Facility should support a significant inflection in revenues
The move to volume production should support a significant inflection in revenues. With an estimated £4m to be invested in the facility over FY18 and FY19, capacity will be significantly larger than the current QD line, which management estimates has the capacity to supply c 1m large televisions per year (implying well over £15m revenue potential). We also note the follow-on R&D agreement that Nanoco signed with the same customer in April, to further develop nanomaterials for the same application. This indicates that this relationship has the potential to be a lasting one, as well as being a meaningful endorsement of Nanoco’s IP and expertise.
Apple – the most likely candidate?
We note recent broker reports hypothesising that Nanoco will be a supplier for the 3D sensor in Apple’s next generation of mobile devices. Given the scale of facility build-out, we cannot think of any other obvious candidates who would require such capacity. Apple has pioneered the 3D sensing market, including a rear-facing 3D sensor in the top of the range iPhone X models (X, XS, XS Max and XR) models to power a facial recognition system called FaceID. Current models use a silicon-on-insulator sensor, but nanomaterials could potentially be used in future generations. Many observers expect FaceID to permeate deeper into the product portfolio over time. The Android camp is now following suit, with the feature set to be included in a number of high-end models scheduled for launch this year. Front-facing 3D sensors are expected to start appearing in the 2020 timeframe.
Whether the customer is Apple or not, it is clear that this customer relationship is significant and creates the prospect of commercial volumes within the near term.
Significant product uptake cycle
If correct, successful execution on this opportunity would expose the company to what is anticipated to be one of the strongest technology uptake cycles for electronics components over the next five years, with market analyst Yole Development forecasting the total addressable market for 3D sensing components to grow at a 43% CAGR, from just below $2bn in 2018 to $18bn in 2023.This growth will be driven first by adoption in the consumer market (primarily handsets but also tablets and PCs) and then by the rapid proliferation of sensors in cars, both inside the cockpit (gesture recognition, face authentication, fatigue monitoring) and outside, with the introduction of more sophisticated safety features and the migration towards autonomous driving.
Exhibit 1: 3D sensor shipment forecast by vendor
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Looking for a brighter future in display
The first commercial shipments of high-end gaming computer monitors using Nanoco’s CFQDs have been pushed out to CY19. This is a low-volume specialist market, although it is growing healthily. Market analyst WittsView estimated that 2.5m units were sold in 2017 (up 80% y-o-y) and forecasts growth to 3.5m in 2018. Nevertheless, penetrating the high-volume, mid- to high-end TV market (total annual shipments c 260m units a year) will be key to driving an inflection in this segment.
Development efforts are now being focused on producing brighter CFQDs, key to driving uptake in 8k televisions, which require brighter back lights. Resource has been reallocated from the Runcorn display production site to R&D to support this development.
Despite the delays, we believe that the window of opportunity will remain open. QDs’ ability to enhance colour gamut and dynamic range while leveraging existing LCD infrastructure remains an attractive proposition for the volume market in mid- to high-end televisions. OLED is likely to remain a high-end technology for some time, due to the cost of building dedicated capacity to support volume growth. This may now be starting to happen – and we note industry chatter that Samsung may offer a sub-$1000 QDTV in the Black Friday sales.
The launch of second-generation devices could be a catalyst for first-generation QD film technology to permeate into the lower mid-segment. Samsung is developing hybrid blue OLED displays using QD for colour conversion and could demonstrate the first devices at CES in January. Nanoco is also active in the industry’s development of second- and third-generation QD television architectures. The company works with Merck on second-generation colour filter/hybrid OLED + QD and third-generation electroluminescent applications. Dow is targeting high-volume opportunities in first-generation QD film.
Lighting: Targeting lighting partners in indoor farming
Nanoco’s QDs are now shipping in end-product through Carewear, a US company that has developed QD-based light systems to treat pain and injuries. The company is initially targeting the professional sports market, so volumes will be modest.
Commercialisation efforts in lighting are now focused on the horticultural segment, where the rapid forecast growth of indoor farming presents an attractive potential opportunity. Market analyst Statista estimates that, as of 2016, there were 2.3 million square feet of indoor farms worldwide, but expects this to grow to between 8.5 million square feet and 16.55 million square feet by 2021. Yole estimates that the total market for lighting for this segment will be worth c $3.8bn in 2017, increasing to $5.8bn in 2020, of which LED will account for $794m, growing to $2bn.
The opportunity for Nanoco lies in the fact that QDs can be used to efficiently deliver highly tuned light-emitting wavelengths to optimise growth, reduce energy or even tune flavours. The key objectives for management over the course of the 12 months will be to sign up one or more lighting customers/partners and to establish a foundation of trials to support broader adoption.
The use of Nanoco’s QD technology for use as a detection agent in medical imaging is an early-stage development, but one with exciting potential. The opportunity in this market stems from the fact that the molecular size of QDs suggests that they could preferentially accumulate in tumours and lymph nodes. The light emitted by these accumulated QDs can then enable better detection or more targeted treatment of cancers.
Since Nanoco’s QDs are cadmium-free, they are particularly suitable for use in the human body compared to cadmium-based alternatives. The company’s biological QDs are water-soluble to enable the absorption process, whereas those intended for other applications are not.
To reduce the lead time and costs to commercialisation, the initial focus is on opportunities that require only topical application, as the clinical trial costs are typically much lower for agents that are administered in a topical patch in comparison to those that are injected (administered systemically). Also, for agents with short-term exposures, such as diagnostics, the toxicological study cost is significantly lower than for agents that are chronically administered.
The company is now working to prepare the technology for clinical trials. The company has engaged a global contract research organisation to perform toxicology trials and initial tests have found no evidence of mutagenicity (capacity to cause mutations).
The funding requirement and timescale to commercialisation cycle of Nanoco Life Sciences will require a fundamentally different strategy for value crystallisation compared to the company’s other businesses. Management has stated that in early stage discussions to identify the right strategic partner to take the business forward and provide funding.
Leading IP owner in a heavily patented area
While the pathway to commercialisation has been a protracted process, we believe that it is worth highlighting that the number of patents filed mentioning QDs has increased markedly over the past few years. We believe that this signals that the technology is now starting to come of age, with potential for commercialisation across a broad range of applications.
Nanoco now has over 650 patents covering QDs, their manufacture, applications and other nanomaterials, which we believe makes the company one of the most significant IP owners in this domain. We also note that the company’s IP portfolio, specifically its proprietary scalable ‘molecular seeding’ manufacturing IP, was key to securing its major US customer. Given the increased patenting activities, other opportunities could well arise, while the company’s intrinsic IP value should support the share value if commercialisation is delayed.
Exhibit 2: The trend in the number of patent applications filed that mention QDs
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Source: CB Insights. The patterned column(s) may show a decline due to a delay between patent filing and publication.
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Financials: Results reflect delays, billings support cash
FY18 results were as flagged at the trading update. Growth in revenues to £3.3m (vs £1.3m in FY17) reflects the contribution from the company’s US customer, offset by continued delays in display. Adjusted operating loss dropped to £7.2m from £10.7m last year, with the higher revenues supported by the full-year benefit of cost savings last year.
Cash performance was better than expected. Year-end net cash was £10.7m (excluding a £407k 2028 loan note related to university grants) versus our estimate of £7.9m, with an increase in billings to £6.5m from £1.1m last year. This figure includes £3.1m of deferred income – we had previously categorised some of this as loans.
