Nanotechnology in Japan. (A Special Section for Professional Investors Focused on Japan: Investor Insight).

"The new, new thing. It's easier to say what the new new thing is not than to say what it is. It is not necessarily a new invention. It is not even necessarily a new idea -- most everything has been considered by someone at some point. The new new thing is a notion that is poised to be taken seriously in the marketplace. It's the idea that is a tiny push away from general acceptance and when it gets that push, will change the world."

from The New New Thing by Michael Lewis

THROUGHOUT THE 1990S, THE search has been on for the new, new thing. Most of the candidates were somehow linked to the Internet -- either hardware that was necessary to support the infrastructure of the Internet (routers, optical equipment, et cetera) or software/services that enabled one to do things and to offer services on the Internet. Enormous sums were thrown at those who claimed mastery of the opportunities this brave new world offered, especially in 1998 and 1999, and huge sums were lost, especially in 2000 and 2001. There may still be money to be made in the Internet, but the hot money, or what is left of it -- the money that hopes to identify the new, new thing -- is looking elsewhere. One perennial contender -- which predates the Internet, but which has proved difficult to turn into profits despite a number of very significant technological breakthroughs in recent years -- is biotechnology. Another is nanotechnology.

The significance of biotechnology has long been recognized by the Japanese government. In the fiscal 2001 budget, it was recognized by the Council of Science and Technology Policy as one of four broad priority areas, along with the even broader categories of life science, information and communications and the economy. Typically, there are also fears that in nanotechnology, Japan is being left behind. Equally typically, these fears relate exclusively to the US -- the launch of the National Nanotechnology Initiative (NNI) by the Clinton administration with an initial funding of $270 million (due to rise to $518 million this year) has exacerbated these fears.

In fact, in terms of expenditure, Japan can more than match the US effort. In fiscal 2002, the total Japanese nanotechnology budget is [yen]74.6 billion, or over $600 million, up from [yen]60.6 billion ($493 million) in fiscal 2001. The bulk of this funding will come via the Ministry of Education, Science and Technology (MEXT) -- around [yen]41.5 billion this fiscal year -- while METI will provide [yen]31.7 billion. The small residual amount will come via the Ministry of Health, Labor and Welfare, which is launching its first nano proiect this year.

Contrary to many discussions in the Japanese media, this is not a two horse race. There are also extensive research operations in Europe, and the other Asian nations are also focusing on this area -- South Korea has a plan to spend about $160 million per year; Taiwan intends to spend $666 million over five years.

If Japan is falling behind in the nanotechnology race -- as the pessimists insist -- it will not be from a lack of expenditure. The question, particularly from the narrow perspective of the investor, is whether these projects will yield commercial results and if so, where.

The general perception is that the transmission of technological expertise is from the academic sector to the commercial sector and especially to the smaller company sector. The model for this type of development is Silicon Valley, which has grown up at the gates of -- and on the back of technology coming from -- Stanford University. And as companies have blossomed, they have prompted the development of all the required commercial structure -- lawyers, investment bankers and, most importantly, venture capitalists -- which have enabled the extraordinary profusion of startup companies that occurred in the 1990s. There is nothing quite like Silicon Valley anywhere else in the world, but the phenomenon of high tech companies clustering around major universities is seen elsewhere -- for example in Massachusetts or in Cambridge, England.

But not, it seems, in Japan. The perception is that the best Japanese researchers either stay within academe or toil away in the research labs of the major companies (or the not so major companies -- it is rare for scientists from the corporate sector to be awarded Nobel Prizes, but this honor was bestowed this year on Koichi Tanaka of Shimadzu). The sort of academic entrepreneur as typified, for example, by the hero of The New, New Thing, Tim Clark, is nowhere to be found.

Such is the conventional view. It may be, however, that the concentration of research in large facilities -- be they academic or corporate -- is more appropriate in a field such as nanotechnology, with its interdisciplinary nature and where application may be more significant than inspiration, than in other fields of technology where there is more of a role for the detached visionary. It is worth noting where the thrust of Japanese nanotechnology research is going. The vast bulk of the Japanese government expenditure is being directed toward either the IT/electronics field or toward nanomaterials --- areas of traditional Japanese strength and areas where, perhaps, engineering ingenuity counts more than conceptual brilliance. Nanomaterials is an area in which Japan has long had a leading position -- one of the most important developments was the discovery of carbon walled nanotubes by Sumio Iijima, then of NEC and now of the Research Center for Advanced Carbon Materials at Japan's National Institute of Advance d Industrial Science and Technology. It is an area of intense competition -- a recent report identified 21 companies seeking to develop such products. The key question here is the practical issue of who can produce in industrial quantity at the best price. And one of the major contenders here is, unsurprisingly, NEC, which hopes to produce nanotubes in commercial quantities by 2004.

NEC also places top in a recent Nikkei survey as the firm is most highly regarded in nanotechnology. It is followed by other large high-tech firms. Hitachi is No. 2. More interesting is the position of two trading companies: Mitsui & Co, tied for second place with Hitachi, and Mitsubishi Corp at No. 5. That's two trading houses in the top 10.

