Abzena — Fund-raising could drive transformational growth

Abzena provides biological research services aimed at creating more effective and safer biological products. The group initially evolved through the combination of three key businesses: PolyTherics, Antitope and Warwick Effect Polymers. More recently, it has also acquired PacificGMP (contract, development and manufacturing) and TCRS (specialist contract chemistry and bioconjugation). This enables Abzena to offer a more comprehensive and integrated offering. Abzena listed on AIM in July 2014 (raising £20m) and in 2015, from a secondary placement, raised £20m net of expenses from the sale of 35m new shares at 60p. The group is primarily based on the Babraham Research Campus in Cambridge (UK) and, following two acquisitions in 2015, has operations in San Diego (PacificGMP) and Philadelphia (TCRS). The company employs c 200 staff.

We have reviewed our rNPV model and updated it to reflect the change in our financial forecasts for the services business following the recent net fund-raising of £23.9m. We have raised our rNPV to £132m (vs £105m) primarily due to the increase in forecast service revenues and improved gross margin. This has been slightly tempered as we have also increased the percentage of group admin costs relating to the service business to 90% (vs 70%). Finally, we have rolled the model forward by three months and incorporated the estimated FY17 cash position of £4.1m, and included the £23.9m net fund-raising cash.

Following the net fund-raising of £23.9m (75.8m shares at a price of 33p each) to expand its services, capabilities and capacity, we now forecast a cash runway to profitability in FY20. As the fund-raising was after the FY17 March year end, we do not expect any impact on our FY17 forecasts. We now forecast revenue of £29.7m, £41.2m and £55.2m in FY18, FY19 and FY20 respectively (services business CAGR from FY17 to FY20 of 40%) and for the services business gross margin to improve to 50% in FY20, from 39% expected in FY17. Alongside this increase in revenue, we expect an increase in costs and now forecast £4.0m in FY18, £4.2m in FY19 and £4.4m in FY20 of R&D costs and £19.5m in FY18, £19.8m in FY19 and £23.0m in FY20 of SG&A costs. Finally, we expect capex to increase in FY18 and FY19 as a result of investment into increasing its capacity.

With stable and growing revenues from its services business and a licensed portfolio of drugs that does not require investment to develop, Abzena operates a relatively low-risk business model. However, the biological services industry is highly competitive and will require Abzena to continually invest in enhancing its technologies and offering to the sector, which may require development and/or purchasing further assets. Having acquired two manufacturing businesses at the end of 2015 to expand its offering, it is integrating and embedding the broader offering, which is not without risk. While potential future royalty revenues on sales of products developed using Abzena’s technologies appear to offer pure upside, the development of these candidates is not within Abzena’s control. Advancing these candidates into late-stage clinical studies will require significant investment and/or a larger partner, so success of part of the pipeline will depend on the ability of Abzena’s licensees to secure the finance and/or partner. This does not include Gilead, Roche, two undisclosed major pharmas and private companies Opsona and Vascular Pharmaceuticals (large pharma investment). Finally, it should also be noted that Abzena’s revenues and costs are predominantly in US$ and therefore could be affected by exchange rate movements.

Abzena recently announced a £25m (£23.9m net) fund-raising through a placing of 75.8m shares at a price of 33p each. It indicated that the funds will be used to expand its services, capabilities and capacity. Specifically, it has indicated that it will use the funds to upgrade and grow its US-based biomanufacturing facilities and capabilities, invest in its existing biology, chemistry and biomanufacturing services in the UK and US, and invest in its sales and business development functions. In essence, this fund-raising, according to the company, should enable it to deliver a transformational growth plan including:

Abzena’s services business (pre fund-raising) accounted for 97% of group revenues (£8.7m H117). Approximately 84% of the services revenue to H117 was derived from repeat customers, yet the customer base remains relatively broad with the top 10 customers accounting for ~47% of total revenues. Geographically, these revenues in FY16 were broadly split between North America (67%) and Europe (21% not including UK, 6% in the UK).

The growth Abzena has experienced has, according to the company, led it to the point where it is capacity constrained and therefore requires further investment to enable it to grow further. For example, its capacity was already assigned through to 2018, its number of repeat customers had doubled and there was an increase in the number of manufacturing programmes that were enacted alongside Abzena inside contracts. Alongside this, the company had limited GMP chemistry (ADC) manufacturing capability which, if put in place, could provide the ability to attract high-value, follow-on projects.

We expect Abzena to invest the proceeds primarily across the three areas of the service business, and forecast capex of £11m in manufacturing, £3m in chemistry and £3m in biology. We expect the majority of this investment to be in FY18. We expect the new facilities to be completed by Q1 FY19.

