Abzena — Starting to get back on track

After the disappointment of the trading update earlier in September, where revenues at all three of Abzena’s service offerings were below expectations, some reassurance of 7.6% revenue growth (£9.6m) at group level in the six months to 30 September 2017 should be welcomed by investors. Two out of three of Abzena’s service lines demonstrated meaningful growth, if lower than was previously expected, compared to H117. While Biology research services was the laggard with a revenue decline to £2.3m in the first half, at least the capacity constraint issue is addressable by the existing investment programme. The adjusted EBITDA loss of £7.0m and reported loss of £8.0m were both about twice that reported in the previous half-year’s numbers, representing increased operational expenditure in the face of close to flat sales.

At the time of the fund-raising in April, management aspired to that stock issuance being the last before break-even. We believe this is still achievable and our model continues to forecast adjusted EBITDA break-even in c FY20. Depending on the interplay between capital expenditure phasing and revenue growth on Abzena’s cash balance, the investigation of a secured debt facility in order to maintain healthy headroom without further shareholder dilution looks eminently sensible. For the moment, we have not included a debt facility in our model.

The issues at Biology research services that resulted in a decline in sales in the half-year to September were (a) demand exceeding capacity and (b) industry introspection on immunogenicity assays. Increasing demand is a good thing as long as customers are not lost while extra capacity is built. In framing the sector’s debate on immunogenicity assays, Abzena’s thought leadership and engagement with key opinion leaders and customers continue so that Abzena’s enhanced assay capabilities become recognised as the standard.

Abzena sees a significant proportion of its service business deriving from repeat customers, with seven of its top 10 customers returning for a more integrated service. This was demonstrated in the recent announcement of the largest manufacturing contract awarded to date (~$5m). This ADC manufacturing contract award was by a longstanding customer of the Chemistry business. An integrated service offering is important for the maximisation of cross-selling opportunities. One of the challenges of this interconnection was seen earlier in the year when a delay to a project at the manufacturing process development stage had a knock-on effect on the planned GMP manufacturing campaign. Although the antibody will be manufactured by Abzena for the client now the issue has been fixed, freed-up manufacturing capacity and cost can be difficult to absorb at short notice.

While much comfort was given on the profile of Abzena as a growing biopharmaceutical services business, it will probably take another earnings announcement before investor confidence returns. Between then and now, further licence agreements for Abzena Inside products should be expected. New contracts like that recently signed on ADC manufacturing with a US biotech company have already occurred, so business development appears to be humming along. In the medium term, two of Abzena’s Inside products will report Phase III results next year. Gilead Sciences’ andecaliximab is in Phase III for gastric cancer and management appeared excited by Bioverativ’s BIVV009 in cold agglutinin disease. One of the reasons for this could be that haematological clinical trials can have much shorter treatment durations than oncology studies and results for the first BIVV009 Phase III study might be available during the first half of 2019.

The only way out of the revenue volatility caused by delays that occur in the earlier stages of a project (as described above) is to have more capacity available. This means that a delay to one programme (even if Abzena eventually recognises the full value of the integrated contract) has much less of an effect on the group. Currently, the top 10 customers account for 58% of revenues and this can probably be expected to reduce over time as multiple and larger contracts are awarded. Abzena’s investment program has the additional objective of increasing margins since the new automated bioreactors have shorter downtimes and need less committed labour.

We have reduced our fair value to £90m (from £110m) or 42.1p per share (vs 52p) by using the cash number at the end of November, a revised exchange rate, average burn rate (calculated on the average monthly change in cash in Abzena’s year to date) and number of shares in issue. In addition, we have looked at the sales growth rate implied by September’s trading update and applied it across the services businesses and licensing revenues through to FY20. As a result, our FY18, FY19 and FY20 revenue estimates were reduced by c £1m, c £1m and c £3m respectively. We may have underestimated R&D tax credits in later years on our valuation since none were received in H118, but will update this in our model after the full-year results. The three-phase DCF for the services businesses and risk-adjusted royalties from existing and future licensed products have all been adjusted. For future royalty revenues, we estimate peak sales, launch dates, probabilities of success and small royalties (up to 1%) for the programmes in clinical development. We have estimated better deal economics from the ADC candidates and as a result we model a 2.5% royalty. Further newsflow from the progression toward royalties from its Abzena Inside products, further service contract deals and/or ThioBridge deals may provide additional upside to our current estimates. After Abzena’s full-year results we will be looking to incorporate the more accurate estimates of its increased capacity and margins in the later years.

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 prior to its IPO. After its listing, during 2015 the group acquired PacificGMP (contract, development and manufacturing) and TCRS (specialist contract chemistry and bioconjugation). This enables Abzena to offer a comprehensive and integrated biologics offering.

The significant service aspect to Abzena’s business model provides investors with a lower-risk exposure to the biotech sector than a pure-play product development company where most of the risk resides in the success or failure of one molecule. The Abzena Inside portfolio also provides investors with a diversified product royalty exposure. While the pharmaceutical services sector is growing and fragmented, with the trend towards pharmaceutical companies outsourcing this type of work, a public standalone integrated biopharmaceutical services business is uncommon.

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, now has operations in San Diego (PacificGMP) and Philadelphia (TCRS). The company employs c 220 staff.