Until recently, investors looking for a "pure play" investment in the field of nanotechnology had one choice: Harris & Harris (NASDAQ:TINY) -- a publicly traded venture capital firm that owns small equity stakes in more than a dozen privately held nanotechnology start-up companies. Another company, however, has recently begun making some noise, and investors interested in nanotechnology are encouraged to pay it some attention. That company is Arrowhead Research (NASDAQ:ARWR). It's headed by industry veteran R. Bruce Stewart, who founded Acacia Research, which brought Acacia Technologies (NASDAQ:ACTG) and CombiMatrix to market.

Arrowhead, like Harris & Harris, focuses almost exclusively on nanotechnology, but its approach is quite distinct from TINY's and carries with it the potential for greater rewards as well as greater risks.

Arrowhead invests in promising nanotechnology research at leading universities -- primarily the California Institute of Technology at this time -- and, in exchange for the right to license certain intellectual property, will seek to translate that nanoscience research into real businesses.

Few knowledgeable investors question whether there is promising nanotech-related research taking place in university labs across America. This is, in part, thanks to Uncle Sam's willingness to generously underwrite the field to the tune of almost $1 billion a year. There is disagreement, though, over the issue of whether much of this research is yet ready for the commercial marketplace. A number of promising nanotech companies have set out for commercial gold in years past only to end up shipwrecked on the cruel, unforgiving shoals of today's hypercompetitive economy.

Arrowhead makes strategic investments at the university level. But rather than rush that technology to the market, it instead allows it to cook a little longer in the labs. When the technology is more mature or a viable product is ready to generate revenues, the company's seasoned management team will either create a market-driven subsidiary, license the intellectual property, sell its interest to a larger company, or guide it to an IPO.

This strategy allows Arrowhead to snatch up valuable intellectual property long before any venture capital firm or large corporation would consider investing. In this sense, Arrowhead's approach fills a much-needed gap between basic research (in which the private sector is loath to invest) and the venture capital market, which often extracts an unusually high price in return for its investment.

The risk of Arrowhead's strategy is, of course, that the basic research it's buying is still "basic." No one knows for sure whether it will ever amount to anything. The flipside is that because of its early entry investment, Arrowhead -- unlike Harris & Harris and other venture capital firms -- ends up owning a significantly larger percentage of its subsidiary companies. This not only gives Arrowhead's management a much greater claim of any future profits, but it also ensures a higher degree of managerial control. Of the four subsidiaries it has created, Arrowhead owns more than 50 percent of each.

To date, management appears to be highly selective with its investments. The company claims it is interested only in technology or products that can generate between $300 million and $1 billion annually in revenues, and it typically makes no more than an initial investment in the neighborhood of $200,000 -- although that figure has grown as high as $2 million-$5 million in a few select instances.

Currently, Arrowhead has four subsidiaries. The first is Insert Therapeutics, which is developing a drug-delivery platform that uses "molecular design" -- technology that puts every atom and molecule exactly where it needs to go in order to achieve the best result. So far, Insert's leading drug platform has shown excellent promise in animal trials in transporting cancer-fighting agents to its target with high precision and low toxicity. The company is preparing to enter its lead anti-cancer drug, IT-101, into human clinical trials in early 2006. Arrowhead has invested $5 million in the company and owns 68.5% of its shares.

The second subsidiary Arrowhead has created is Calando Pharmaceuticals, of which it has invested $2 million and owns 52%. Calando is another nanotech-related start-up and is developing a proprietary technology that can deliver short-interfering RNA (siRNA) to target cancer cells and can inhibit tumor growth by silencing the target gene. The company's technology has also been demonstrated as being effective in animal trials and is expected to begin human trials sometime in 2006.

Aonex is Arrowhead's third subsidiary, and it is seeking to create semiconducting nanoparticles for use in everything from LED lighting to thin, flexible solar cells. The areas of flexible solar cells and LEDs are both ripe with promise -- and I am bullish on nanotechnology's playing an integral role in their respective development -- but here, too, Aonex faces an uphill battle. GE, Philips, and Siemens (among others) are also placing big bets on these fields.

The final subsidiary is called NanoPolaris. It is an intellectual property platform covering carbon nanotube technologies. Little more is known about this "platform" at this time, but company officials promise that more information is coming soon.

Each subsidiary has some promise. However, the field of nanotechnology is now so vast that each faces significant competition from Fortune 500 companies and private start-ups alike. For instance, Insert Therapeutics, whose most promising platform involves the targeting of a variety of cancers, faces competition from any number of companies, including GlaxoSmithKline (NYSE:GSK) and pSivida (NASDAQ:PSDV). Both are further along in their clinical trial processes, and if either is successful, Insert's prospects will wither.

The same is true of Calando. Several public companies, including Alnylam (NASDAQ:ALNY) and Sirna Therapeutics (NASDAQ:RNAI), are aggressively pursuing the development of RNA interference therapeutics.

Lastly, anyone who has followed the field of nanotechnology knows that carbon nanotubes are among its most promising materials. The downside is that the field also has an almost endless list of competitors -- including Japanese industrial giant NEC, which has made noise in the past year about enforcing its original carbon nanotube patent. Without knowing the details of the NanoPolaris' IP platform, it is impossible to surmise the strength of Arrowhead's position or adequately assess its strategy. It may have the equivalent of a winning lottery ticket, or it may just be holding a lot of worthless paper.

Arrowhead has a market cap of $82 million, with $25 million cash on the balance sheet. It also has few revenues and no licensing agreements. From this perspective, then, it looks very pricey. It does, however, hold some promising intellectual property and technology. At its current burn rate, it has almost another two years before management would have to go back to investors to seek additional cash.

So does the company make for a good investment? The answer depends on your penchant for risk. If it is high, I would say yes. If it is average or low, I would recommend staying away from the stock for now. (As always, investors need to also be aware that small-cap companies this small often face great volatility).

Either way, here's what investors should look for moving forward. First, Insert has stated that it'll begin human trials in early 2006. Investors are encouraged to watch whether management meets this milestone. Investors should also look for the same from Calando. In both cases, the initiation of human trials doesn't guarantee success because phase 1 drugs have historically high failure rates. But moving into clinical trials does suggest that the technology is showing promise and that it is at least on the right track.

Investors are also encouraged to look for signs of corporate partnerships for Aonex -- especially in the areas of LED lighting or flexible solar cells. Such partnerships will provide some tangible proof that its technology is being taking seriously by the big players -- which is ultimately what Aonex will need to become a commercial success.

The same can be said for Arrowhead. Technology and intellectual property, in and of itself, are nice, but they don't pay the bills. Arrowhead's strategy has merit, but it needs to bring real products to the commercial marketplace before it can be deemed a success.

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Jack Uldrich has been thinking small since grade school. He is the author of The Next Big Thing Is Really Small: How Nanotechnology Will Change the Future of Your Business and can be reached at jack@nanoveritas.com. He owns shares of GE and pSivida. The Motley Fool has a disclosure policy.