Imperial Innovations — Update 14 June 2016

Imperial Innovations is a UK-based technology commercialisation and investment company. As at 31 January 2016, it had a portfolio of 105 investments in spin-out companies in the healthcare (therapeutics, medtech and devices), engineering and materials and ICT/digital sectors. These companies are spin outs from the UK’s leading academic centres within the so-called ‘golden triangle’ between London, Oxford and Cambridge (in the UK) and include Imperial College London (ICL), Cambridge University, Oxford University and University College London (UCL). In 2016, closer ties were forged with Cambridge University, ICL and UCL through participation in the £40m Apollo Therapeutics Fund and the £50m UCL Technology Fund. Innovations was founded in 1986 as the technology transfer office for ICL and was later itself spun out and subsequently admitted to AIM in 2006. It has raised a total of £346m in equity to date. Since listing in 2006, Innovations has invested a total of £264.3m across its portfolio companies, which have now collectively raised more than £1.3bn. Co-investors in the therapeutics portfolio are typically tier 1 institutions or VCs backed by big pharma or A-list funds.

Innovations’ shares (at 430p) currently trade at a c 34% premium to our estimated end-FY16 (31 July 2016) NAV of 321p/share. Innovations has historically traded at a premium to NAV, which can be ascribed to the unrecognised value of its portfolio (mostly private companies that are typically valued at cost or last financing round) and its access to innovative and disruptive technologies emerging from Imperial College and other leading UK universities (Oxford, Cambridge and UCL). We believe this premium is fully justified, based on strong historical portfolio performance and the prospect of significant uplift in the next couple of years from its maturing portfolio, including those companies that presented at Innovations’ capital markets event. We also expect that the funding rounds secured so far during financial H216 (Mission Therapeutics, Nexeon and FeatureSpace) will prompt a revaluation of the carrying value of these companies. Assuming some portfolio 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 investment. Ultimately this determines the return on investment for both Innovations and Innovations investors.

The investment case rests on the success of Innovations’ 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 for its publicly listed companies. With the carrying values of these companies marked to market at each financial period end, share price performance (particularly Circassia, which accounted for 22% of the total portfolio value at end-January 2016) may significantly affect the total portfolio value, positively or negatively: the upcoming results of the Circassia Phase III Cat-SPIRE study are likely to have a significant impact on reported FY16 portfolio NAV (end-July 2016).

With £91.6m of cash at end-January 2016, a £100m equity issue in February 2016 and the currently undrawn second £50m EIB loan, Innovations has sufficient funds to support its accelerating investment strategy (c £239m). Approximately £50m has been committed to date in FY16; we estimate £70m in portfolio investments for the full year. Innovations’ investment is steadily increasing with gross £60.8m invested in FY15 and £32.8m in FY14. We continue to predict a similar portfolio investment rate of £70m in FY17.

Circassia’s upcoming Phase III Cat-SPIRE read out is a key focus for investors. While Circassia is the largest single component of Innovations’ portfolio (21.8% share with a net carrying value of £77.5m), the remaining 78.2% has the potential for significant value creation and is a vital part of Innovations future. Nevertheless, the Cat-SPIRE data coupled to Innovations’ limited free-float (c 10%) means that this binary outcome will inevitably have a significant impact on both Circassia and therefore Innovations’ share prices and investor sentiment in the near term (Exhibit 1).

Longer term, however, there is significant potential for value creation from Innovations unquoted portfolio, especially as a number of maturing ‘accelerated growth’ companies approach important catalysts. As of 31 January 2016, the unquoted portfolio was valued at £255.1m (vs £220.4m at 31 July 2015), with the quoted portfolio valued at £100.0m (vs £106.8m). Achieving technical, clinical and commercial milestones should prompt greater valuation uplifts in the future, while other mechanisms for unlocking unquoted portfolio value include IPOs or trade sales.

