Imperial Innovations — Update 10 March 2016

Imperial Innovations’ focus on ‘putting capital to work’ has seen significantly increased investment across its portfolio of maturing and rapidly emerging companies. £60.8m was invested into 30 portfolio companies during FY15 (vs £32.8m in FY14 across 25 companies), and £41.4m has been invested, or committed, so far in FY16 (since 1 August 2015).

As of 31 December 2015 the portfolio consisted of 103 companies, with a net portfolio value of £347.2m (vs £327.2m at 31 July 2015). The £20m portfolio uplift was comprised of investments of £21.2m across 14 companies, less disposals of £0.1m and fair value losses of £1.1m. Since 31 December, and excluding the recently committed investments in Precision Ocular (£6.9m) and Aqdot (£3m), Innovations reports that it invested a further £10.3m into the portfolio. This was offset by £0.9m of impairments in the unquoted portfolio, and a £7.6m reduction in the quoted portfolio (mainly affected by the wider biotech market sell-off), such that the estimated net portfolio value as of 4 February 2016 had increased slightly to £349m.

Following the £100m (gross) equity raise and with c £239m now available for investment, we see the current investment rate increasing further, such that we now estimate £70m in portfolio investments in FY16 (vs £60m previously). We expect the bulk of investment to be made into the maturing portfolio of unquoted companies, which typically holds greatest potential for unlocking nearer-term hidden value through M&A or IPO. These companies include the likes of Cell Medica, PsiOxus Therapeutics and Veryan Medical, which secured significant investments in FY15 (see Exhibit 1) and are advancing their technologies and products to pivotal stages of development (see Exhibit 2).

Meanwhile the substantial investments recently made into Mission, Inivata and Precision Ocular, all relatively early-stage companies in terms of technology/product status, also show a flexibility to make appropriate investments across the full spectrum of the portfolio. These investments (or committed investments) and other portfolio company investments made so far in FY16 (ie since 31 July 2015) are summarised in Exhibit 3. Of particular note, the £60m committed to Mission Therapeutics is Innovations’ fourth portfolio company to raise over £40m in a single private funding round, and is substantially higher than the $25m average series C round for a European biotech company in 2015 (EvaluatePharma1). We assume the recent financing round in Mission was equivalent to a series C, although technically not referred to as such; the last disclosed financing was a £20m series B.

Within the healthcare portfolio, the products/technologies being developed by Mission, Inivata and Precision Ocular demonstrate the sweet spot combination of innovation, market need and potential for disruptive technologies that Innovations seeks.

Mission is an early-stage drug discovery company focused on developing selective inhibitors of deubiquitinating (DUBs) enzymes. DUBs are involved in multiple cellular processes, including DNA damage and cell proliferation, so the inhibition of these enzymes holds potential to treat cancer and other unmet medical needs, including neurodegenerative disease, muscle wasting and infectious disease. Mission is not aware of any DUB inhibitors currently in clinical development, so the recent funding will help to accelerate the development of a series of first-in-class small molecule drugs candidates, targeting specific DUBs, into early clinical development.

Inivata is a cancer genomics company working in the burgeoning field of ‘liquid biopsies’, the concept that a simple blood test can be analysed to help diagnose multiple cancers, triage patient treatment options and monitor treatment response. Inivata’s technology is based on circulating DNA analysis (ctDNA) to detect and analyse genomic material from a cancer patient's cell-free, circulating tumour DNA collected from a blood sample. The fresh funds will be used to accelerate clinical studies to demonstrate the clinical benefits of Inivata’s technology.

Precision Ocular’s technology is focused on the optimum delivery and distribution of existing and new ophthalmic therapeutic agents, with the aim of increasing efficacy while reducing side-effects and minimising frequency of treatment. A wide range of retinal diseases are targeted, including age-related macular degeneration (AMD), diabetic macular edema (DME), retinal vein occlusion (RVO), uveitis and cystoid macular edema (CME). Notable co-investors in the financing round are Consort Medical and Hovione Scientia, specialists in the field of drug-delivery devices and particle engineering/drug encapsulation, respectively, with which Precision already has development collaborations. The funding will be used to develop novel candidates before proceeding into human clinical studies.

As a technology commercialisation and venture investment company, Innovations’ ability to replenish its portfolio of innovative technology companies via its primary/preferred partner status with some of the UK’s leading academic institutions is critical to the group’s long-term future. Operating almost exclusively within the so-called ‘golden triangle’ between London, Oxford and Cambridge (in the UK), Innovations has substantially strengthened its ties with University College London (UCL) and Cambridge University through two recent initiatives, to bolster its core collaboration with Imperial College, London.

