ICT & digital portfolio update

Imperial Innovations 6 September 2016 Update

Imperial Innovations

ICT & digital portfolio update

Pharma & biotech

6 September 2016

Price

420.00p

Market cap

£677m

Net cash (£m) at 31 January 2016 including post period £97m net equity issue

189

Shares in issue

161.2m

Free float

9%

Code

IVO

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.6

2.4

(16.0)

Rel (local)

(1.0)

(6.7)

(25.3)

52-week high/low

516.50p

341.25p

Business description

Imperial Innovations is a technology transfer, incubation and venture investment company. It invests in ventures from Imperial College London, Cambridge and Oxford universities and UCL. Over 90% of its portfolio value is in 20 companies, with most (c 77%) of its investments in healthcare.

Next events

Circassia interims

27 Sept

FY16 results

October

CellMedica: Phase II CITADEL data

2016/17

PsiOxus Phase I EnAd data

2017

Analysts

Katherine Thompson

+44 (0)20 3077 5730

Lala Gregorek

+44 (0)20 3681 2527

Daniel Wilkinson

+44 (0)20 3077 5734

Imperial Innovations is a research client of Edison Investment Research Limited

Imperial Innovations (IVO) has been executing on its intention to rebalance its investment portfolio away from therapeutics companies by building up activities in the non-therapeutics space, in particular ICT/digital. Ongoing investment in both established and new ICT/digital companies should see this sector grow in both importance and value. This report focuses on Featurespace, a company outside IVO’s top 10 assets by value of holding at end-H116, but one that received additional investment in May ahead of important catalysts over the next year.

ICT/digital: Accelerating the pace of new investment

ICT/digital is a ‘small but growing’ part of the IVO portfolio. At end-January, Yoyo Wallet was the single representative of this sector in IVO’s top 10 assets, accounting for only 4.1% (£9.5m) of top 10 value. Ongoing investment in both established companies (Yoyo, Cortexica and Featurespace) as well as new investments should increase the relative contribution of this sector. Of the £10m invested in six new companies in H116, five were in ICT/digital: Garrison Technology, Import.io, SAM Labs, Telectic and WaveOptics.

UCL Technology Fund: Tapping into new sources

IVO’s £24.75m commitment (matched by the European Investment Fund) to the new £50m UCL Technology Fund in January effectively secures an option on top ideas from University College London (UCL). This should increase IVO’s access to deal flow for innovative technologies emerging from a leading UK’s academic institution.

Featurespace: Adaptive behavioural analytics

IVO invested £2.5m as part of Featurespace’s £6.2m funding round in May; its stake now stands at 36.9%. New proceeds will fund expansion of its commercial operations in the UK and US, particularly into the financial services markets. At end-July 2015, Featurespace was number 14 in IVO’s top 20 investments; disclosure at end-January 2016 has shifted to only the top 10.

ICT & digital portfolio update

We last wrote on IVO’s ICT & digital portfolio in March 2015. Since then, IVO has been actively investing in this area – it has added six companies to the portfolio for a total investment of £12m as well as making follow-on investments in existing portfolio companies.

The table below shows the movements in the overall IVO portfolio from the end of FY14 to the end of H116. Where disclosed, we also show the percentage of the overall IVO portfolio made up by ICT & digital companies and their contribution to the top 20 or top 10 companies in the portfolio.

Exhibit 1: Portfolio movements FY14-H116

FY14

FY15

H116

31/07/2014

31/07/2015

31/01/2016

Total portfolio (£m)

252.0

327.2

355.1

ICT & digital portfolio (£m)

18.7

32.3

N/A

ICT & digital as percentage of total

7.4%

9.9%

N/A

Top 20*(£m)

234.7

292.3

ICT & digital within top 20 (£m)

12.0

24.0

ICT & digital as a percentage of top 20

5.1%

8.2%

Number of ICT & digital investments within top 20

3

3

Top 10 (£m)

228.7

232.6

ICT & digital within top 10 (£m)

9.5

9.5

ICT & digital as a percentage of top 10

4.2%

4.1%

Number of ICT & digital investments within top 10

1

1

Source: Imperial Innovations. Note: *Disclosure has changed from top 20 to top 10.