Momentum in and increasing maturity of the unquoted portfolio is evidenced by the number and size of recent funding rounds that Innovations has led. These include £19m for Kesios, £60m for Mission Therapeutics, £30m for Nexeon, £31.5m for Inivata and £6.2m for FeatureSpace. This also highlights the wider belief in the potential of these companies shared by the respective investment syndicates. Management from the first three companies presented at the recent Capital Market’s Day; we profile these and the other presenting companies below.

Innovations’ first Capital Markets Day in May 2016 provided the opportunity to showcase a number of its unquoted portfolio companies, including both established companies (Nexeon, PsiOxus, CellMedica and Mission Therapeutics) as well as more newly created ‘rising stars’ (Kesios and Econic Technologies). These companies collectively represent c 28% of the Innovations portfolio at end-January 2016 and, as such, had a similar portfolio weighting to Circassia. However, with material near-term milestones approaching for a number of these companies, there is significant potential for future valuation uplift, so that, together they could make a greater contribution to overall Innovations portfolio value than Circassia in the mid-term.

A common theme across the presentations was that Innovations’ involvement is not limited to providing funding to build high-quality companies, but also to supporting technology development and building highly skilled management teams. These world-class internationally experienced management teams consist of individuals with the right scientific and commercial acumen to develop and grow their respective companies with the aim of creating substantial value.

The fact that a number of important value inflection points are approaching for these portfolio companies (Exhibit 2) is of particular importance as, while the quoted portfolio is simply marked to market value, a substantial portion (c 83%) of the unquoted portfolio is valued at cost or last funding round, with a much smaller, albeit growing amount of value (c 14%) attributed to the last funding round and adjusted for milestones and impairments. As of 31 January 2016, the carrying value of the six presenting companies was c 1.58x the cumulative cash invested. Consequently, additional investment (such as the recent funding rounds for Nexeon and Mission Therapeutics) and the positive outcome of key catalysts have the potential to unlock hidden value.

Nexeon was founded in 2005 with an aim to develop next generation batteries built on silicon anode technology. Innovations reported cumulative investment £22.4m as of 31 January representing a net carrying value of £34.1m. Post period, Nexeon announced a £30m funding round in May in which Innovations committed £5.0m. Innovations’ stake in Nexeon, including the most recent funding round, was reported at 33.7%. Nexeon has raised a total of £85m in equity.

Nexeon has been led by CEO Dr Scott Brown since June 2009. His prior senior management roles at Cambridge Display Technology included responsibilities for commercial and R&D activities; he also spent time in Japan working closely with some of the leading Asian electronic companies. In August 2013, Tsuyonobu Hatazawa joined Nexeon in 2013 from Sony after a long career in battery development; he is now directing Nexeon technical strategy as chief technology officer. An experienced scientific advisory board strengthens Nexeon’s battery sector expertise.

The new funds raised in May will enable Nexeon to both acquire IP complementary technology and begin designing a larger manufacturing plant. A new lab in Japan also aided by the recent funding round will enable Nexeon to be closer to its key customers and partners and facilitate access to local battery expertise, while a 20 tonne manufacturing plant in Oxfordshire will allow delivery in the quantities that are required.

Unlike most current lithium batteries, which use carbon anodes, Nexeon uses silicon. Silicon anodes allow for approximately 11 times the increased gravimetric battery capacity (theoretical capacity of 4,212mAh/g) of carbon anodes (theoretical capacity of 372mAh/g); however, they generally have poor life cycles caused by mechanical failure. These result from large volume changes (often up to 400%) that occur when the batteries are charged and drained. Nexeon states that it has overcome this problem, allowing for both increased capacity over carbon anode technology as well as similar battery lifespan. This volumetric increase needs to be considered in battery design; as such the volumetric energy density is a still impressive but more modest increase, typically representing a three-fold improvement over lithium carbon batteries.

Nexeon believes it has a market leading technology that is, amongst other things, compatible with current manufacturing processes and demonstrates increased capacity per weight/volume. However, little is publically disclosed about Nexeon’s current batteries including their capacity and lifespan. As the company continues to grow, more visibility on its technology may occur as Nexeon looks to position itself as a market leader.

