY's outlook.
We are in a period of accelerating nano-enabled commercialization and market penetration. Nanotechnology has become a driving force of technology innovation across major segments of the global economy. The year ahead is shaping to be an exciting year for several Harris & Harris portfolio companies, including D-Wave Systems, Bridgelux, Nantero, Metabolon Xradia, and Adesto, many of which we have written about in the past.
This article features a view into Adesto Technologies, which is a next-generation memory company that has now moved from the development stages to commercialization and expansion. We expect the company to capture a significant portion of the non-volatile memory outside of the commodity data storage market and enjoy profitable royalty licensing from a number of other markets. Adesto Intrinsic Value will expand rapidly from the current $570 million as revenue grows, additional licensing deals are signed, and more products are introduced.
Prospects for additional liquidity events for Harris & Harris are good. As we enter 2013, six of the 27 Harris & Harris portfolio companies are in the process of considering liquidity opportunities. A few companies have indicated plans to go forward with an initial public offering, while others are exploring acquisition proposals from major corporations. Several of these liquidity opportunities are likely to provide Harris & Harris with attractive venture-type returns.
Harris & Harris has indicated plans for managing additional, non-dilutive, third-party capital. Success on this strategic front -- which we believe could be announced within the next six to 12 months -- would significantly bolster the company's investment capabilities and enhance its ability to generate increasing value for shareholders in the future.
Investors have yet to recognize the value inherent in TINY, as the stock continues to trade below estimated net asset value per share of $4.78 and well below our intrinsic value estimate of $10-$12 per share. We encourage investors to take a close look at the company during a time of accelerating nanotech commercialization, the likelihood of several liquidity events and prospects for the addition of non-dilutive third-party capital. We see compelling value and growth.
Nanotech Innovation Ahead
Nanotechnology is now experiencing accelerating commercialization. Nanotechnology is beginning to fulfill its potential as a General Purpose Technology (GPT), akin to other GPTs such as electricity and the Internet, with wide-ranging economic and financial effects that have yet to be appreciated and discounted by investors.
Nanotechnology has become a driving force of technology innovation in many key segments in the global economy, including communications, electronics, energy, transportation, consumer products, and health care. Nanotech innovation is being driven by startups, such as those backed by Harris & Harris, as well as established, Fortune 500 companies. It is noteworthy that major corporations have evolved to have well articulated needs and strategies for working with innovation at the nanoscale. In short, nanotech innovation is taking place throughout corporate America as well as overseas.
The fact that larger corporations are embracing nanotech for new innovation is indicative of the technology's capability of fulfilling its role as a GPT. Today, over two-thirds of Harris & Harris portfolio companies have strategic investment and strategic development agreements with major corporations. This activity is the foundation that will support and fuel an acceleration of nano-enabled products in the marketplace in the future. It is interesting to note that some corporations today are launching or beefing up their venture capital divisions as a way of fostering the development of new products and applications.
Harris & Harris is well positioned to capitalize on corporate-led nanotech innovation. The company is at the forefront of identifying promising nano-enabled products and applications and investing at an early stage in companies that are developing and commercializing them. Harris & Harris has enjoyed a good deal of success over the past couple of years, having experienced five liquidity events in 2011, including two IPOs and three acquisitions by major corporations. While past success is no guarantee to future success in investing, our research suggests that the best may yet lie ahead for Harris & Harris.
Our ongoing research of Harris & Harris portfolio companies suggests the likelihood of additional liquidity events during the next 12-24 months, several of which are likely to provide the company with attractive venture-type returns. A number of Harris & Harris portfolio companies -- six in total -- have indicated plans to file for initial public offerings in the months ahead, or are evaluating opportunities for potential acquisition with established companies.
While the fundamental outlook for nanotech is favorable, there are some headwinds in the outlook for Harris & Harris, many of which already appear to be fully discounted in the company's stock price. Chief among these headwinds are trends on Wall Street and in the financial sector in general that have worked to shun small, innovative, early-stage growth companies -- especially those that are driven by technologies associated with deep science. Over the past decade, the financial sector has increasingly migrated away from longer-term investing strategies -- the type that fosters the development of science-based innovation. What we see increasingly today is a focus on short-term trading and quarterly earnings and overall shorter investor holding periods.