New UCL Technology Fund

In January, IVO announced it had signed an agreement with the UCL Technology Fund. This provides formal access to IP developed by UCL researchers and is the first investment fund created by UCL to commercialise its research. The fund is expected to invest £50m over the next five years to support ideas from academics in life sciences and physical sciences. It will be used to fund early-stage proof of concept, licensing opportunities and new spin-out companies. As a limited partner in the fund, IVO has committed £24.75m over a five-year period; this will be matched by the European Investment Fund (EIF).

Accelerating the pace of new investments

IVO added one company to the ICT & digital portfolio in each of FY14 and FY15, but during the course of H116 the pace of investment accelerated, with five new companies added for a total investment of £9.0m. We summarise the investments in Exhibit 2.

Exhibit 2: New investments made in FY15 and H116

Company

Date

Amount invested (£m)

Total raised in this round (£m)

% stake

Business description

FY15

Concirrus

Jul-15

3.0

3.0

28.6

Internet of things (IoT) solution provider

H116

Garrison Technology

Aug-15

1.6

2.0

 

Develops anti-malware solutions for enterprise cyber defences

Telectic

Oct-15

1.3

1.5

18.3

Start-up that uses artificial intelligence to interpret the content of the internet

WaveOptics

Dec-15

1.5

N/A

 

Develops augmented reality technology displays

Import.io

Jan-16

2.6

9.0

 

Machine-learning start-up addressing the data-as-a-service (DaaS) market

SAM Labs

May-16

2.0

3.2

 

Develops wireless electronics kits that allow anyone to build their own smart inventions

Source: Imperial Innovations

Follow-on investments

We summarise the follow-on funding rounds in which IVO participated over the last 18 months in Exhibit 3.

Exhibit 3: Follow-on investments made in FY15 and H116

Company

Date

Amount invested (£m)

Detail

Cortexica

Mar-15

2.3

Convertible bond

Yoyo

Apr-15

5.0

Part of £5.9m series A round

Featurespace

May-16

2.5

Part of £6.2m round

Source: Imperial Innovations

In the next section, we revisit Featurespace, one of the ICT & digital portfolio’s larger investments.

Featurespace

Featurespace uses proprietary software to analyse the behaviour of people in a commercial and social environment. It can be used in a wide variety of applications but is focused on predicting, identifying and preventing fraud in the financial services and gaming industries. In a case study from Betfair, use of Featurespace technology resulted in a 50% reduction in the number of staff conducting manual assessments and a 77% reduction in false positives. The combination of better fraud detection, lower costs to service customers and improved revenues due to fewer false positives makes the company’s software an attractive alternative to widely used rules-based solutions. Featurespace has c 30 customers and is on track to grow revenue by more than 150% this year.

Exhibit 4: Investment details (at 31 January 2016)

Net investment carrying value

£6.8m

% of shares outstanding held

36.9

Cumulative cash invested

£6.6m

Source: Imperial Innovations

Company background

Featurespace was formed in 2005 by Dave Excell (CTO) and Cambridge professor Bill Fitzgerald as a university-based consultancy. They were approached by Betfair to solve a problem it was having with identifying fraudulent transactions. The deal was agreed in 2008 and Featurespace built its first on-premise Fraud Manager system. Using their novel Bayesian inference methodology, the Featurespace co-founders correctly identified 90% of fraudulent transactions in a sample of data provided by Betfair. As a result, Betfair became Featurespace’s first customer. It has since expanded to c 30 customers over a variety of segments, and anticipates more than 150% growth in revenues and 210% growth in bookings this year.

The core software engine is branded ARIC (adaptive real-time individual change identification) and has been developed into three products: ARIC Fraud Manager, ARIC Responsible Gambling and ARIC Accept. Each of these products has significant opportunity but Fraud Manager is the current focus. Revenue is based on a standard software licensing model with additional support and maintenance revenue. There are currently 52 members of staff, with engineers and data scientists making up more than half of the total.

