The company's patented technology is used to advance the assessment of cognition to develop safe and effective treatments, improve patient outcomes and measure cognitive health. The Cambridge Neuro-psychological Test Automated Battery (CANTAB) cognitive tests were first developed at the University of Cambridge and have since evolved to include tests that can now be run on an iPad, and other smart devices. Cambridge Cognition’s product suite is focused on three key areas - clinical trials, research, and healthcare technology – and its partners include global biotechnology and pharmaceutical companies, academic institutions and public-private healthcare providers.
What makes the company interesting from an investment perspective is that it’s at an inflexion point, having just turned in a maiden pre-tax profit of £116,000 for the 2016 financial year, reversing a £867,000 loss in 2015, on revenues up from £5m to £6.9m. The eye-catching top-line growth not only reflects a successful move to accelerate the commercialisation of its valuable intellectual property (IP), but the greater attention that’s being paid by individuals, carers and employers to all aspects of cognitive function in health. This is supportive of demand in the fields of drug development, academic research and occupational health. The favourable industry back drop is good news for companies operating in these areas given that regulatory filings for any new drug crossing the blood-brain barrier require safety data and analysis of potential impact on cognitive function.
Not surprisingly, of the three business segments, clinical trials is by far the largest and the fastest growing with revenues soaring from £3.4m to £4.8m last year. Recent contract wins highlight the lucrative business opportunity in this specific area. For instance, Cambridge Cognition was awarded a £2.82m contract last autumn by two US biopharmaceutical companies for late stage clinical trials using its CANTAB Connect technology, a cloud-based platform combining leading science with leading edge technology. Around £820,000 of revenues earned from the contract contributed to a bumper second half trading performance and helped the company deliver pre-tax profits of £222,000 on revenues of £3.6m in the six-month period.
It’s not a one-off award either. Since launching its cloud-based CANTAB Connect software platform in 2014, Cambridge Cognition has become the leading provider of Human Abuse Liability (HAL) assessment technology, helping its drug development partners to achieve multiple Food and Drug Administration (FDA) approved abuse deterrent labels in North America. In the past tree years, the company has signed 35 HAL contracts and generated total revenues in excess of £3m in a market which is expected to continue to grow.
Indeed, the abuse of prescription drugs is the fastest growing drug problem in North America, according to the National Institute on Drug Abuse, with an estimated 48m people using prescription drugs for non-medical reasons. As a result, with a rising number of compounds targeting the central nervous system and tighter government regulation in place, clinical trials assessing drug abuse potential are becoming more commonplace and necessary. The company’s CANTAB Connect platform has been used to significantly reduce data errors and increase efficiencies in these studies, saving both time and cost for drug manufacturers.
A diversified product range
Moreover, by diversifying its product suite, the company is tapping into a wide range of areas requiring cognitive assessment.
For example, its Cognition Kit product enables the tracking of everyday cognitive health and wellbeing, and provides enriched real-time data collected using wearable devices for use in clinical trials and healthcare technology. The commercial potential of this IP is highlighted by a recently announced collaboration with US-based Takeda Pharmaceuticals, a R&D-driven pharmaceutical group focused on oncology, gastroenterology and central nervous system therapeutic areas, to pilot the use of a specially designed app on an Apple Watch. The aim of the pilot is to monitor and assess cognitive function in patients with Major Depressive Disorder (MDD), a leading cause of disability worldwide, affecting an estimated 350m people of all ages.
According to The Society of Neuroscience, disorders affecting the brain are now the leading cause of disability and ill health worldwide. In fact, there are more than 1,000 disorders of the brain and central nervous system which result in more hospitalisations and loss of productivity than any other disease group, including heart disease and cancer. So to support neuroscience research, CANTAB Connect’s validated cognitive assessment software enables researchers to assess participants in a quick and cost-effective manner.
Of course, in order to carry out effective studies and trials in the first place, drug companies need to identify qualified participants. To tap into this opportunity, Cambridge Cognition has developed CANTAB Recruit – an online platform to improve the efficiency of recruitment of patients into clinical trials, initially focused on those for patients with Alzheimer’s disease. For example, a Phase III Alzheimer’s disease trial looking to recruit 1,000 patients will require up to four times this number to be screened to allow for drop-outs based on exclusion criteria (e.g. age, sex) and stage of memory impairment, according to analysts at equity research firm Hardman Partners.
CANTAB Recruit can significantly improve the value proposition by predicting with a greater degree of accuracy which patients will satisfy the inclusion criteria defined in the trial protocol. This is the key to success of clinical trials as one-third of total trial costs are within the recruitment phase and 80 per cent of clinical trials are delayed due to recruitment issues.
Another exciting product innovation is the company’s CANTAB Mobile device which detects clinically-relevant memory impairment in older adults at the point of care and can help detect symptoms of depression and problems with performing regular activities of daily living. The CANTAB Mobile memory assessment is sensitive to detecting the earliest signs of prodromal Alzheimer's disease years before a clinical diagnosis, according to academic research.
Since being classified as a European Medical Device in 2013, CANTAB Mobile has been used to assess over 26,000 patients in the UK who had concerns about their memory or were considered by their physician to be at increased risk of dementia. The company is tapping into the North American market too, having recently received regulatory clearance from the FDA to market the product as a medical device for commercial distribution in the U.S. where “significant interest has developed among primary and secondary care organisations and corporate health providers.”
I would also flag up the notable contribution from the company’s academic research business which focuses on the licensing of tests to academics and is essential for the scientific validation process. Cambridge Cognition’s products are used by over 800 universities and research institutions, demand from which led to a 30 per cent rise in divisional revenues to £2m last year to account for about a third of the company’s total turnover. Interestingly, the company has secured its first sale to an international biobank, an organisation which collects large amounts of data to catalogue and then makes it available to researchers across many fields. Biobanks play a key role in biomedical research and there should be potential for similar opportunities to be pursued.
