With a market capitalisation of £22m, Aim-traded IXICO (IXI:47p) may be under the radar of most investors, but the London-based company is at the forefront of a technological revolution. That’s because the world’s largest biopharmaceutical companies are investing huge sums of money in the field of neurology to target therapies for diseases affecting the central nervous system including Huntington’s, Alzeihmer’s and Parkinson’s disease.
This has created a surge in demand for the services of companies that use proprietary artificial intelligence (AI) software algorithms to analyse images from brain scans - magnetic resonance imaging (MRI) and positron emission tomography (PET) – in order to provide measurements of small changes in brain structure, assess the efficacy of new drugs being trialled, monitor patient safety, and provide valuable insights on different aspects of trial performance.
In a nut shell, IXICO’s cutting edge proprietary LEAP algorithm harnesses the power of large datasets and computer-based learning to segment specific regions of the brain and then accurately measure their volume, thus providing a reliable method of measuring brain atrophy which can indicate progression of neurological disease. To date the algorithm has been applied to over 150 brain regions, analysed over 100,000 brain scans and has been cited in over 750 scientific publications.
The company has also developed AI technology to assess brain pathology like white matter lesions and, more recently, uses data from wearable biosensors to accurately measure sleep patterns in Parkinson’s disease and dementia patients. These approaches enhance the understanding of disease symptoms more directly compared to manual assessment or complex in-clinic technology. Importantly, by applying IXICO’s data science expertise, these measurements have the potential to increase success rates of clients’ clinical trials by improving patient selection, lowering the cost of running them, and reducing the burden on trial participants and their carers by reducing the need for clinic visits.
High operational leverage
The technology is proving incredibly popular. In fact, no fewer than eight of the 14 top 20 biopharmaceutical companies that have active neurological drug development programmes are clients of IXICO. They clearly hold the company in high esteem as IXICO has booked over £20m worth of new orders since the start of last year, a revenue stream that supports a sustained move to operating profitability.
Once that inflexion point is passed, the high gross margin (62 per cent) earned from its cutting edge data analytics activities means that operating profits are set to move sharply higher in the years ahead given the significant amount of automation in the workflow and remote management of the clinical trial imaging sites. This means that IXICO is able to take on additional revenue generating activities without an equivalent increase in staffing costs, the effect of which is that any outperformance against revenue forecasts delivers a high conversion rate of incremental gross margin earned to operating profit. This operational leverage effect is also illustrated by the fact that over the past few years IXICO’s staffing levels have remained between 60 to 70 employees even though revenues earned have more than doubled since 2016.
The possibility of profit upgrades was certainly not priced into the company’s valuation when I suggested buying IXICO’s shares, at 33p, in last month’s 8,000 word small-cap report for our Alpha subscribers ('Alpha: Simon Thompson spies opportunity in cutting edge technology', 23 July 2019). It still isn’t for that matter even after the 42 per cent rise in the company’s share price following yesterday’s trading update when management revealed that growth has been accelerated by new and existing contracts coming on line, deployment of newly developed algorithms and faster turnaround times in trial situations.
Increased target price
To put the current valuation into perspective, analyst Chris Donnellan at house broker Cenkos Securities has torn up his previous estimates and now expects IXICO to post 32 per cent revenue growth in the 2018/19 financial year, and 20 per cent top-line growth in both the 2019/20 and 2020/21 financial years, too. On this basis, IXICO’s annual pre-tax loss is forecast to be slashed from £0.8m to £0.1m on revenue up from £5.4m to £7.1m in the 12 months to 30 September 2019.
Furthermore, Mr Donnellan now forecasts that IXICO will generate both an operating and pre-tax profit of £239,000 on revenue of £8.5m in the 2019/20 financial year to produce a net profit of £339,000, rising to an operating and pre-tax profit of £0.88m, and net profit of £0.79m on revenue of £10.25m in the 2020/21 financial year. He had previously forecast a £0.44m operating profit on revenues of £9.55m in the 2020/21 financial year, so the additional £0.7m of revenue that is now expected to be booked that year will produce £0.43m of incremental gross margin, all of which is effectively being converted into operating profit.
Cenkos estimate IXICO will have net funds of £5.5m at the end of next month which means that its enterprise valuation of £16.5m equates to 20 times forecast net profits in the 2020/21 financial year, hardly a punchy rating for a highly operationally geared business that is winning new orders and looks to be at the start of an earnings upgrade cycle. Indeed, around two-thirds of the 2020 revenue target is already covered by the contracted order book, so if contract momentum continues to build then it’s not unrealistic to expect IXICO to over deliver even against analysts’ upgraded expectations.
In the circumstances, I am raising my 55p target price to 62p, implying a fair value enterprise valuation of £23.5m, in anticipation of the contract momentum in the business continuing to build and the release of another positive pre-close trading update in mid-October. Trading on a bid-offer spread of 45p to 47p, I continue to rate IXICO’s shares a buy.
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