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Tickers in this Article: SMMX, DOW, XOM, MSFT, F, AMAT
The difference between growth and value styles is the chosen priority. A value investor cares most about price. For example, when analyzing the price-to-earning (P/E) multiple, a growth-oriented investor focuses on the denominator ("how fast will the earnings grow?") but the value-oriented investor focuses on the numerator ("is the price less than intrinsic value?"). Of course, we all want both: growth at a good price. In practice, value investing is associated with Warren Buffet's style which seeks understandable companies that deliver sustainable earnings by virtue of a moat (or competitive advantage). A loyal value disciple discounts the predictable future earnings stream in order to compute intrinsic value.

But the exercise of projecting future earnings streams is getting harder. This is not really because the business of investor relations is changing. To tell the truth, much of so-called investor relations is about upcoming quarterly guidance-a myopic timeframe that, thankfully, many investors continue to care deeply about. In so doing, they create inventory for those with a timeframe longer than a fruit fly's lifespan.

The real culprit is complexity; i.e., complexity in products, markets, customers and business models. The famed Fisher Black argued that, as an economy grows, the economic sectors will splinter and fracture until eventually there are "billions" of sectors. Technology funds the exponential advances that create the complexity. Whereas Buffet prefers to invest within his enviable "circle of competence" (that is, businesses that he can understand), the problem going forward is that businesses are becoming much less understandable. Consequently, the typical circle of competence shrinks. Complexity makes predictions harder and, for this reason, the growth/value dichotomy will no longer be helpful, if it even is today.

My favorite example of a company that represents the next paradigm is Symyx Technologies (SMMX). Symyx helps customers like Dow Chemcial (DOW) and ExxonMobil (XOM) conduct applied research more rapidly. They create tools that turbo-charge the scientific research process. Are they in the chemicals sector then? Yes. Energy? Yes. Semiconductors? Yes. Material sciences? Pharmaceuticals? Yes and Yes. Nanotech? Near enough (but technically nanotech is atomic not molecular, so I like to refer to them as nanotech-adjacent).

When Advisor initiated coverage on Symyx Technologies, I called them a software company in disguise. On the last quarterly call, they formulized the software business with the addition of a new senior vice president of software operations and some visibility into their rapidly growing software tools segment. They also have their able hands in integrated circuits, solar (photovoltaic cells), and sensors (a booming market).

Basically, they are one big buzzing beehive of intellectual property and human capital. Their CEO says that the efficacy of applied research is a function -- at least in part -- of the number of experiments conducted in a lab. Thomas Edison was forced to conduct experiments by trial and error; Symyx enables their clients to "generate hundreds to thousands of unique materials at a time." In short, they are transforming research from a sequential process into a massively parallel process.

Symyx represents the next paradigm: human capital (not tangible assets) fund an intellectual property portfolio; a thick ecosystem of joint ventures, collaborations, and partnerships create predictable revenue streams in the form of royalties and licensing fees; amorphous sector boundaries (i.e., energy, information, pharma, materials, semiconductor) provide diversification without diluting core competencies. The core competence, in Symyx's case, is high-throughput research tools.

And we always like to invest in companies that have a solid ongoing business while offering tantalizing "real options" on future growth. These are the incubated opportunities (or joint ventures) that, while they have little or no current value, could possibly scale or payoff financially. Symyx has a long list of these. Here are three of my favorites:

• Minority ownership (~18%) in Ilypsa, a biotech company with several preclinical drugs in development that are non-systemic (i.e., safer because they are not absorbed into the bloodstream).

• Co-investment in Stargate Mobile, a company backed by Microsoft (MSFT) and Ford Motor (F), that is developing an onboard sensor that monitors a vehicle's oil condition.

• Co-investment in Intermolecular, a secretive company staffed by former Applied Materials (AMAT) executives working on semiconductor technology.


The upshot of this activity is that the company is both an ongoing business and a corporate venture capitalist. The bad news is that the company is not undiscovered. (Thankfully, Advisor has a Swing for The Fences portfolio because this stock would never clear the valuation hurdle in the other portfolios). Their current valuation is rich. Jeremy Seigel would find in Symyx his classic "growth trap:" a highly-valued company, with growth expectations already well embedded in the current price, itching for a takedown at the next hint of trouble.

And this next year could be rough. Like many other technology companies, Symyx is careful to report EPS guidance both before and after the impact of option expensing. Because the option hit stings! They forecast EPS of $0.53 to $0.58 before option expense. They predict the impact of option expense will be $0.20, such that diluted EPS on a GAAP basis will be reduced to $0.26 to $0.31. Given a $28 price, that produces a forward P/E ratio of either 50x or 98x. In short, the stock is either very expensive or Donald Trump. The $0.20 option deduction may seem aggressive, but that is really due to the relatively low baseline. According to my estimate, the company intends to grant options on about 2.4% (+/- 0.5%) of their common shares, which is entirely competitive for their profile. As the company grows EPS, the option deduction, in percentage terms, will naturally fall.

(While we are discussing risks, it should be noted that Symyx's two anchor customers do give material event risk: two five-year strategic partnerships with Dow and ExxonMobil, are eligible for renewal in 2008 and 2010. Together these relationships account for $320 million of expected funding, cumulatively over the contract periods. Disruption or disassociation with either of these partners would be a bad event.)

Could a company that sports such a heady valuation, in complete violation of a traditional valuation discipline, possibly be a good buy? You betcha! You only need to believe that they have the epic potential to help transform applied research and, in doing so, to in turn help their customers produce new materials, chips, drugs, sensors, molecules, and ideas. Symyx could become the next household name, except for a few pesky problems: it's hard to spell their name, explain what they do, decipher all of their products, sort through their partnership ecosystem, etc, etc.

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