Imperial Innovations — Update 3 November 2016

FY16 was defined by the contrasting performance of the quoted and unquoted portfolios. Net portfolio value increased to £335.1m for FY16 from £327.2m in FY15. However, this is a decrease from H116 results, where IVO reported a portfolio value of £355.1m. A negative Phase III cat allergy readout in June 2016 at Circassia, formerly IVO’s largest portfolio company, was the main contributor to this decline in portfolio value (£54.8m of the £67.1m). Nevertheless, Circassia remains IVO’s largest quoted company and value inflection points over the next 12 months could see it recover some of its lost value. The unquoted portfolio continues to gather momentum, with significant funding rounds, clinical success and business partnerships throughout FY16.Below we outline key points from FY16 in the unquoted and quoted portfolios.

Other quoted companies in the portfolio with material newsflow include Abzena and Oxford Immunotec. Key partnerships with Halozyme Therapeutics and Faron Pharmaceuticals underscore a year of significant business progress for Abzena, although this has not been mirrored by stock performance, which has supressed its net carrying value. IVO has invested £13.0m, representing 19.8% of the issued share capital; with a current market capitalisation of £47.3m, this represents a current net carrying value of £9.37m (at 2 November 2016). Oxford Immunotec (OXFD) has recovered from a July low of $7.73/share and is now trading c 77% higher at $13.66. At its Q3 results, revenues exceeded company’s expectations with solid growth from the US, China and Japan. It reported total revenues in the three months ending 30 June 2016 of $19.2m, a 34% increase over the same period in 2015. IVO has invested £7.6m, representing 4.6% of share capital, which at a current market capitalisation of $308.7m is valued at a current net carrying value of $14.2m (at 1 November 2016).

A range of development and business milestones have been achieved across the unquoted portfolio in addition to significant funding rounds. Therapeutics and medtech companies could be a major value driver in the next 12-36 months as key trial readouts and potential public listings/private follow-ons come into view. Oncology companies, which represent c 25% of the total portfolio value (£86m) and on average a 1.5x increase in value on cash invested, exemplify this. Our recently published in-depth look at seven of the eight oncology companies (excluding the recently formed Artios Pharma) provides more information on the scope and breadth of the oncology portfolio (see report). Artios Pharma, a company focused on therapeutics for DNA damage, raised £25m in a Series A round in September, of which IVO committed £5.1m.

Key oncology achievements in 2016 include: the collaboration between Cell Medica and Baylor College of Medicine to develop next-generation cell-based immunotherapy products; a deal, including a $10m upfront payment, between PsiOxus and Bristol Myers Squib to test its oncolytic adenovirus therapeutic enadenotucirev in combination with BMY’s Opdivo (nivolumab) (a recent Edison TV interview with Dr John Beadle, the CEO of PsiOxus, can be found on our website); and a collaboration between Crescendo Biologics and Takeda, worth potentially up to $790m, to develop Humabody candidates against multiple targets (a recent interview with Dr Peter Pack, the CEO of Crescendo, can be found on our website).

Progress remains strong within the rest of the healthcare portfolio as key clinical and commercial milestones were achieved:

At IVO’s FY16 results, it showcased one of its ‘rising star’ portfolio companies: Ieso Digital Health. Ieso was launched in July 2011 with seed investment from Cambridge Angels; IVO joined as an investor in 2013. IVO has invested £1.4m to date, representing a 28.8% share with a carrying value of £1.5m, which gives Ieso an implied valuation of £5.2m. Ieso aims to address the “treatment, affordability and accountability” of mental health treatment through a digital platform that is focused on cognitive treatment behaviour. It offers a web-based platform that enables the real time one-to-one treatment of people dealing with depression and anxiety.

Ieso has seen threefold year-on-year growth with a focus on the UK market. It believes it can continue to build and learn from its experience with the NHS as it looks to make inroads in the US. In readying its approach to the US, Ieso has developed a detailed US market access strategy with Navigant. Partnerships within the UK, for example with Beacon Health Options, continue to validate the platform. Ieso predicts that patients treated to completion will rise from about 11,000 in 2016 to around 180,000 by 2021. Approximately 30,000 will come from the UK, but Ieso predicts that the majority of its patients treated will be US-based. The US behavioural health ecosystem is changing dramatically with an array of start-ups with significant backing each looking to address problems in both the management and provision of care.