In January 2016, Innovations announced that it had committed £24.75m to a new UCL Technology Fund, the first investment fund that UCL has created to commercialise its research. Innovations’ investment will be matched by the European Investment Fund, creating a total fund of £50m to invest over a five-year period, via early-stage proof of concept funding, licensing opportunities and the formation of spin-out companies within life sciences (not therapeutics) and physical sciences. The fund will be managed by Albion Ventures, a UK venture capital investor, while the UCL’s technology transfer company, UCL Business (UCLB), will be the technical advisor to the fund.

As a limited partner in the fund, Innovations now has visibility of potential intellectual property from across UCL’s research base, and will be offered co-investment opportunities or first-refusal rights to invest in projects that the fund decides not to invest in. As such, in addition to its £24.75m commitment to the fund, Innovations expects to also have opportunities to make direct investments into selected UCLB spin-outs that fit its technology and growth profile.

Also in January 2016, Innovations announced that it had committed £3.3m to a new £40m joint venture between AstraZeneca, GlaxoSmithKline, Johnson & Johnson and the technology transfer offices of three top UK universities (Imperial College London, UCL and Cambridge University), namely Innovations, UCLB and Cambridge Enterprise, respectively. The so-called Apollo Therapeutics Fund is a significant new enterprise within the tech-transfer sector, being the first time that global pharmaceutical companies and world-leading universities have collaborated to create this type of fund.

Each pharma company will contribute £10m over six years to the fund, with £3.3m invested from each technology transfer office (Innovations, UCLB, Cambridge Enterprise). The aim of Apollo is to advance academic pre-clinical research from the three universities to a stage at which it can either be taken forward by one of the pharma companies, following an internal bidding process, or be out-licensed. The pharma partners will also provide R&D expertise/resources to help with commercial evaluation and development of projects.

In summary, Innovations’ participation in the Apollo fund and strengthening relationship with UCL significantly enhance the group’s access to intellectual property and novel technologies from a broader university base and provide greater opportunity to collaborate with major pharma companies like AZ, GSK and J&J.

As of 31 December 2015, the investment portfolio comprised 103 companies, of which Innovations classified 44 as ‘accelerated growth’ companies, and this sub-group represented 98.9% of the total net portfolio value (£347.2m vs £327.2m at 31 July 2015). The accelerated growth portfolio typically comprises businesses that Innovations has co-founded, actively invests in, holds a board seat and retains a majority interest in (typically 25-40%). A further 31 companies are deemed ‘lighter touch’, with less direct funding required but strategic advice given, while the remaining 28 companies are in the ‘low involvement’ category, where Innovations typically does not invest further without appropriate further development of the product/technology.

As of 31 December 2015, the unquoted portfolio was valued at £239.6m (vs £220.5m at 31 July 2015), with the quoted portfolio valued at £107.7m (vs £106.8m). While the quoted portfolio is simply marked to market value, a substantial portion (c 95%) of the unquoted portfolio is valued at cost or last funding round, with only a small amount of value (c 3%) attributed to the last funding round and adjusted for milestones and impairments. As of 31 July 2015, the carrying value of the unquoted portfolio was just 1.3x the cumulative cash invested into these companies. Consequently, additional investment and the positive outcome of key catalysts have the potential to unlock hidden value.

The development of public companies will typically offer the prospect of significant near-to-medium-term gains/losses as newsflow will have a more pronounced and immediate impact. One obvious near-term example is the Phase III data due in Q216 from Circassia’s Cat-SPIRE study with its allergy immunotherapy technology. However, the unquoted portfolio offers the prospect of longer-term growth, especially as a number of Innovations’ maturing ‘accelerated growth’ companies approach important catalysts. Achieving technical, clinical and commercial milestones should prompt greater valuation uplifts in the future.

We again highlight the potential valuation discrepancy with the likes of Cell Medica and PsiOxus and publicly traded biotech companies focused on cancer immunotherapy companies that are developing similar technologies. The respective implied valuations of these companies (as of 31 July) of £78m and £81m remain significantly lower than peers such as Juno Therapeutics ($3.9bn), Kite Pharma ($2.3bn) and Bellicum Pharmaceuticals ($250m) even after significant recent falls in share prices across much of the NASDAQ biotech sector.

Other mechanisms for unlocking portfolio value from the unquoted portfolio include IPOs or trade sales. Innovations has had success on both fronts. Its four healthcare holdings (Circassia, Abzena, Oxford Immunotec and Ixico) that listed in 2014 accounted for £106.8m (32.6%) of the portfolio (at 31 July 2015), with all except Ixico ranked within the top 10 portfolio investments. The top 20 portfolio companies (as of 31 July 2015) are presented in Exhibit 4.

