Shares in Mercia Technologies (MERC:31p), a cash-rich fund management business that also invests in some of its investee companies, rallied 30 per cent to 39p after I included them in my 2019 Bargain Shares Portfolio. However, the share price has since drifted back towards my 29p entry level on profit-taking, thus offering a decent repeat buying opportunity and a timely one, too, ahead of annual results on Monday 8 July.
That’s because the shares are trading on an unwarranted 25 per cent discount to net asset value even though over a third of Mercia’s market capitalisation of £94m is backed by cash and its directly held investment portfolio backs up 90 per cent of its market capitalisation. The portfolio is invested in innovative UK technology businesses with high growth potential and is hardly underperforming, having delivered a double-digit annual internal rate of return since 2014.
This means that you are effectively getting a fund management business that earned fees of £10.2m in the 2018 financial year in the price for free. In the 2018 financial year, fee income was only marginally below the company’s £10.6m annual administration costs, highlighting the potential for the asset management business to turn profitable as mandates grow. Bearing this in mind, Mercia now has £500m of assets under management, a hefty 25 per cent increase since the company released half-year results at the end of 2018. I don’t think Mr Market has noticed this, nor is it taking into account the possibility of valuation uplifts either when the company reports results.
For example, just before Mercia’s 31 March 2019 financial year end, its second-largest holding, Oxford Genetics – a specialist designer and developer of biological molecules such as proteins, viruses and cells within the growing synthetic biology market – raised £6.5m in a syndicated funding round comprising of Canaccord, Invesco Asset Management and Mercia, which valued it at £30.5m. In the past year, Oxford Genetics has signed six licensing deals for its scalable gene therapy manufacturing technologies and has quadrupled annual revenues. That’s rather good news for Mercia as the company’s 33.3 per cent stake in Oxford Genetics is valued at £10.17m, implying a £670,000 net uplift on its September 2018 carrying value of £9.09m after accounting for its £400,000 follow-on investment.
Mercia is cherry picking investment opportunities in the rest of its portfolio, too. That’s because by focusing initially on the provision of finance through Mercia's managed funds, the company can identify, help build and derisk managed fund portfolio companies ahead of providing, on a selective basis, capital to these companies from its own balance sheet. Mercia has been doing just that.
In the past three weeks, Mercia has made a £2m follow-on investment in Medherant, a clinical-stage company developing innovative products for pain and central nervous system diseases using a unique transdermal delivery technology, TEPI Patch®; and a £1.8m investment in Locate Bio, a Nottingham-based gene and cell therapy company that’s developing next generation medicines that utilise proprietary technologies for non-viral gene therapy and cell therapy. Locate Bio is currently expanding the application of its technologies (IntraStem™ and TAOS®) into new therapy areas, beyond musculoskeletal, to provide further in-house development and partnering opportunities.
The bottom line is that the heavily cash-backed shares are simply too lowly rated even if you ignore the value being created in Mercia’s asset management business, which is easily worth at least 15 per cent of its current market capitalisation. For good measure, the directors and the management team own 23 per cent of the issued share capital so they have significant skin in the game. Buy.
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