Of importance is Nexeon’s approach to manufacturing. The speed of adaptation of innovative technology can often rely on how well it fits with current standards and practices. Nexeon has a ‘drop in’ (batteries can be manufactured with minimal change to existing techniques) approach to its manufacturing that it believes minimises disruption. Additionally the batteries are designed to easily ‘drop in’ to products. One way this is achieved is by having them operate at the same voltage as existing lithium ion batteries. This allows them to be used with existing technology without the need for modifications.

Improved battery technology is largely seen as one of the main technological challenges facing both the automotive and mobile phone sectors. Most advancements in battery life have been incremental in the last decade and the majority are a result of better software rather hardware. As such, there is a major need for new higher capacity battery technology and many companies are competing to become the market leader. Arguably Tesla Motors (TSLA) is leading the way and has diversified into power cells for both business and homes. The construction of its own gigafactory battery production plant will make them one of the global leaders in battery production and highlights the growing global demand for higher capacity batteries. This increased awareness being generated by companies like Tesla is beneficial for Nexeon as it widens the audience of potential investors beyond what was, until recently, a niche market.

PsiOxus Therapeutics is an immune-oncology company focused on oncolytic viruses. It was founded in 2010 in its present form, having been created by the combination of Imperial College-spin out Myotec Therapeutics with Hybrid BioSystems. It has, to date, raised £45.7m with the most recent funding round being a £25m Series C in May 2015. Innovations has invested £13.7m which had a last reported net carrying value of £22.6m and represented a 27.9% of holding.

John Beadle has been CEO of PsiOxus since inception, having been CEO of both progenitor companies. He was previously co-founder and chief medical officer of PowderMed, which was subsequently acquired by Pfizer for over $300m in 2006. Prior to PowderMed, he held roles at PowderJect, Pfizer and GlaxoSmithKline where he was most recently VP, Global Medical Operations. PsiOxus’ management was further strengthened by the appointment of Paolo Paoletti in January 2016. Dr Paoletti is CEO of another Innovations portfolio company, Kesios Therapeutics, and was previously president, GSK oncology and VP, clinical development at Lilly Oncology.

Enadenotucirev (EnAd), PsiOxus’ lead programme, is an oncolytic virus that was generated from an adenovirus library that underwent multiple rounds of selection against tumour cells. Viruses that killed the aforementioned tumour cells were then tested against healthy cells to check specificity. Viruses that demonstrated low healthy cell death were then chosen as a product candidate (EnAd). It can be delivered intravenously or by intra-tumoural injection and kill the cancer cells by lysis.

EnAd, formerly known as coloAd1, is being studied in four clinical trials in a variety of cancer indications. Data is available from a dose finding Phase I/II study (EVOLVE) and a Phase I mechanism of action study (MoA). Combination studies of EnAd with paclitaxel (OCTAVE study) and pembrolizumab (SPICE study) are ongoing. Results so far suggest that EnAd has a safety profile in line with other adeno-associated viruses with mostly grade 1 or 2 events while efficacy data at this stage is limited due to the early stage of results and limited patient numbers (data to date is from 10 patients in the MoA study and 15 patients in EVOLVE). Safety and initial efficacy data from OCTAVE and maximum tolerated dose data from SPICE are expected later this year, with clinical proof of concept in both studies expected to be achieved in 2017.

EnAd appears to have a number of potential benefits over Amgen’s first-in-class oncolytic virus, Imglyic (talimoegne laherperivec or T-vec), which is approved for melanoma and was the rationale behind its $1bn acquisition of BioVex in 2011. These benefits include mode of administration, not being subject to the same manufacturing limitations, improved stability and potential for use in all epithelially derived tumours (but not melanoma or other neuroendocrine tumours).

