A profitable venture for accelerated earnings growth

Background to acquisitions

Established in 2010, Venture Life is an integrated UK-based consumer healthcare company that addresses the needs of the ageing population. This market benefits from a number of attractive growth drivers, including shifts in demography, with people living longer, government organisations actively promoting self-care due to increasing constraints on public sector healthcare budgets, and lifestyle factors. As a result, consumers are expected to take more responsibility for treating many non-critical ailments. This is usually through pharmacies and supermarkets.

The over 50s comprise a significant proportion of this self-care audience. They generally have much higher disposable income and own the majority of their financial assets. An increasing awareness of the need for each of us to take personal responsibility for our own healthcare is bringing many younger people into this market, too. Dermatology and oral care are significant sectors in this space, and Venture Life has strong expertise in both.

The product portfolio principally targets the regulated over-the-counter (OTC) segment of the consumer healthcare market. The OTC market was worth $133bn (£106bn) in global sales in 2017 and is forecast to grow at 6.5 per cent a year between 2018 and 2023, according to analysts at Mordor Intelligence. Venture’s portfolio includes medical devices, food supplements and dermo-cosmetics, which address issues associated with ageing such as cognitive function, sleep disorders, cholesterol, joint and muscle ache, proctology and health of skin and hair, all of which are sold in compliance with EU regulations. Other key areas identified by the directors for future growth opportunities include diabetes, obesity, gastroenterology and oral health.

Products are typically sold into pharmacies through Venture’s growing international network of more than 100 distribution partners in 44 countries worldwide and are generally protected by intellectual property rights such as patents and trademarks. Both medical devices and cosmetic products are manufactured from a facility in Italy by Biokosmes, a company acquired by Venture at the time of its public offering in March 2014.

As well as having an extensive library of proprietary formulations, Biokosmes provides development and manufacturing capabilities. It also provides Venture with the platform to leverage its expertise in new product development, brand management and commercialisation. But Venture needed to scale up its activities significantly first. This explains why it moved into the oral healthcare market three years ago through the acquisition of Periproducts, a UK-based oral care products company that owns a range of premium products under the UltraDEX brand, including mouthwashes, which are alcohol-free, and toothpastes.

UltraDEX-branded products

Incorporating patent protected and licensed intellectual property, Periproducts’ UltraDEX-branded products, including UltraDEX Recalcifying & Whitening range, are regarded as being effective at managing bad breath, supported by clinical data. The brand is well-established in the UK and enjoys high levels of customer loyalty.

At the time of the acquisition in March 2016, the products were manufactured by third parties and sold primarily through a number of leading UK retailers with whom Periproducts had long-standing relationships, including Boots, Tesco, Sainsbury’s, Waitrose and Amazon. Sales through Boots accounted for 45 per cent of Periproducts’ turnover prior to acquisition and over 95 per cent of sales were made in the UK, with the balance originating from eight other EU territories. However, Periproducts was barely profitable, turning in annual operating profits of £200,000 on revenue of £2.8m prior to its acquisition by Venture, thus offering the opportunity for Venture to boost profits.

The company achieved this by revitalising UltraDEX’s UK marketing strategy; extending the UK retail distribution into more stores; leveraging relationships with its key overseas distribution partners to internationalise Periproducts’ brand and achieve meaningful commercial roll-out in Europe (the brand is now represented in 20 countries, including four of the five largest EU countries, with nine new partners signed up in new markets in 2018); bringing functions such as product development, regulatory compliance and quality assurance in-house; developing new oral care products to complement Periproducts’ existing range; and identifying additional product cross-selling opportunities across both Venture’s and Periproducts’ respective customer bases.

Venture’s management has been successful, increasing UltraDEX’s revenues by a quarter to more than £3.3m in both 2017 and 2018 to generate trading profit of £1.1m from the brand, a fourfold increase since acquisition in March 2016. That performance more than justifies the £5.6m cash consideration Venture paid for the business.

The performance of UltraDEX was the key driver in Venture reporting a maiden pre-tax profit of £63,000 in 2017 on revenues up 12 per cent to £16m, and reversing the hefty losses made in prior financial years. The major issue being that £518,000 of Venture’s operating profit in 2017 was used to service interest payments on gross borrowings of £11.4m, which included £3.7m of convertible loan notes and £0.4m of vendor loan notes – a hefty sum in relation to shareholders funds of £10.9m. Venture’s balance sheet clearly needed an injection of equity to free the company from its financial constraints, and to enable management to scale up the business by targeting similar bolt-on acquisitions. And that’s why last summer’s placing at 40p a share, which raised net proceeds of £17.5m after expenses, has transformed Venture’s prospects.

Funded for accelerated profit growth

The equity-raising more than doubled Venture’s issued share capital and enabled the company to pay off the expensive convertible bonds and loan notes and slash annual interest costs by £280,000. Venture also used £4.2m of the placing proceeds to acquire mouthwash and mints business Dentyl. This still left the directors with gross cash of £9.6m and net funds of £5.8m (after taking into account £3.8m of low-cost debt facilities) at the end of 2018 to target further earnings-enhancing acquisitions.