This trend toward short-term quarterly focus in financial markets prompted Solazyme's CEO, Jonathan Wolfson, to remark on the company's latest earnings call with investors that he and his team are not managing by press release and that Solazyme is not being built in a quarter. For a CEO such as Wolfson to have to make such a remark on a call is surely a sign of the times. That said, it was refreshing to hear; no doubt Wolfson's remarks resonate strongly with other Harris & Harris portfolio company CEOs, not to mention Harris & Harris' executive team.
It is a fact today that nanotechnology and the companies commercializing nano-enabled products, such as Solazyme, require long development time frames that are inconsistent with the time frames and the focus of the financial sector today. It remains unclear at this juncture just how disruptive this trend is toward restricting nano-enabled innovation and commercialization and innovation in the year ahead and beyond. Suffice it to say that this is a dynamic that we continue to monitor closely.
While the macroeconomic and financial market conditions are likely to prove challenging for emerging nanotech companies in the foreseeable future, prospects for nano-enabled innovation and commercialization are as promising as ever. Nanotech is enabling a new generation of products and applications, some of which are nothing short of game changers. A case in point is D-Wave Systems and its quantum computers, which are attracting the attention of leading companies, researchers and investors. (For more on D-Wave Systems, see our report "Harris & Harris Group: Nanotech Phase Change Ahead," from Nov. 2, 2011.) Another prime example is Bridgelux with its transformative solid-state lighting technology that has the potential to dramatically reduce the cost and increase the functionality of LEDs for general illumination in coming years.
Other Harris & Harris portfolio companies are using nanotech to pioneer new, powerful semiconductor memory technologies, such as Kovio, Nantero, and Adesto. We have done in-depth research on Nantero, which is pioneering the use of carbon nanotubes in electronics and is tracking to become the ARM Holdings of memory technology. In this report, we take a closer look at Adesto, which is developing a next generation semiconductor memory technology and, as part of its growth strategy, recently purchased a division of Atmel.
Portfolio Company Profile: Adesto Technologies
Adesto has spent the last five years developing a non-volatile memory (NVM) that delivers an order of magnitude improvement in speed with lower power consumption. It's a simple technology in concept: A solid electrolyte between two conductors can be "turned off or on" with a charge that creates or removes a conductive channel in the material. The invention is obvious, but hard to execute. There's an industry consensus that this is the most promising new emerging memory technology for mainstream applications.
From the start Adesto has focused on commercialization by attracting strategic funding and licensing agreements, securing intellectual property, sticking to a profitable business model. This is the combination that can drive high consistent returns on invested capital. Presently, the company is shifting from the development to the commercialization stage after investing $55 million in capital from a mix of strategic partners and top-tier VC firms. The strategic investors and technology licensees have helped to develop the manufacturing process and have strong interests in end market adoption.
Adesto acquired substantial revenues and relationships with nearly every major OEM from their purchase of the Serial Flash business from Atmel. Having this product line and distribution channel provides a solid business foundation and accelerates the process of bringing the new technology into the marketplace. The management team is made up of industry veterans with experience that spans many leading companies including AMD (AMD), Silicon Storage Technology, National Semiconductor, Broadcom, Transmeta, Cirrus Logic (CRUS), Fairchild, AMCC, and Tower Semiconductor.
Over the next 12 to 18 months we expect the company to sign additional licensing deals, and begin to experience a ramp in their revenue growth while margins expand at the same time. Based on our own estimates and a simplified intrinsic valuation (IV) model we put the fair valuation for the company at $570 million.
Memory and storage has a long way to go in order to deliver the performance, capability and efficiency we're going to need in our computational systems. Complicating the challenge is the shift to mobile and wireless. This means that power consumption is as important as speed unless and until the "battery problem" is solved in some profound way. Memory close to the processor in mobile devices is a critical component for which disruptive advances in the speed/density/power envelope can create significant market opportunities for semiconductor companies. This helps to explain the dizzying array of R&D projects aimed at producing the "ultimate memory."
There is a great chasm between the breathless descriptions of memory technology "breakthroughs" in R&D labs and devices that can be shipped by the millions and embedded in consumer products. It's fun to talk about molecular memories and storing bits as spinning electrons but when the discussion turns to manufacturability, data retention, cost, stability and endurance, excitement evaporates quickly.
