Like all fads, the craze for everything "nano" pushed up a lot of junk stocks and produced few real companies before investors moved on to the next new new thing. While FEI Company (Nasdaq:FEIC) has gotten attention for its nano credibility, investors would probably do well to see this more as an analytical technologies company like Waters (NYSE:WAT), Thermo Fisher (NYSE:TMO) or Agilent (NYSE:A) than a hot next-generation tech story.
While the company does still have a large footprint in the cyclical electronics sector, the company is finding more and more applications for its technologies in sectors like natural resources and life sciences. Moreover, as the company continues to drive down the costs of its own technology, electron microscopy adoption could grow at an accelerating rate, as it has happened before with many other analytical technologies.

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A Market in the Very Small Could Get Much Larger
Generally speaking, analytical technology companies tend to focus around a few core technologies, especially in the early years. For Waters, it has been liquid chromatography and mass spec, while Bruker (Nasdaq:BRKR) serves markets for magnetic resonance, mass spec and gas chromatography (among others). For the more diverse Agilent, liquid chromatography, mass spec, x-ray crystalography and magnetic resonance have all been added through internal development or external acquisition.

For FEI, electron microscopes are the name of the game. Not only does FEI develop and market standard electron microscopes (scanning and transmission), but also focused ion beam systems and a combination device called DualBeam that combines a scanning electron microscope and a focused ion beam into a single device.

Perhaps not surprisingly, these systems have found adoption in the electronics sector where companies like chip manufacturers can use them for circuit editing and defect and failure analysis. While these applications are focused more on R&D rather than production ((unlike the equipment sold by a company like Applied Materials (Nasdaq:AMAT)), ordering patterns are nevertheless cyclical.

While there's certainly growth potential in electronics and technology, the FEI story could get really exciting if lower instrument costs grow markets in applications like life science, healthcare and natural resources. Most people have seen electron microscope images of pollen or microfauna, but there is considerably greater research potential in areas like cell biology and structural biology.

As FEI has developed more rugged systems, they are also getting a look from the natural resources sector. The company has a partnership with Halliburton (NYSE:HAL) among others, and these systems can be used to assess energy reservoirs and/or ore samples - potentially adding up to a market of over half a billion dollars.

SEE: The Ups And Downs Of Investing In Cyclical Stocks

A Share Leader in a Growth Market
Although FEI's share in scanning electron microscopes is somewhat modest (roughly between 10 and 20%), it holds approximately 40% of the transmission microscope market, and upwards of three-quarters of the market addressed by the DualBeam. Fighting FEI for share are well-known players like Hitachi (NYSE:HIT) and Zeiss, and not-so-well-known companies like JEOL and Tescan.

The key to the FEI story may not be so much about direct competitors, though, as it is about reducing the cost of electron microscope ownership and expanding its applicability into a wider range of fields and markets. To that end, companies like Agilent, Danaher (NYSE:DHR) and Waters are just as relevant as potential competitors.

Part of the risk of this story is that this sort of broad adoption may never occur, but the history of analytical technology is marked by these transitions. Technologies that were once too expensive to ever show up outside of the lab are now routine in fields like medicine, energy exploration and food and beverage, and the same should be true here.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
Potential aside, valuation still matters. I believe that FEI can grow its top line at a high single-digit rate for several years, and couple that with an improvement in free cash flow conversion that can deliver double-digit free cash flow growth over the next decade.

Even with that relatively robust growth expectation, fair value comes in around the mid-$50s. That suggests some undervaluation, but not necessarily enough to jump in today. Patient investors may just want to sit tight in the hopes that the market continues to treat FEI as just another semiconductor story and sells it off on the cyclical worries that go with that sector.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.