Experienced management team

Martina King (CEO) was previously managing director of Capital Radio and Yahoo Europe and is non-executive director of Cineworld and Debenhams. Gordon Hurst, previously the FD of Capita, is Chairman and Dr Mike Lynch (founder of Autonomy) is also a non-executive director.

Technology

The ARIC core engine uses a combination of Bayesian inference, signal processing and machine learning to derive meaning from a variety of data sources. Each install is capable of processing over 120m events each day in real time, with a millisecond response, and adapts over time. It means that rather than categorising clients based on a manually specified set of criteria or rules, the engine learns the typical pattern of behaviour of a good customer and with its anomaly detection algorithms can detect fraudulent transactions automatically. This principle can be applied to multiple areas but fraud management in financial services and gambling are the main areas of focus. The software is designed so that other sources of risk management data (eg third-party ID checks) can be fed into the system to increase accuracy. The software can be implemented on-premise, in the cloud or hosted by Featurespace. The set-up time can vary significantly by client and can range from weeks to months, depending on how quickly the customer can develop processes around the new technology. Most customers choose to implement the software on-premise.

Focused on three core markets

Financial services: Fraud detection – cost and revenue benefits

The cost of fraud in the financial services industries has several sources: running fraud detection and prevention services, reimbursing customers who are the victims of fraud and the revenues lost from false positives. Rules-based analysis is the most common method of fraud detection, but it tends to result in a high level of false positives, ie, the system prevents legitimate transactions being processed as it concludes that the transaction is fraudulent.

In the financial services market, Featurespace attempts to identify fraudulent transactions passing through a bank or payment processor’s systems by learning the behaviours of each customer and all customers simultaneously in real time and spotting unusual activities. Getting the balance right between false positives and false negatives is crucial in terms of cost, reputation and customer satisfaction. According to management, Featurespace’s adaptive behavioural analytics provides a more optimal trade-off than other currently available systems so there is a clear positive return on investment that Featurespace should be able to use to win market share.

Research carried out by Oakhall Advisors1 suggests that the annual cost of card fraud globally is c $16bn (ie the value of fraud losses). In addition, false positives drive at least another $14bn in costs: c $4bn in lost card fee income and more than $10bn of costs incurred in dealing with customer queries/complaints arising from having transactions blocked. Data provided by Featurespace to Oakhall shows that its software is capable of reducing fraudulent transactions by 25% (ie potentially worth $4bn across the industry), while at the same time reducing the incidence of false positives by 70% (worth nearly $3bn) and reducing customer-service related costs by 50% (worth more than $5bn). Overall, use of Featurepace across the card industry could cut fraud-related costs by as much as 40%.

“The cost of card fraud to banks” – Oakhall Advisors, July 2016

Rules-based systems the main competition

Rules-based analysis is good at detecting fraud from known methods. However, when a new way of committing fraud emerges, it will take time for this to be identified and for the rules to be updated. Featurespace’s software is more quickly able to identify new sources of fraud by understanding normal behaviour and thereby spotting anomalies.

The main competitor in financial fraud prevention is $3.7bn market cap, US listed, Fair Isaac Corp (FICO), which provides a range of services including credit rating, fraud protection, data management and marketing & customer engagement services. IBM and SAS also offer fraud solutions to this industry.

Expanding customer base

Featurespace has built and deployed a fraud detection system for Vocalink-owned mobile payment platform, Zapp. This year, Featurespace signed a contract with Total System Services (TSYS). TSYS is a US-listed payments company with annual revenues of $2.8bn from payment processing (for c 650,000 merchants) and card issuing services (for more than 400 customers). TSYS will use Featurespace’s ARIC Fraud Manager software to help its clients reduce fraud. We view TSYS as a crucial reference customer – success at TSYS should pave the way for new financial services customers. More recently, Featurespace has signed up a top 20 North American bank to use its fraud solution.