The technology Adesto has been working on is called Conductive Bridging RAM (CBRAM) and has been gaining adherents around the industry (a few very large semiconductor firms have licensed the technology already from Adesto). Adesto has tackled the key obstacle to mainstream CBRAM adoption, which is manufacturability. The advantages from CBRAM come from simplicity and the relatively low impetus needed to create and destroy connections or "bits" of information. The lower impetus means greater durability and lower power requirements. Simple design improves density and performance.
Click to enlarge images.
Adesto has worked through advanced manufacturing partnerships to develop the expertise needed for effective scale manufacturing. For example, Altis Semiconductor is an investor and manufacturer that is based in Europe and has key manufacturing platform expertise gained from a history involving both IBM and Infineon.
Memory in general is a very large existing market on the order of $70 bilion/year in sales. Initially, however, Adesto will be offering discrete products in the lower density, but "sticker socket" used for code rather than data storage. This part of the market is relatively small but still in excess of $5 billion/year.
The licensing model of the Adesto business plan gives them access to the much larger (but highly capital intensive and competitive) data storage market. As far as we're concerned, this is the only way to go after the memory market and achieve high returns. Any market that is highly competitive, commodity-like and capital intensive is not good for equity investors. Going after the attractive low density segment and licensing the rest is the right approach.
Adesto investors should look at the market in terms of the margin opportunity. By making their own devices in the lower-density code storage market and licensing in data storage the company can capture a meaningful total share of the available gross and operating margins in the total memory business over time. The next few years of execution will dictate the ultimate revenue opportunity and operating margins that can be achieved in the longer term.
Competition and Industry Dynamics
No major innovation in the memory market is going to slip by unnoticed. Most of the large firms in the market and some that are not have ongoing R&D initiatives that are closely related to the Adesto CBRAM technology. Right now, Adesto is recognized as the leader and has a substantial IP base upon which to build. However, we expect other memory-makers to offer at least something competitive. In non-core markets like NV memory for bulk storage we might see a licensing arrangment undertaken by Micron (MU) or SanDisk (SNDK).
In terms of semiconductor industry dynamics we've seen this many times before. Some examples include Invensense (INVN) (motion processing chips), Nvidia (NVDA) (graphics processing), and OmniVision (OVTI) (image sensors). All of these companies have competed against much larger, broader semiconductor firms and maintained their advantages to build meaningful independent public companies.
We expect the Adesto timeline to show additional licensing agreements, next generation products and a strong revenue and profit ramp. All these developments serve to expand the company valuation over the next few years and generate high returns for equity holders, including Harris & Harris.
Summary and Outlook
Adesto is one of over two dozen Harris & Harris portfolio companies using nanotech in novel ways to create new, innovative, and -- in some cases -- game-changing products and applications. The Harris & Harris portfolio currently consists of six late-stage companies, two of which are publicly traded, Solazyme (SZYM) and NeoPhotonics (NPTN). There are 15 mid-stage investments, including D-Wave Systems, Nantero and Adesto, and six early-stage companies, such as HzO, PWA, Ultora and Senova. The exhibit below provides a breakdown of the current Harris & Harris portfolio by investment stage.
Looking forward, we see a great deal of potential for Harris & Harris's portfolio companies to expand their products and applications in the marketplace. The year ahead is shaping up to be an exciting year for several companies, including D-Wave Systems, Bridgelux, Adesto, Nantero, Xradia, and Metabolon. We also see prospects for growing interest in H&H portfolio companies by major corporations and prominent institutional investors.
The outlook for Harris & Harris pivots around three key dynamics:
- Accelerating nanotech innovation and commercialization.
- The growing likelihood of additional liquidity events, several of which could provide attractive venture-type returns.
- Prospects for enhanced investment capabilities through the successful raising of non-dilutive, third-party capital.
All three of these dynamics are positive for future growth and value creation for Harris & Harris. While macro economic and financial market conditions are likely to continue to prove challenging for emerging nanotech companies in the foreseeable future, prospects for nano-enabled innovation and commercialization are as promising as ever.
Investors have yet to recognize the value inherent in TINY, as the stock continues to trade below estimated Net asset value per share of $4.78 and well below our intrinsic value estimate of $10-$12 per share. We encourage investors to take a close look at the company during a time of accelerating nanotech commercialization, the likelihood of several liquidity events in the next 12-24 months, and prospects for the addition of non-dilutive third-party capital that expands Harris & Harris investment capabilities. We see compelling value and growth in TINY.