We believe Abzena is well-positioned to achieve its growth plans. It has already indicated that demand exceeds its current capacity and it has previously demonstrated its ability to capture an opportunity and deliver following two acquisitions in 2015 (PacificGMP and TCRS). Exhibit 1 outlines how it has grown since the acquisitions.

At the time of the acquisitions the strategic plan was to capture greater value from providing an integrated, broader service offering, both in terms of capability and stage in the development process. This has started to prove fruitful and with the fund-raising we expect Abzena to build on this by increasing its cross-group utilisation and attracting a diverse and international customer base including major pharmaceutical companies and public and private biotech companies.

Exhibit 2 illustrates Abzena’s operations, the two aspects of its business model and where it is able to capture value across the development process.

While the fund-raising is important for the expansion and growth of its service business and ultimately transitioning the company to profitability, there remains a second aspect to its investment case: its expanding clinical pipeline of antibodies, being developed and fully funded by global partners, which were derived using Abzena’s protein engineering technology, termed Abzena inside products. The Abzena inside portfolio has grown to 12 (in clinical development) and it has recently announced another significant licensing deal for its novel site-specific ThioBridge technology.

Abzena combines three distinct but complementary areas in biology, chemistry and manufacturing to enable better biopharmaceuticals. It is the integration of these areas that underpins Abzena’s business model.

The Biology division provides immunology, protein engineering, protein production bioassay and bioanalysis services (divisional forecasts outlined below in Exhibit 4, with hyperlinks to detailed overviews of the specific technologies and services).

The Chemistry division provides custom synthesis of antibody drug conjugate (ADC) linkers, payloads and conjugation services (divisional forecasts outlined below in Exhibit 5, with hyperlinks to detailed overviews of the specific technologies and services).

The Manufacturing division provides cell line development, process and manufacturing capability to GMP standard for Phase I and II clinical trials (divisional forecasts outlined below in Exhibit 6, with hyperlinks to detailed overviews of the specific technologies and services).

Abzena has potential additional upside to its service business growth from its Abzena inside products. This licensed portfolio of antibodies was developed using its Composite Human Antibody (CHA) or ThioBridge (antibody drug conjugates) technology (outlined above). This portfolio offers the prospect of small royalties (~1%) on sales (CHA) and potentially higher royalties (up to 5%) on its ADC products (ThioBridge). This provides risk-free upside as Abzena benefits if the product successfully reaches the market; however, it assumes none of the R&D or partnering risks and is not restricted by indication as its ‘inside’ is applied across a broad range of indications.

To date, 12 antibody candidates (up from five at the time of Abzena’s IPO in July 2014), developed using Abzena’s humanising technology (CHA), have been disclosed as in active clinical development with customers currently conducting Phase I, II and III studies. Alongside this have been two significant licensing ThioBridge deals for two separate biotech companies to develop up to three and 10 products (to include ThioBridge as the linker in the resulting products) respectively. For a more detailed overview of these deals, please see our previous update note. An overview of the disclosed Abzena inside pipeline is outlined below.

Abzena’s most recent ThioBridge deal announcement indicated that it had signed a significant licensing agreement with a San Diego-based biopharmaceutical company for its novel, site-specific ThioBridge technology and a master services agreement to use its chemistry services. The licensing deal includes the use of ThioBridge in up to 10 ADCs across a wide range of indications. According to the company, the value of the agreement has the potential to reach more than $300m in development/commercial milestones if the partner successfully develops the ADC products. Alongside this, Abzena would also receive royalties on sales of any approved products that incorporate the ThioBridge technology.

With stable and growing revenues from its services business and a licensed portfolio of drugs that does not require R&D spend, Abzena operates a relatively low-risk business model. However, the biological services industry is highly competitive and will require Abzena to continually invest in enhancing its technologies and offering to the sector. This may include the need to acquire new assets/companies, which adds an element of execution risk, but with shrewd selection of targets this should only help strengthen Abzena’s position and therefore the investment case. Although the potential future revenue streams from royalties on sales of products developed using Abzena’s technologies appear to offer pure upside, the development of these candidates is not within Abzena’s control. With the exception of Gilead, Roche, two undisclosed major pharmas and private companies Opsona and Vascular Pharmaceuticals (a large pharma investment), a number of candidates are being developed by relatively small private companies that may struggle to secure the finance required to develop their products in a timely and effective manner. Advancing these candidates into late-stage clinical studies will require significant investment and/or a larger partner, so success will depend on the ability of Abzena’s smaller licensees to secure the finance/partner. Finally, it should also be noted that Abzena’s revenues and costs are predominantly in US$ and therefore could be affected by exchange rate movements.