Investor opinions are divided on the Japanese general trading companies. The conventional -- inevitably pessimistic -- view is that these are dinosaurs whose basic trading business is disappearing into the primordial slime and who are likely to follow the brontosaurus and the diplodocus into extinction. The alternative view sees a bright future at least for the major and less financially troubled trading houses, including both Mitsui & Co and Mitsubishi. For these companies, the traditional middleman business has already shrunk in importance -- on the one hand they have moved closer to the producer by building up substantial portfolios of production assets, especially in fields such as raw materials and energy, while on the other hand, they have been moving closer to the consumer by increasing their exposure to retail (Mitsubishi has, for example, taken a significant stake in Lawson's). At the same time, they have become investment holding companies and significant providers of venture capital.

Both Mitsui and Mitsubishi are involved in the development of carbon nanotube production technology (production has already begun). Mitsui has set up two R&D companies, the Carbon Nanotech Research Institute (CNRIJ and the Bio Nanotec Research Institute (BNRI), and already begun pilot plant production of nanotubes.

Mitsubishi is a partner in Fullerene International Corporation (FIC), along with Materials and Electrochemical Research Corporation (MER) of Tucson, Arizona. FIG was established back in 1999, although the relationship between the two partners dates back five years earlier. FIG advises Nanotech Partners, a nanotechnology fund whose corporate investors include Mitsubishi, Mitsubishi Chemical (which figures at No. 4 in the Nikkei survey), Honjo Chemical, and UFJ Capital, the venture capital subsidiary of UFJ Holdings. Total funds raised by Nanotech Partners are around Y7 billion. Nanotech Partners' major project is Frontier Carbon, which has constructed a pilot plant in Mitsubishi Chemical's Kurosaki production facility in Kitakyushu City and which hopes to start large scale fullerene production in 2007.

While it is gratifying to see that some of Japan's major companies are taking nanotechnology seriously, the would-be investor may well feel a pang of disappointment. These are all large companies whose fortunes are unlikely to be transformed by nanotechnology and thus will not represent a very concentrated play on this potentially epoch making new technology. This may not be entirely a bad thing. The stock that has been seen, at least by some, as the closest to a pure nanotechnology play in Japan has been Shimura Kako (SK). SK's traditional business -- nickel processing -- has been in long term decline and has been, in effect, the subject of a reverse takeover (an innovative financing technique for Japan but common elsewhere) by San-Ei Kasei, which has claimed an innovative production technology for making "spherical shaped fine metal particles made of nanometersized structures," using a "nannomizer," which can be used in the manufacture of high tech magnets and other applications. For whatever reason, SK has proved a grave disappointment, with shares falling below [yen]100 as earnings have been revised down. There have also been a number of arrests for share price manipulation.

What the investor -- or, more accurately, the investor prepared to take an aggressive bet on nanotechnology -- requires is a selection of startups that can quickly transmit the fruits of the best academic research into the marketplace. This has long been commonplace in the US and, to a lesser extent, in Europe, but it is now starting to be seen in Japan. Until April 2000, professors and researchers at national universities were prohibited from serving as corporate directors. The lifting of this ban and the adoption of a policy by METI in 2001 to encourage university derived startups and increase their number to 1,000 within three years are beginning to bear fruit. According to a METI survey, there were 263 startups by the end of 2001, double the number of a year earlier.

The development of the Japanese technology startup sector took a major step forward in September with the listing of AnGes MG, which was founded by an Osaka University associate professor in December 1999 to commercialize his research on gene therapy. AnGes thus became the first university-based startup to sell its shares to the public and it has, thus far, been a success. The shares were listed at Y220,000 and now trade at [yen]386,000. Hopefully, there will be many more listings, and one can expect that at least some of these will be in the nanotechnology field. Companies, perhaps, like Nanocarrier, which was founded in 1996, that use nanoparticles in drug delivery systems -- a relatively rare example of a Japanese company pursuing a health-care-related application of nanotechnology.

Despite the widely held view that the Japanese venture capital industry is substandard, Nanocarrier has been able to raise funds from JAFCO, Nikko Capital, Diamond Capital, Aozora Bank and Orix Capital among others. And it has been able to sign research agreements with Nippon Kayaku, Glaxo SmithKline and Kirin. If nanotechnology is ever to develop into the new, new thing, investors will have to be able to invest in the likes of Nanocarrier. Such stocks may ultimately offer more risk than reward -- like most of the Internet stocks of the late 1990s -- and one might be better off with Mitsubishi or Noritake, but one needs to be able to make the choice. II

STARTUPS BY AREA OF SCIENTIC EXPERTISE


Other                     20%
Nanotechnology             8%
Biotechnology             16%
Manufacturing Technology  21%
IT                        35%

Source: METI

Note: Table made from pie chart

RELATED ARTICLE: THE FULL TOP 10 IN THE NIKKEI SURVEY

1.NEC Corp. (6701)

2. Hitachi Ltd. (6501)

2. Mitsui & Co. (8031)

4. Mitsubishi Chemical Corp. (4010)

5. Mitsubishi Corp. (8058)

6. Toray Industries, Inc. (3402)

7. Noritake Co., Ltd. (5331)

7. Matsushita Electric Industrial Co., Ltd. (6752)

7. Shimadzu Corp. (7701)

10. Toyota Motor Corp. (7203)

10. Osaka Gas Co., Ltd. (9532)

10. Fujitsu Ltd. (6702)

Note (stock code number)

Source: Nikkei