PsiOxus also has a tumour specific delivery platform, T-SIGnTherapy, which underpins its next-generation pipeline. This includes a number of preclinical projects that are being designed to deliver immunotherapies to local tumour sites of action using variously cytokines, antibodies, T-cell activating ligands and combinations of the above. The lead T-SIGn programme is NG-348, a virus that modifies tumour cells to express a receptor that is recognised by a T-cell. It aims to be an off-the-shelf mass-produced product directed against solid tumours and is expected to enter the clinic in 2017.

Founded in 2007, Cell Medica is focused on T-cell immunotherapies for immune reconstitution and immuno-oncology. To date they have raised £72m, of which £12.3m has been invested by Innovations (representing a carrying value of £21m at end-January 2016). Innovations holds a 27% interest in the company. The most recent capital raise was a £50m series B funding led by Innovations (which committed £15m) in November 2014.

Cell Medica has one marketed product, Cytovir CMV, which is indicated for the prophylaxis and treatment of CMV (cytomegalovirus) infections following allogeneic hematopoietic stem cell transplantation (allo-HSCT). Cytovir CMV consists of anti-CMV T-cells, which are manufactured from the peripheral blood mononuclear cells of a matching healthy donor.

Cytovir CMV was studied in two clinical trials ASPECT and IMPACT. ASPECT involved two arms, which were randomised 2:1 in favour of the treatment arm. 35 patients were enrolled in the treatment arm with 18 withdrawals due to various factors mainly relating to existing GvHD (n=6) or insufficient starting material (n=8). A 109.1 +/- 42.5 fold increase in CMV specific cells for the treatment arm was observed compared with a 10.5 +/- 7.1 increase in the control arm (17 patients with six withdrawals). The IMPACT study demonstrated similar safety in the treatment arm as the control; while there were reduced CMV reactivations in the treatment arm, they were not statistically significant. Cytovir CMV is commercially available (pre-reimbursement) in the UK, Germany and Ireland; reimbursement is anticipated in 2017.

The second immune reconstitution programme, Cytovir ADV, is in development for the treatment of adenovirus (ADV) infections following an allo-HSCT. Cytovir consists of allogenic, expanded ADV specific T-cells. It is currently in an ongoing Phase I/II trial (ASPIRE); interim analysis reported complete adenovirus remission in all five patients who received treatment. Consultation with the EMA for scientific advice is planned in Q316.

Cell Medica’s immune-oncology pipeline is focused on viral and infection related cancers. The lead product candidate, CMD-003, consists of engineered T-cells that target cancer cells which express the oncogenic Epstein Barr virus (EBV). EBV is part of the Herpes family of viruses and by some estimates infects around 90% of the population. EBV was the first virus to be discovered to cause cancer and is now widely associated with a range of cancers. CMD-003 is being trialled across four indications, three of which are at the preclinical stage. The lead indication is EBV positive extranodal natural killer T cell lymphoma (ENKTCL), which is in a Phase II trial titled CITADEL.

CITADEL is a single-arm 35 patient Phase II trial for patients who have previously failed asparaginase-based chemotherapy or are high risk (regardless of chemotherapy status). Treatment involves two injections at days one and 15 with further injections at week eight, month three and month six for patients without clinical signs of disease progression at week eight. CITADEL enrolled its first patient in early 2015; initial data is expected towards end-2016 with completion expected in 2017. A similar product to CMD-003 is also under investigation in patients with a range of EBV+ lymphomas in the GRALE study at the Baylor School of Medicine; data updates are anticipated in 2016.

CMD-003 was given orphan drug status by the FDA in March 2015 for the treatment of EBV+ non-Hodgkin lymphomas. FDA Fast Track Status and European Orphan Designation may be achieved later this year. This would potentially allow for accelerated progression to market with possible BLA/MAA filings for ENKTCL in 2018/19.