Innovations intends to maintain or increase its current rate of portfolio investment while increasing its capacity for identifying and managing investments. Key hires in its ventures team and positioning as the collaborative partner of choice for technology transfer offices/university venture funds should help achieve this. Extensive expertise in healthcare (therapeutics/medtech) has generated a sector that accounted for 73.7% (£233m) of total portfolio value at 31 July 2015. The focus for 2016 will be on replicating this success in other sectors and rebalancing the investment portfolio by building up activities in the non-therapeutic space. Innovations is seeking to increase the relative contributions of other sectors, in particular ICT/digital, which was only 9.9% (£32.3m) of the portfolio, although this partly reflects the low capital intensity of ICT and the successful execution of three trade sales in past two years. Increased investment in Yoyo, Impression Technologies and Featurespace,2 and the recent additions of Garrison Technology, Import.io, Telectica and WaveOptics to the ICT portfolio demonstrate this intent.

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 three publicly listed companies within the top 10 valued assets. As highlighted earlier in the report, the share price performance of the public portfolio companies (particularly Circassia, which accounted for 27.5% of the total portfolio value at 31 July 2015) may affect the total portfolio value either negatively or positively, with the carrying values of these investments marked to market at each financial period end.

With regard to Circassia, we note that the stock is currently trading c 11% lower than the closing price on 31 July 2015, which would similarly reduce Innovations’ carrying value in Circassia by c 11%, or c £8.75m, to c £71m.

Imperial Innovations is also very tightly held, with four shareholders accounting for a total of 90% of the equity, including Invesco (39.75%), Woodford (19.99%), Imperial College (17.4%) and Lansdowne (12.88%). This contributes to limited free float (10%) in the stock, which may increase volatility even on low trading volumes.

Imperial Innovations’ shares (at 410p) currently trade at a c 30% premium to our estimated FY16e NAV of 315p/share (at 31 July 2016), after adjusting for the recent capital raise and disclosed portfolio performance. Innovations 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 other research organisations (eg Babraham Institute). We note that the current premium is substantially lower than the >50% premium typically observed over the last 18-24 months; undoubtedly this has been affected by the wider stock market declines, which have had an impact on healthcare stocks in particular, but it could now provide a more favourable entry point, particularly as Innovations seeks to accelerate investment into a maturing portfolio.

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

Importantly, Innovations has substantial financial resources (c £239m following the recent capital raise) to make the required investment in its maturing portfolio companies that could deliver significant returns in the long run.

As of 31 December 2015, Innovations’ portfolio consisted of 103 companies, with a net portfolio value of £347.2m (vs £327.2m at 31 July 2015). The £20m portfolio uplift was comprised of investments of £21.2m across 14 companies, less disposals of £0.1m and fair value losses of £1.1m. Since 31 December, and excluding the recently committed investments in Precision Ocular (£6.9m) and Aqdot (£3m), Innovations reports that it invested a further £10.3m into the portfolio. This was offset by £0.9m of impairments in the unquoted portfolio, and a £7.6m reduction in the quoted portfolio (mainly affected by the wider biotech market sell-off), such that the estimated net portfolio value as of 4 February 2016 had increased slightly to £349m.

The recent capital raise, which grossed £100m (£97.5m net estimate) through the placing of 23.5m new shares at 425p, primarily to IVO’s major institutional shareholders (Woodford 56%, Invesco 25%, Lansdowne 7%), significantly increases Innovations’ financial position. When added to the £91.6m held in cash at 29 January 2016 (as reported by IVO) and the £50m EIB loan facility (currently undrawn), we estimate that Innovations has c £239m available for investment.

As such, we now see the investment rate increasing further and estimate £70m in portfolio investments in FY16 (vs £60m previously). We note that £41.4m has been invested, or committed, so far in FY16 (since 1 August 2015), which compares to £60.8m invested during FY15 and £32.8m in FY14. We have now extended our financial forecasts to FY17 (Exhibit 5) and predict a similar portfolio investment rate of £70m in FY17. We currently assume that £30m of the total £50m EIB loan is drawn-down in FY17; this second EIB loan was granted to Innovations in July 2015 and can be drawn in £10m minimum tranches until July 2017. We note that Innovations drew down the full £30m from its first EIB loan (in two £15m tranches in FY14 and FY15).

Our FY16 revenue forecast of £5m (revenues derived from licensing/royalties, services and corporate finance) is maintained in-line with FY15 (£5.1m) at this stage, although we note that Innovations has emphasised the potential for greater revenue growth over the medium to long term. During FY15, 39 new licences were signed and 66 patents filed, demonstrating the ongoing robustness of the Innovations IP portfolio.

With relatively stable operating expenses, Innovations’ 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 FY16 now reflects an estimated loss of £4m (vs a £10m gain previously), mainly as a result of the reported £9.8m net fair value loss in the quoted portfolio in H116 (1 August 2015 to 29 January 2016). We expect some fair value gains (c £5m) to be recorded in H216 (as portfolio companies progress), but acknowledge that the major swing factor will be the results of Circassia’s Cat-SPIRE Phase III study in Q216, which is likely to have a materially positive or negative impact on Innovations’ fair value for its holding. We estimate a £15m fair value gain in FY17, although this could be conservative in the context of a maturing company portfolio approaching important catalysts.