Specifically, the company is targeting the acquisition of unloved and undercommercialised brands that it can grow internationally using its operating leverage and distribution channels to deliver incremental profit growth in addition to organic growth from its existing businesses. Vendors are predominantly larger companies that are often rationalising their brand portfolios to focus on bigger assets, so are offloading sub-scale non-core brands as a result.

The strategy is to acquire these profitable, cash-generative brands, integrate them into Venture’s operating structure, and then grow brand revenue through rapid geographic expansion and new product development. Venture’s management team is already enjoying early success at reinvigorating Dentyl’s sales.

Earnings-accretive strategic acquisition

Dentyl Dual Action is a prominent brand in the UK mouthwash market. The formulation consists of an aqueous phase, which contains an anti-bacterial agent, and an oil phase, which contains mint oil. It is activated by shaking, with the two phases interacting to create an electrostatic charge, which removes bacteria, and it is packaged in a distinctive triangular bottle. Dentyl’s BB Mints product is a sugar-free breath-freshening capsule. 

Prior to Venture’s acquisition, Dentyl derived 95 per cent of its revenues from the UK where it has been sold for over 20 years, with its top five customers by sales being Tesco, Morrisons, Sainsbury’s, Asda and Wilkinsons. South Africa was the largest overseas market, representing less than 3 per cent of Dentyl’s revenues, and the only other significant international distribution partner was in China.

However, Dentyl’s sales had been in decline, partly because the business was not a core holding of the vendor, but also due to underinvestment. This offered Venture the opportunity to expand Dentyl’s UK listings and internationalise the brand by partnering in overseas markets using Venture’s network of marketing partners; improve marketing and product innovation; bolster sales through cross-selling across the complementary retailer channel of both UltraDEX and Dentyl which target different markets; and make cost savings.

In the first five months under Venture’s ownership, Dentyl contributed £1.6m of revenues, split 50:50 between the UK and international markets. On a pro-forma basis, revenues for the brand increased by a third to £3.9m in 2018, more than justifying the acquisition price of 3.5 times Dentyl’s 2017 pre-tax profit of £1.17m. The improved sales contribution from Dentyl meant that Venture’s revenues from its branded products increased by almost half to £6.6m in 2018, and led to a 17 per cent rise in the company’s total revenues to £18.8m, the balance of sales being generated by its manufacturing activities where it works on behalf of third parties from Biokosmes’ facility in Italy. The contribution from Dentyl last year also meant that Venture posted a maiden full-year post-tax profit of £0.4m, a significant milestone in its move towards sustainable profitability and cash generation.

Boosting sales at both UltraDEX and Dentyl, and targeting similar bolt-on acquisitions will play a part in delivering the step change in Venture’s profits this year and next, but there is decent organic growth and useful contributions coming through from other products in its branded portfolio, too. These products include Venture’s Lubatti skincare range, which is distributed in 2,000 Gialen stores in China; Myco Clear, a solution to treat and prevent nail fungal infections and a cleanser for the hands and feet to guard against further infections; Procto-eze, a cleanser and a cream to relieve the discomfort of haemorrhoids; and Bioscalin, a treatment to help control hair loss, promote new hair growth and enhance the overall condition of hair.

In aggregate, Venture’s smaller brands contributed £0.9m, up from £0.5m in 2017, of the company’s annual revenues of £18.8m in 2018.

A scalable manufacturing operation

Employing 62 staff, Venture’s manufacturing facility in Lecco, Italy covers 5,500 sq metres of space and has capacity to produce 27m units a year across 10 filling and packaging lines. It’s a key differentiating factor for the company versus peers as it enables Venture to develop and make both its own branded goods and those for third-party customers. Goods are shipped to more than 40 countries worldwide.

The plant has generated 25 per cent revenue growth since 2015, and last year produced 23m units, up from 21m in 2017. It’s scalable as the directors believe that with additional annual capital expenditure equating to only 2 per cent of manufacturing revenue per year for the next three years, capacity can be increased to 40m units per year. The point being that Venture can boost its output markedly for a modest capital investment.

Bearing this in mind one of Venture’s largest customers, Alliance Pharma (APH:73p), has extended its manufacturing contract with the company for a further seven years to 2026, and with a run-off period of three years thereafter if it is not further extended. Alliance is an international pharmaceutical company specialising in the acquisition and licensing of healthcare products. It sells its products in more than 100 countries worldwide via direct sales, joint ventures and a wide network of distributors. The company has a strong track record of acquiring the rights to established niche products and owns or licenses the rights to 90 pharmaceutical and consumer healthcare products.

Venture manufactures a number of products for Alliance and the contract extension incorporates the manufacture of new products under Alliance’s Atopiclair brand (a steroid-free cream for the treatment of mild to moderate atopic dermatitis), to generate additional annual revenues of at least €1.6m (£1.4m) from 2019 onwards. 

Another key partner, Menarini Group, launched its Relife range of products in Italy in 2018, which includes 21 products developed and manufactured at the Biokosmes facility. The launch has gone well and contributed to revenue growth in 2018.

Venture’s management is in discussions with a number of its other customers to generate further meaningful revenue streams for its manufacturing business. The company has also taken on a significant amount of work for customers in order to adapt and modify products as a result of the changes to European medical device regulations that become effective in May 2020.