To date Ieso has treated more than 7,000 patients within the UK and captured over 75m individual pieces of data. It utilises this data to improve the care provided to patients, in particular monitoring the effectiveness of clinicians in delivering care, something that is difficult in conventional mental health treatment. Notably if a clinician does not deliver the standard of care required, they are no longer utilised, ensuring a consistently high standard of care. Ieso has benchmarked its care against NHS Digital national statistics for other providers in 2013/14 as shown in Exhibit 2. In ever-constrained healthcare systems, the ability to deliver treatment cost effectively is vital. An analysis by the York Health Economics Consortium in October 2014 predicted that if Ieso Digital health was rolled out to 50% of the available UK market it would result in cost savings of £108m a year. Ieso plans to accelerate the uptake of its platform in the UK and US markets and hopes to treat over forty thousand patients by 2018. Key to this will be continuing to prove the effectiveness of its technology at a cost that payers can accommodate.

Significant progress is also being made in both the engineering & materials and ICT & digital portfolio companies. At end-FY16 Nexeon (net carrying value: £41.9m) had overtaken Circassia as IVO’s largest holding within the entire portfolio (representing 11.25% of the portfolio). A £30m funding round in May provides the funds for refinement of Nexeon’s silicon material technology for use in batteries, a technology that outperforms current available systems. Nexeon has advanced significantly over the last 12 months and is now able to provide potential clients with product samples. It recently opened a new office and development laboratory in Yokohama to be closer to its key clients. In the next 12-18 months it expects to move from sampling to pre-production quantities and remains on the lookout for complementary technology and IP.

Featurespace, a technology company focused on adaptive behavioural analytics for fraud detection, has also made significant progress in the last 12-18 months including adding a number of major clients, including but not limited to TSYS, William Hill and Camelot. For more information on Featurespace please see our recently published ICT and digital portfolio update report and a recent interview with CEO Martina King. IVO has invested £3.9m, representing a 37.5% shareholding and a last reported carrying value of £6.8m.

Of the seven new companies added to the portfolio in FY16, five are in ICT & digital (Garrison Technology, Import.io, Telectic, WaveOptics and SAM labs) and one each in engineering & materials (Silicon Microgravity) and therapeutics (Precision Ocular), demonstrating IVO’s continued drive to diversify its portfolio. Of new companies added in the last five years, 38% have been in ICT & digital, compared with 29% for therapeutics, 18% for engineering & materials and 15% for medtech & diagnostics. Five technology companies have been sold in the last three years and the technology franchise has generated c $25m to date from exits.

While the top 10 portfolio companies comprise mostly healthcare companies, Nexeon (11.25%) is now the biggest holding. Major funding rounds and revaluations have caused changes in the portfolio composition, as seen in Exhibit 3.

IVO continues to expand its access to IP. Two major strategic developments have been announced this year: the £50m University College London (UCL) technology fund and Apollo Therapeutics, a £40m collaboration between some of the world’s top universities and global pharmaceutical companies. IVO has committed £25m over five years to the UCL fund and is joined by UCL, UCLB, Albion Ventures and the European Investment Fund. The fund will have access to all UCLB projects and IVO has co-investment and step-in pre-emption rights. Of the £50m, £5m is earmarked for proof-of-concept projects and the fund has already backed a spin out from the department of computer science and has provided later stage funding to two therapeutic companies.

Apollo Therapeutics is a collaboration between UCL, University of Cambridge and Imperial College London and three global pharmaceutical companies: AstraZeneca, GSK and J&J. The company has launched with £40m in investment, £3.3m of which is committed by IVO, and is focused on translational research. The company has visibility of IP from all three universities and has appointed Dr Richard Butt as CEO. Dr Butt joined from Pfizer where he was most recently a senior director and research project leader of clinical research at Pfizer Neusentis within the Neuroscience and Pain Research Unit. Additionally he recently led Pfizer Neusentis’s translational medicine strategy through a series of collaborative clinical trials.