Towards the end of 2016 we expect the initiation of label expansion studies for CMD-003 with the CIVIC trial. This will study CMD-003 in three additional indications: EBV+ Hodgkin’s lymphoma, EBV+ diffuse large B cell lymphoma and EBV+ post-transplant lympho-proliferative disease. Label expansion applications could be filed in 2022/2023. The expected completion of the CITADEL trial and data updates for CIVIC, both expected in 2017, will represent potential major value inflection points for Cell Medica. Additionally, progress is expected with the earlier-stage pipeline in 2017; in particular: (1) CMD-044 for HPV-related cancer, which has shown proof of concept in academic studies and will move into Phase I in 2017; and (2) CAR and TCR-modified targeted cancer programmes, of which the first should complete preclinical development in the same timeframe, ahead of possible Phase I start in 2018/19.

Mission Therapeutics is a drug discovery and development company that was founded in 2011 by Professor Steve Jackson of the University of Cambridge. It is developing a pipeline of small molecule drugs focused around the ubiquitin pathway, particularly inhibitors of deubiquitylating enzymes (DUBS). Ubiquitin is a small protein that is found in the vast majority of tissues and is involved in numerous cellular processes, including DNA damage and cell proliferation, so the inhibition of these enzymes holds the potential to treat cancer and other unmet medical needs, including neurodegenerative disease, muscle wasting and infectious disease.

Since January 2015, Dr Anker Lundemose MD PhD has been CEO. He has extensive management experience, most recently having been CEO of Bionor Pharma and co-founder/CEO of Prosidion, and has also been involved in six biotech exits and IPOs. Mission’s founder and chief scientific officer, Professor Steve Jackson, has been part of the Gurdon Institute in Cambridge since 1991 and is the senior group leader as well as the head of Cancer Research UK’s laboratories. He also co-founded KuDOS Pharma, which was acquired by AstraZeneca in 2006 for £120m and was the originator of Lynparza (olaparib), the first PARP inhibitor, approved in 2014.

Mission has raised a total of £87m in venture associated capital, with £60m coming from a February 2016 Series C funding round. Innovations had invested £5.8m as of 31 January 2016 and made a further commitment for £11.3m in the February fund raise. This fresh financing allows Mission Therapeutics to accelerate the development of a series of first-in-class small molecule drug candidates, targeting specific DUBs, and advance their product candidates into the clinic. The two lead programmes, a potentially disease modifying USP30 inhibitor for Parkinson’s disease and a USP7 inhibitor for unspecified cancers, are expected to start their lead IND candidate selection process within the next 12-18 months.

The USP30 inhibitor for the treatment of neurodegeneration in Parkinson’s disease is believed to enhance mitophagy and will begin the IND track candidate process in late 2016. USP30 is a deubiquitylating enzyme that when overexpressed can block the degradation of damaged mitochondria through mitophagy. Defective mitophagy is believed to be linked to Parkinson’s disease; thus inhibition of USP30 may be beneficial in Parkinson’s disease by promoting mitochondrial clearance. Initiation of Phase I studies is planned around end-2017 to provide proof of principle for improving mitophagy in Parkinson’s disease patients in a sub-acute Phase Ib setting. There is potential for expansion of clinical studies into other neurodegenerative indications involving mitochondrial dysfunction (eg amylotropic lateral sclerosis, Huntington’s and Alzheimer’s diseases).

Their second lead candidate is a USP7 inhibitor for use within oncology that inhibits regulatory T-cells (Tregs). Its IND track candidate process is expected to start in H117. USP7 is known to be involved in several oncogenic pathways; of key interest is its ability to control the suppression of Tregs through regulation of Foxp3. Inhibition of USP7 decreases Treg suppression, which may be beneficial in a cancer setting as it has the potential turn non-responsive immune-oncology patients into responders. Hence Mission plans to combine its USP7 inhibition with immune checkpoint inhibitors. Initiation of Phase I is planned for 2018.

Mission’s strong cash balance post-Series C should enable it to deliver Phase I results for its two lead programmes, which if successful will provide validation to their wider platform. Deubiquitylating enzyme-based therapies are in their infancy and while they hold promise, Phase I results will prove the first litmus test for the company and more broadly the field.