Potential for sharply rising profits and cashflow
Buoyed by a year-end sales pipeline worth £2.68m in the clinical trial division, and the increasing demand being seen in this niche area of the healthcare sector, analysts Alex Pye and Mark Brewer at broking house finnCap believe that Cambridge Cognition’s revenues can continue to post mid to high-teens growth over the next two financial years, pencilling in turnover of £8.2m and £9.5m, respectively. Reassuringly the directors confirmed to me that these forecasts are in-line with those discussed at board level.
Moreover, with gross margins stable at around 87 per cent, and revenues rising faster than operating costs, then if the company hits these sales forecasts its profits will soar: finnCap expects pre-tax profits to more than quadruple from £111,600 to £500,000 this year, and double again to £1m in 2018. On this basis, expect EPS to increase from 1.3p to 2.2p in the current financial year, rising to 4.6p in 2018.
Importantly, having raised £1.1m of net proceeds in a placing 12 months ago, the company is in a healthy net funds position of £2.4m, a sum more than adequate to cover working capital requirements and fund the anticipated growth in the business. In fact, Cambridge Cognition generated an operating cash inflow of £267,000 last year before accounting for a modest positive working capital movement, and before the receipt of a £193,000 tax credit on research & development spend.
Guidance is for profit before tax excluding non-cash items such as depreciation and share-based payments to be broadly equal to cash income, subject to working capital movements, which explains why analysts at finnCap expect the cash pile to increase by £500,000 to £2.8m by the December year-end, rising to £3.7m at end 2018. Based on an issued share capital of 20.4m shares, this implies that net funds could equate to 14p of the share price by the year-end, rising to 18p by the end of 2018. In other words, the rising cash pile could account for more than a fifth of the small cap’s current market value of £17.7m.
It also means that on a cash-adjusted basis, the shares are being price on 34 times forward earnings, falling to only 15 times in 2018. For a company predicted to increase EPS by 250 per cent over the next two financial years, that’s not a punchy rating. Furthermore, with £8m of accumulated tax losses available to offset against the tax liability on future profits, then corporation tax will not prove a drag on net profits.
Of course, there are risks to consider in any investment and it’s worth flagging up several in the case of Cambridge Cognition.
Risk assessment
Firstly, the company has only just turned profitable and has yet to prove that it has made a sustainable move into profitability. So although analysts’ forecasts point to prospects for electrifying EPS growth, there is execution risk regarding the commercialisation of new and existing products even if 2016 is highly likely to have proved a major turning point.
The fact that the company’s two largest customers accounted for 21 per cent and 11 per cent, respectively, of last year’s revenues highlight the lumpy nature of revenues too. However, I would point out that no other customer accounts for more than 10 per cent of revenues, and the largest customer is a repeat client and one of more than 100 the company has relationships with. The fact that it has a medical sector and academic focused client base is actually a bull point as it mitigates the risk of bad debts arising from what is generally regarded as sound credit risk customers. In fact, I understand that all of Cambridge Cognition’s trade receivables outstanding at the end of 2016 have been paid in full. In addition, the closing sales pipeline for the clinical trials business accounted for over half of the division’s sales, highlighting the ongoing demand for the company’s services.
Currency movements are worth considering as 47 per cent of revenues last year came from North America and 16 per cent of all sales were from EU countries, although only 7 per cent were paid in euros. Bearing this in mind, sterling’s Brexit driven weakness benefited revenues to the tune of £230,000 and increased sterling profits by £100,000 in the 12-month period. Although the company has a natural hedge in place by way of its US based office and employees costs, this currency matrix is worth noting in the event of a major recovery in the value of sterling.
A key reason for the sharp ramp up in sales is due to the investment made in recruiting additional staff. As the company becomes more successful then it will be because employees are hitting their objectives, so retaining high calibre staff could become an issue and lead to increased share ownership schemes and financial awards being made as part of remuneration packages.
Liquidity in the shares is another issue as the three largest shareholders hold around 50 per cent of the issued share capital, and the top eight shareholders hold 76 per cent of the 20.4m shares in issue. This means that share price movements are likely to be accentuated on good news flow, but could be harsh if the company disappoints.
It may also catch your eye that non-executive director Nick Kerton sold 150,000 shares at 78p at the end of March. He was a former chief executive of the company and stepped down from the position on health grounds in the summer of 2015 in order to take an extended period of leave to help combat his illness. I understand the share sale freed up some cash for his family, so the disposal is due to exceptional circumstances.
Calculating a fair valuation
Having considered all the risks, I still feel that Cambridge Cognition’s shares represent a good investment at the current share price, on the proviso of course that management hit their budgets and deliver on finnCap’s earnings estimates. If they do then I feel a cash-adjusted rating of 25 times 2018 EPS estimates is a much fairer valuation, implying a target price of 130p, in-line with finnCap’s own objective.
Interestingly, the share price is on the cusp of breaking out above the 87p to 90p level which has acted as a glass ceiling since September 2016. If that happens it would pave the way for a sharp rally to the all-time high of 105p dating back to September 2015, and one which is warranted by the recent move into profit. Beyond that my 12-month price objective of 130p comes into play. Please note that although the official bid-offer spread is 82p to 87p, it’s possible to deal between the spread with buy orders generally going through the market at 86p and sells at around 84p, but it may mean dealing in smaller bargain sizes to get these prices as the normal market size is only 2,000 shares.
Needless to say, offering 50 per cent potential share price upside to my target price, I rate Cambridge Cognition’s shares a micro cap growth buy.