The point being that with Venture’s central administration costs relatively stable, and with spare capacity to be utilised at the Biokosmes facility, then based on a gross margin of say 30 per cent for new contract work taken on, a high percentage of incremental margin earned is converted into operating profit given the operational gearing of the business. Pre-central overheads, the manufacturing business reported an operating margin of 19 per cent in 2018, up from 15 per cent in 2018, so the upwards move in margins seen in recent years looks set to continue. This is good news for Venture’s profits this year, and beyond. Indeed, theextra work for Alliance Pharma could add almost £400,000 to Venture’s trading profit in 2019.

Venture’s operating leverage about to kick in

The contributions from the UltraDEX and Dentyl acquisitions, and the additional margin being earned from the manufacturing operation, should lead to another milestone in Venture’s profitability this year and next.

In fact, house broker Cenkos Securities expects Venture’s underlying operating profit, which doubled from £581,000 to £1.22m in 2018, to double again to £2.4m in 2019 based on a £3.1m rise in revenues to £21.9m. Moreover, with a higher proportion of branded goods being sold (these enjoy gross margins of between 40 and 50 per cent), Venture’s operating margin is getting a double boost from the combination of rising sales and the higher level of profitability on incremental sales.

This explains why analysts believe that an extra £1.8m of revenue generated in the 2020 financial year could produce incremental operating profit of £750,000 and result in operating margins doubling between 2018 and 2020 to produce operating profit of £3.17m in 2020, up from £1.22m in 2018. Rising sales, rising margins and an increasing amount of recurring revenue are not the only positives.

Corporate activity set to accentuate pre-tax profit surge

With Venture’s balance sheet de-geared, shareholders are set to benefit from the company’s improving cash generation and a step change in profitability rather than funding hefty interest payments to debt holders. Indeed, the finance charge of £518,000 in 2017 was slashed to £341,000 in 2018, and could be as little as £50,000 this year.

It makes sense for Venture to still tap its Italian debt facilities as it is borrowing at interest rates of 1 per cent or less. The upshot being that although the company had gross cash of £9.6m and net funds of £5.8m at the end of 2018, it actually has around £8m of free cash plus untapped debt facilities to make further acquisitions. That’s important because assuming Venture deploys the £8m free cash to purchase a business on 1.5 times annual sales, a multiple in line with what it paid for Dentyl, and the acquisition makes a gross margin in line with Venture’s own gross margin of 39 per cent, then this could add upwards of £1m to Venture’s operating profit.

In other words, potential for corporate activity offers upside to Cenkos’ current pre-tax profit forecasts that point towards Venture delivering pre-tax profit of £2.4m this year and £3.17m in 2020. The respective earnings per share (EPS) estimates are 2.27p and 3.12p. Indeed, there could be scope for 30 per cent EPS upgrades to next year’s numbers if Venture finds the right target. The directors are actively looking out for the right deal.

Moreover, Venture has £9.27m of accumulated UK tax losses to offset against the UK corporation tax charge, so UK shareholders rather than Her Majesty’s Revenue and Customs (HMRC) will be the main beneficiary. The Italian manufacturing business is still subject to that country’s corporate tax rate, but the major point is that by recycling around £8m of cash into the right acquisition then Venture could earn £1m a year of additional operating profit, the vast majority of which could be tax-free. My models suggest that Cenkos’ 2020 EPS estimate of 3.12p for 2020 could be upgraded by 39 per cent to 4.3p in this scenario, the caveat being that Venture needs to find the right deal(s) in the first place.

Management has skin in the game

Importantly, the directors have significant shareholdings and are incentivised by share options too. Chief executive Jerry Randall holds 3.9m shares (4.7 per cent of the issued share capital); Gianluca Braguti, chief manufacturing officer and founder of Biokosmes, owns just over 7m shares (8.1 per cent); and chief commercial officer Sharon Daly owns 1.67m shares (2 per cent). Mr Randall and Ms Daly both have share options over 1.35m shares at exercise prices of between 41p and 45p which expire in August 2022 and November 2023.

Importantly, there are some shrewd fund managers on the shareholder register, including Gresham House Asset Management, Livingbridge VC LLP, Ennismore and River & Mercantile. Admittedly, almost 80 per cent of the share capital is held by the top 12 shareholders, but it’s still possible to buy and sell the shares in bargain sizes up of 25,000 shares, so liquidity is not really an issue.

Significant rerating potential

No matter which way I look at it Venture’s shares are underrated. This is a business that could be making operating profit of £4.2m in 2020 if the surplus cash is deployed on an appropriate acquisition, and still have an unencumbered balance sheet. Venture’s market capitalisation of £34m fails to reflect this step change in profitability.

So, having first suggested buying the shares in my May Alpha Report, and rated on a modest cash-adjusted price/earnings (PE) ratio of 11 for the 2020 financial year after taking into account Venture’s net funds of £5.8m (7p a share), I feel the shares rate a compelling buy.

Please note that I am now on annual leave and my next column will be published on our website at 12pm on Monday, 8 July.

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