Econics Technologies’ platform uses proprietary catalyst technology to develop polymers that partly comprise carbon dioxide (CO2) displacing more expensive petrochemical feedstocks. It was founded in 2011 as a spin out from the Chemistry Department of Imperial College based on technology co-invented by Prof Charlotte Williams (CSO) and Dr Mike Kember (head of research & IP). In 2014 Dr Rowena Sellens joined the company as CEO; she was most recently general manager EMEA at Lucite International after having held a number of previous roles within the same company. To date, Innovations has invested £4.4m with a carrying value of £6.1m, representing a 56.1% shareholding.

Econic’s technology allows for the production of polymers from CO2 and epoxides; these are linked together by Econic’s catalysts and produce an alternating polymer chain (Exhibit 4), which can contain up to 43% CO2 by weight. This basic polymer structure is altered in length and endings to suit the required application. Currently this consists of two main technologies: low molecular weight (LMW) polycarbonate polyols and high molecular weight polycarbonates.

The core focus for Econic is LMW polycarbonate polyols, which are the main component used in the production of more complex polymers such as polyurethane. Polyurethane is used in an array of commercial products from footwear and mattresses to cars. The polyol market represents c 7% of the global plastics market and is, according to Econic, a $20bn market growing at over 5% pa.

A key feature of Econic’s catalyst technology is the reduced CO2 footprint it has vs conventional polymer products. The utilisation of CO2 within the polymers has a dual effect:

Econic’s catalyst technology has both environmental benefits and economic benefits. In polymer production the main cost relates to the raw materials that are derived from petroleum. As nearly 50% of this raw material is replaced with cheaper CO2, overall costs should be significantly reduced. Thus it can be applied to both specialty markets (producing higher value product properties at reduced cost) and bulk markets (saving costs on both raw materials and the production process). Econic’s technology produces a uniform and consistent product under the same conditions as the original process and it also has a process advantage vs the competition (eg Covestro and Novomer). It is lower cost and also the only catalyst that can be retrofitted on to existing manufacturing assets.

The transition to commercialisation from development is underway. Econic has active programmes with six out of the 10 global polyol producers and is at the process and product development stage with two market leaders. Catalyst scale up is ongoing during 2016, with first catalyst sales (and therefore revenues) and customer scale up expected in 2017. Potential first product launch could be in 2019 with regular sales from established customers anticipated by the company by 2020.

Kesios Therapeutics is a clinical stage drug development company focused on personalised medicine for multiple melanoma. It was founded in November 2015 as a spin out of the Department of Medicine at Imperial College having raised £19m in a Series A round. Of this £19m investment, £3.3m was invested by Innovations, which at end-January 2016 reported having a net carrying value of £5.7m. Innovations currently has a 42% shareholding.

Kesios has a highly experienced management team, which is led by CEO, Paolo Paoletti, who was previously the president of GSK oncology and the VP of clinical development at Lilly Oncology. The CMO, Jane Robertson, is a practising physician who was previously Executive Global Clinical Director (Oncology) at Astra Zeneca. Kesios was founded by Guido Franzosa MD,PhD, Menotti Ruvo, PhD and Laura Tornatore, PhD to develop and commercialise initial work at Imperial College London where Professor Franzosa is the head of the centre for signalling and inflammation, as well as professor and chair of signal transduction and inflammation.

Kesios’s lead product candidate is KES-001, which has a novel target (GADD45β/MKK7) in NF-KB signalling pathway in cancer (Exhibit 5). KES-001 binds to the JNK kinase, MKK7, causing disruption of the GADD45β (an anti-apoptotic protein)/MKK7 complex that in turn disrupts the NF-KB survival pathway. The binding of GADD45β to MKK7 is an essential survival pathway of cancerous cells; hence inhibition of this should lead to an increase in cancer cell death.

Preclinical data presented at the Capital Markets Day demonstrates an increase in non-myeloma cell survival compared with bortezomib (a proteasome inhibitor marketed as Velcade) while retaining a similar decrease in cell survival for multiple myeloma plasma cells. This indicates a potential increased selectivity over the current treatment standard. KES-0001 (iv formulation) received IND clearance in March 2016 and is on track to begin a Phase I trial in Q2/Q316.