Other customers include a short-term loan provider in the UK (where Featurespace has enabled that client to lower its risk while improving performance), a global credit card issuer with more than one million UK customers, and a UK credit reference agency (where Featurespace software is used to identify criminal behaviour at the early application stage).

Gaming: Combatting fraud and identifying problem gambling

Fraud is also a big problem for gaming companies and Featurespace can help by identifying the key characteristics of fraud and predicting when it might occur before it actually happens. It can also help reduce customer churn and encourage responsible gambling by providing a player health check across all players on a platform. Fraud identification in gaming companies has the same false positive versus false negative trade-off as the banking industry and therefore the analytics tool that can optimise this trade-off can generate substantial value and command a pricing premium.

Betfair – an early adopter of Featurespace technology

The Betfair case study is a good example of how Featurespace can generate value for gaming companies. Before using Featurespace, Betfair used a manually defined rule-based system and score cards to identify customers that might commit fraud. This, however, meant that unknown fraud types would not be identified. Featurespace used data such as bets placed, cash deposited and withdrawn from accounts and the sporting calendar to independently and automatically identify potentially fraudulent clients. This resulted in a 54% reduction in chargebacks, a 50% reduction in manual review by analysts, and a 77% reduction in false positives. Betfair now claims to operate with one of the lowest fraud rates in the gaming industry and can scale its operations without having to expand its fraud analyst team significantly.

Growing adoption by the gaming industry

Last year, William Hill signed up to use Featurespace to interpret data and achieve greater insight. and Camelot signed up for a six-month trial to identify problem gamblers. In July, OpenBet signed up to use Featurespace for fraud, risk and compliance management. Also in July, Kyte Consulting became a reselling partner, with a focus on gaming operations in Malta, Europe, the Middle East and Africa.

Insurance: Combating fraud and improving margins

In the insurance sector, Featurespace not only helps prevent fraud but also optimises insurance pricing by analysing and attempting to predict customer behaviour. Pricing of insurance cover is critical as if it is set too low the insurer will make a loss and too high they will lose customers in what is a very competitive market. The insurer that can therefore correctly analyse the likelihood of claim will be able to offer the most competitive prices. Therefore, similar to banking, there is a clear positive return to the customer. The software is also able to help in the fight to identify “ghost brokers”. These are brokers who provide policies that are bought from legitimate insurance companies using false information and then doctored before being sold on to customers, or provide fake policy documents that are designed to look like they have been issued by legitimate insurance brokers.

Competitors in the insurance space include some small players such as Earnix (UK-based private company) and larger consultancies such as Infosys, SAS and IBM.

Progress update

We summarise below the key milestones achieved over the last two years and assess the growth prospects of the company.

Milestones completed

June 2014: £3.0m funding round completed with Imperial Innovations investing £1.7m alongside co-investors NESTA and a number of the Cambridge Angels group.

November 2014: Gordon Hurst (CFO of Capita) appointed as non-executive chairman of the board of directors.

May 2015: opened US office in Charlotte, N. Carolina.

June 2015: William Hill selects Featurespace as a partner for fraud detection.

September 2015: signed five-year deal with Zapp.

December 2015: started six-month trial with Camelot to support responsible gambling.

May 2016: announced contract with TSYS.

May 2016: closed £6.2m funding round, of which IVO invested £2.5m.

July 2016: announced contract with OpenBet.

July 2016: announced partnership with Kyte Consulting.

Future prospects

With a large financial services industry, North America is an attractive target market for Featurespace – in 2015, the company decided to expand into the US and opened an office in North Carolina. The recently signed TSYS and North American bank contracts highlight the strong start the company has made with its US expansion strategy and are a strong endorsement of Featurespace’s technology. Successful roll-out of these contracts should pave the way for additional new business from the financial services sector, in addition to the company’s growing penetration of the gaming market. Based on bookings received to date and the quantum of business in the pipeline, the company has growing visibility on revenues for 2016 and beyond.

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