Bioquell ends bid talks and restructures board

The company had been in talks with several parties regarding the sale of its bio-decontamination control technology products division, but clearly a deal could not be done at a price that reflected the value of the business, nor the potential for profit growth. The plan now is to continue to build the bio-decontamination business and further improve its financial performance.

I have a strong interest here, having recommended buying Bioquell’s shares at 149p in my 2016 Bargain share portfolio in advance of the company returning £40.8m of its cash pile through a tender offer at 200p a share. I also felt that in the event of the bio-decontamination unit being sold then we could expect a decent bid premium. In fact, I recommended reinvesting the 200p a share of cash proceeds to buy back the shares in the market at 145p which in effect lowered your entry point to 125p.

Bearing this in mind, there are several reasons to maintain an interest here. Firstly, there has been a board room restructuring which has seen chief executive Nick Adams step down, and chairman Nigel Keen replaced by Ian Johnson who brings wealth of experience to Bioquell, having spent his career working in a number of life sciences companies. He is currently non-executive chairman of Cyprotex and was formerly non-executive chairman of Celsis International, the international life sciences products and laboratory services company, as well as a non-executive director of MyCelx Technologies Corporation.

Christopher Mills, chief investment officer of 27.5 per cent shareholder Harwood Capital LLP remains a non-executive director, so it’s fair to say that Bioquell’s major shareholder had some influence on these changes made. Indeed, there is history here as Celsis was taken over six years ago in a £54m deal by a vehicle controlled by North Atlantic Value LLP, a fund in which Mr Mills was chief investment officer. Also, the services of Celsis’ chief executive Jay Lecoque were retained by North Atlantic Value post the acquisition, something that’s worth noting given that he has just been appointed commercial director of Bioquell. In other words, Mr Mills, Mr Johnson and Mr Lecoque have successfully worked together before, so the new board set up has a track record. Michael Roller remains finance director, a position he has held since March 2014, and offers valuable sector experience most recently with hip and knee replacement maker Corin, a small cap company that was itself taken over in early 2013.

Financial performance

Board room changes aside, Bioquell’s financial results for the first half of 2016 which were released yesterday were highly encouraging. Revenues increased by 14 per cent to £2.4m in the company’s healthcare unit, and were up by 6 per cent to £8.7m in the larger life sciences business. True, the lumpy income from the much smaller defence operation declined, but the focus will be on growing both healthcare and life sciences, areas in which significant investment has been made in previous years, the rewards of which are now being seen.

That’s not to say there isn’t demand for Bioquell's expertise in specialist Chemical, Biological, Radiological and Nuclear (CBRN) filtration equipment from a number of customers in the Middle East. There clearly is, a point that the use of chemical warfare agents in the conflict in Syria highlights. It’s just that revenue from the CBRN business can be lumpy whereas that from healthcare and life sciences are more stable and rising with a high recurring element too. This explains why Bioquell’s cash profits rose by 14 per cent to £1.6m in the latest six month trading period and, with the benefit of a seasonally stronger second half, this momentum is expected to be maintained.

It’s worth flagging up that sterling has weakened by around 13 per cent against the US dollar and euro since the Brexit vote at the end of June. Bioquell derives 46 per cent of its bio-decontamination revenues in US dollars and 26 per cent in euros, so will benefit from a strong currency tailwind in the second half and beyond. It is also benefiting from a restructuring of its US sales force and higher investment in digital marketing. This has not only lowered sales-related costs, but has also increased revenues. There is potential to trim costs in other areas as well.

Bargain Shares Portfolio 2016 performance

Industry drivers

Industry drivers are supportive of the investment case too. For instance, a new European standard comes into force in February which will require companies selling airborne disinfection systems to pass specific, demanding microbial inactivation tests, including the inactivation of hard-to-kill fungal spores. Low-concentration hydrogen peroxide nebulisers or aerosolisers struggle to pass these microbial tests and experts anticipate that, as was the case in France, a number of nebuliser systems will be removed from the European market when the new standard comes into force.

That’s good news for Bioquell because its hydrogen peroxide vapour (HPV) technology products are highly effective at eradicating micro-organisms such as bacteria and viruses at room temperature. They are principally used by bio-pharmaceutical, biotechnology and research institutions to provide sterile equipment and/or sterile facilities. HPV-based products are also used to eradicate 'superbugs' from hospitals, and are cost effective.

Equally supportive of demand for Bioquell’s high quality decontamination products is a new standard relating to the "Manufacture of cell-based healthcare products - control of microbial risks during processing". The standard specifically highlights the challenges associated with viral vectors used in the production of certain cell-based healthcare products as well as the advantages of using closed systems such as Bioquell’s QUBE over more common biological safety cabinets. Bioquell QUBE comprises a novel, modular aseptic work-station which incorporates HPV technology but is manufactured using unique processes at Bioquell’s facilities in the UK. The QUBE is used to provide an aseptic environment for a range of applications including: sterility testing; the production of toxic, intravenous oncology drugs; and the production of small-scale cell-based healthcare products.

That’s not the only product in demand as Bioquell has launched a POD that enables hospitals to convert multi-bed, open-plan units at high risk of the spread of hospital acquired infection into single-occupancy rooms. PODs can be decontaminated using Bioquell's HPV technology. The company has also launched a space saving wall mounted flatscreen decontamination system which incorporates the use of its hydrogen peroxide consumable cartridges. This was in response to requests from customers, one of which, a large French life sciences company, has already placed a large order.

Cash profits and generation

The key for me here is Bioquell’s cash generation, and prospects for delivering decent profit growth. Having made significant investment in its product development, annualised research & development expenditure is running at around £1.35m, well below the company’s depreciation charge of £1.65m. So, once you factor in an annual non-cash amortisation charge just shy of £1m, then a high percentage of Bioquell’s cash profits are being converted into operating cash flow.

In fact, the company generated £1.27m of net operating cash flow from £1.6m of cash profits in the six months to end June 2016, a performance that boosted net funds by almost £500,000 to £7.3m. And with a seasonally stronger second half to come I would expect the company to exceed the £1.8m of cash profits earned in the second half of last year, so bolstering the cash pile further. House broker N+1 Singer has yet to reinstate coverage as its forecasts were suspended while Bioquell was in a takeover situation, as was required under The Takeover Code, but the odds clearly favour a decent increase in cash profits at the full-year stage.

That’s worth noting because once you strip out net funds from Bioquell’s current market capitalisation of £32.5m, its enterprise value of £25.2m equates to less than 7.5 times cash profits. In my view, that’s hardly a punchy rating for a company now reaping the upside from significant investment made in its business.

Needless to say, I still see upside potential in Bioquell’s shares and continue to rate them a buy on a bid-offer spread of 140p to 142p. Buy.