Initial trials will focus on supporting approval in fourth-line refractory multiple myeloma, targeting US and EU filing by early 2020. In parallel, formulation work will be underway for a second-generation subcutaneous/intramuscular controlled-release formulation. Phase I combination studies of KES-001 in myeloma patients with high GADD45β, targeting earlier lines of therapy, are expected to launch in 2017, before expanding into other haematological malignancies and solid tumours.

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. The share price performance of the public portfolio companies (particularly Circassia, which accounted for 21.8% of the total portfolio value at 31 January 2016) 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. The upcoming readout of the Circassia Phase III cat-SPIRE trial represents a key near-term binary event.

Imperial Innovations is also very tightly held, with four shareholders accounting for a total of 90% of the equity, including Invesco (39.8%), Woodford (20.0%), Imperial College (17.4%) and Lansdowne (12.9%). This contributes to limited free float (8.9%) in the stock, which may increase volatility even on low trading volumes.

Imperial Innovations’ shares (at 430p) currently trade at a c 34% premium to our estimated FY16e NAV of 321p/share (at 31 July 2016), after adjusting for the February 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 remains substantially lower than the >50% premium typically observed over the last two years. We continue to ascribe this 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 Innovations seeks to accelerate investment into a maturing portfolio, with the caveat that the company is facing a key binary event in the coming weeks with the readout of the Circassia Cat-SPIRE trial.

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, including those that presented at Innovations’ capital markets event. 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 Innovations in its portfolio and investors in Innovations’ shares.

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

As of 31 January 2016, Innovations’ portfolio consisted of 105 companies, with a net portfolio value of £355.1m (vs £327.2m at end FY15). The main contributor to the £27.9m portfolio uplift was investments of £27.5m across 17 companies (HY15: £22.4m in 13 companies). Unrealised fair value gains of £12.7m were largely offset by disposals of £0.1m and fair value losses of £12.2m.

The February 2016 capital raise, which grossed £100m (estimated £97.0m net) through the placing of 23.5m new shares at 425p, primarily to Innovations’ major institutional shareholders (Woodford 56%, Invesco 25%, Lansdowne 7%), significantly increased Innovations’ financial position. When added to the £91.6m held in cash at 31 January 2016 (as reported by Innovations) and the £50m EIB loan facility (currently undrawn), we estimate that Innovations has c £239m available for investment after the £27.5m invested in H1. This capital is being put to work at an increased rate; at HY16 results, Innovations confirmed that £38.9m had been invested. This included £27.5m during the period and £11.4m post period (Mission Therapeutics Series C round). Subsequently, Innovations has made further investment commitments in Inflowmatix (£1.8m), Nexeon (£5m) and FeatureSpace (£2.5m).

We maintain our assumption of an estimated £70m in portfolio investments in FY16 as Innovations’ investment rate continues at a higher level than prior years. We highlight that c £50m 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 continue to predict a similar portfolio investment rate of £70m in FY17 and 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 £5.1m (revenues from licensing/royalties, services and corporate finance) is maintained in line with FY15 (£5.1m) at this stage.

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 gain of £6.9m (vs a £4.25m loss previously); we have increased our fair value gain expectation from c £5m to £6.2m in H216 to reflect the £1.4m fair value gain that was crystallised by the sale of Stanmore Implants to Stryker in April. We continue to expect uplift in fair value as portfolio companies mature and progress. We expect that the substantial funding rounds secured so far during FY H216 by Mission Therapeutics, Nexeon and FeatureSpace will prompt a revaluation of the carrying value of these companies. The unquoted portfolio valued at cost or last funding round (83.3% of the unquoted portfolio at end-January), at last funding round adjusted for milestones or impairments (14.4%) or on a sales multiple (2.3%). However, the major swing factor remains 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 continue to estimate a £15m fair value gain in FY17, although this could be conservative in the context of a maturing company portfolio approaching numerous important catalysts.