Imperial Innovations’ investment case rests on the success of its investment strategy, in particular its ability to achieve increases in portfolio value (and hence NAV) over and above net new investment. The company is exposed to the business success of its larger portfolio holdings, especially as its investment portfolio includes two publicly listed companies within the top 10 valued assets. The recent significant decrease in the net carrying value of Circassia exemplifies this and as the unquoted portfolio continues to progress, possibly with future IPOs, increased exposure to the public markets is likely to occur.

Imperial Innovations is also very tightly held, with four shareholders accounting for a total of 90% of the equity, including Invesco (39.0%), Woodford (23.8%), Imperial College (15.3%) and Lansdowne (12.7%). This contributes to limited free float (9.2%) in the stock, which may increase volatility even on low trading volumes.

Imperial Innovations’ shares (at 374p) currently trade at a c 26% premium to our estimated FY17e NAV of 296p/share (at 2 November 2016). IVO has historically traded at a premium to its NAV, which can be ascribed to the unrecognised value of its portfolio assets (many of which are valued at cost or the valuation of their last financing) and its technology pipeline agreement with Imperial College and collaborations with other leading UK universities (Oxford, Cambridge, UCL) and research organisations (eg Babraham Institute). We note that the current premium remains substantially lower than the >50% premium typically observed over the last two years. We continue to ascribe this to ongoing weakness in the wider stock market, which has had an impact on healthcare stocks in particular. This could now provide a more favourable entry point, particularly as IVO seeks to accelerate investment into a maturing portfolio with increasing visibility of upcoming catalysts as presented in our recent analysis of ICT & digital (report) and oncology (report) portfolio companies.

We believe a premium is justified, based on the strong historical portfolio performance and the prospect of significant uplift in the next couple of years from a number portfolio companies. Assuming some of these companies are successful in delivering on their near-term strategic objectives (eg, positive clinical data, deals, pipeline development, etc) we would expect portfolio value to significantly outstrip the cash invested. Ultimately this will determine the return on investment for both IVO in its portfolio and investors in IVO shares.

Importantly, IVO has substantial financial resources (c £148.3m + £50m second tranche of EIB loan) to make the required investment in its maturing portfolio companies, which could deliver significant returns in the long run.

As of 31 July 2016, IVO’s portfolio consisted of 45 “accelerated growth” companies (39 in 2015), which collectively account for 99% of the overall net portfolio value of £335.1m (vs £327.2m at end FY15). £69.9m was invested across 33 portfolio companies (2015: £60.8m across 30 companies), which is more than double the investment rate of two years ago (FY14). The growing maturity of the portfolio is evidenced by 79% of investments being directed towards existing portfolio companies.

The February 2016 capital raise, which grossed £100m (£98.6m net) through the placing of 23.5m new shares at 425p, primarily to IVO’s major institutional shareholders (Woodford 56%, Invesco 25%, Lansdowne 7%), significantly increased IVO’s financial position. With £133.3m held in cash at 31 July 2016 (as reported by IVO), £15m in short-term liquidity investments and the £50m EIB loan facility (currently undrawn), IVO has c £198.3m available for future investments.

We predict an investment rate of £71.1m in FY17 (£71.2m in 2018) and assume that £30m of the total £50m EIB loan is drawn-down in FY17. This second EIB loan was granted to IVO in July 2015 and can be drawn in £10m minimum tranches until July 2017. We note that IVO drew down the full £30m from its first EIB loan (in two £15m tranches in FY14 and FY15).

Our FY17 revenue forecast of £4.4m (revenues from licensing/royalties, services and corporate finance) is maintained in line with FY16 (£4.3m) at this stage. With relatively stable operating expenses, IVO’s profitability is dependent on the level of fair value gains/losses in specific periods taken through the P&L. Gains and losses are inherently difficult to predict.

Our change in net fair value estimate for FY17 now reflects an estimated gain of £30.0m (vs a £56.3m loss in 2016). £54.8m is attributable to the net fair value loss of Circassia (a one-off event related to the Phase III Cat-SPIRE failure). While net portfolio gain/loss is inherently difficult to predict, we believe FY17 gain is conservative in the context of a maturing company portfolio approaching numerous important catalysts.