We have reviewed our rNPV model and updated it to reflect the change in our financial forecasts for the services business following the recent net fund-raising of £23.9m. We have raised our rNPV to £132m (vs £105m) primarily due to the increase in forecast service revenues and improved gross margin. This has been slightly tempered as we have also increased the percentage of group admin costs relating to the service business to 90% (vs 70%). Finally, we have rolled the model forward by three months and incorporated the estimated FY17 cash position of £4.1m and included the £23.9m net fund-raising cash. We maintain our assumptions around the Abzena inside clinical pipeline at this stage.

We believe Abzena is well positioned following its fund-raising to grow its integrated service offering and, as its Abzena inside products move through the clinic and onto the market, we expect upside to our current estimates. Our valuation model and key assumptions are summarised in Exhibit 8.

While we maintain our valuation approach for Abzena, which indicates significant upside to its current market cap of £72m, it is worth considering it against a set of its peers now that there is clarity around its route to profitability. Defining Abzena’s peer group is difficult because, while there are a number of companies that touch on various aspects of Abzena’s offering, there is not a true like-for-like operation. For example, if we consider the competition in terms of breadth of offering, then Lonza and Catalent are potentially significant competitors. Horizon Discovery could be a good peer comparator as it offers services while having a longer-term potential income stream. Equally, a company such as Abcam, a service provider, could be considered. There are also smaller players that compete with one aspect of Abzena’s business, for example Selexis in cell line development services and ImmunoGen for ADC technology. An overview of the possible competitor universe is shown in Exhibit 9. Lonza, Catalent and Abcam are profitable, whereas Horizon Discovery ImmunoGen and Seattle Genetics are currently loss making.

We have looked at the publicly traded companies and EV/Sales multiples (Exhibit 10). If we apply the average EV/Sales ratio to Abzena (having removed the three much higher outliers, Abcam, Horizon Discovery and Seattle Genetics), it would imply an EV of £53m.

Abzena is offering a service in an area that is large and growing rapidly. According to a 2014 McKinsey report, biopharmaceuticals were generating global revenues of $163bn, which was 20% of the pharma market in 2014. P&S Market Research has indicated that the biopharma market is expected to grow at c 10% pa to 2019 and the R&D outsourcing market at >23%, projected to reach $11.4bn by 2020. The potential in these markets is underpinned by the increase in the number of large pharmaceutical companies shifting their presence to biopharma and when we consider recent M&A activity in the biologics field (see Exhibits 11 and 12).

While it is clear that there is significant interest in the biopharma area, it is difficult to quantify how this translates into appropriate potential for Abzena. However, we note the company’s strong progress since its IPO in 2014. It has built its service offering and geographic footprint through investment and through two acquisitions in the US. Alongside this, it has grown its Abzena inside portfolio to 12 (in clinical development) and has recently announced another significant licensing deal for its novel site-specific ThioBridge technology.

Following the recent announcement of Abzena’s £23.9m net fund-raising (75.8m shares at a price of 33p each) to expand its services, capabilities and capacity, we have reviewed our forecasts. As the fund-raising was after the FY17 March year end, we do not expect any impact on our FY17 forecasts, but have reviewed our FY18 estimates onwards to incorporate the full impact of the fund-raising and expansion plans.

We expect Abzena to use the funds to upgrade and grow its US-based biomanufacturing facilities and capabilities, invest in its existing biology, chemistry and biomanufacturing services in the UK and US and invest in its sales and business development functions. The company has indicated that the funds will be invested in the following areas:

As a result of this investment, we now forecast a cash runway to profitability in FY20 and an increase in sales from the services business and improved margin. Exhibit 13 outlines our previous and current forecasts. We now forecast revenue of £29.7m, £41.2m and £55.2m in FY18, FY19 and FY20 respectively (services business CAGR from FY17 to FY20 of 40%) and for the services business gross margin to improve to 50% in FY20, from 39% expected in FY17. We expect growth in each area of the services business (biology, chemistry and manufacturing), but that the most significant and steepest growth will be in the manufacturing division in FY18 following the investment. Alongside this increase in revenue, we expect an increase in costs and now forecast £4.0m in FY18, £4.2m in FY19 and £4.4m in FY20 of R&D costs and £19.5m in FY18, £19.8m in FY19 and £23.0m in FY20 of SG&A costs. Finally, we expect capex to increase in FY18 and FY19 as a result of investment into increasing its capacity and forecast £11m of capex in FY18, £3m in FY19 and £2m in FY20. We have maintained our revenue forecasts from licences at this time, but note that as the services business grows there could be upside with further Abzena inside product agreements coming to fruition.

Importantly, our forecasts indicate that Abzena will be EBITDA positive (£0.1m) in FY19 and become profitable in FY20 (£3.1m PBT).