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Hunting for small-cap hidden gems

A small-cap investment company has material hidden value on its balance sheet, and valuable listed holdings, too.
 Hunting for small-cap hidden gems

I am always on the lookout for special situations offering a hefty ‘margin of safety’. Investment companies are always a good starting point as unwarranted disconnects can develop between the intrinsic value of a company’s assets and the price in the market.

Of course, many of these are ‘value’ traps, reflecting chronic past underperformance. This was certainly the case with NetScientific (NCSI:117p). Shareholders who backed the 2013 IPO lost more than 90 per cent of their capital as previous management adopted a passive approach to investing in early stage life sciences, healthcare, and technology companies.

However, a boardroom clear out at the start of last year brought in an experienced and proactive management team (new chairman, chief executive, and finance director) focused on creating a larger portfolio with varying time horizons, stages of development and wider focus. The major issue being that the company simply didn’t have the requisite expertise and resource, below board and chief finance officer level, to fully implement the strategy.

That’s why last summer’s £2.3m all-share acquisition of EMV Capital, an investment services company that has interests in the industrial high-tech, energy, circular economy, smart city, transportation and healthcare sectors, has proved a game changer.

 

NetScientific’s hidden value revealed

  • PDS Biotechnology stake increases 24 per cent in value to £15.1m since 30 June 2021.
  • Net cash, PDS stake and EMV Capital back up all Netscientific’s market value of £24.5m.
  • Proforma portfolio valuation of £34.8m (166p a share) plus net cash of £7m (33p a share)

The business model of EMV Capital is to syndicate investments between financial and corporate investors, and for its management team to take a strong hands-on role post-investment. Monetisation is mainly through a mixture of corporate finance fees, management and incubation services. EMV also has a carried interest arrangement with investors it has introduced into its portfolio companies and is entitled, on realisation of the investments, to a share of profits (or carried interest) for Capital Under Advisory (CUA – the cost to third party investors). The carried interests range between 10 per cent and 20 per cent of profits above a minimum return hurdle rate of up to 10 per cent.

Bearing this in mind, two of the eight companies subject to carried interests closed fundraises at double-digit premiums to previous funding rounds in the first half this year, helping EMV’s CUA to increase from £14.6m to £18.2m at 30 June 2021. Since then EMV has since co-led the first close of a £12m investment in Martlet Capital, a fund that is acquiring a portfolio of minority interests in the Cambridge  tech-sector. Martlet aims to raise £22m in total over the next six months.

Moreover, NetScientific’s stake in Nasdaq-listed PDS Biotechnology Corporation (PDSB – US$15.67) has soared seven-fold in value to £15.1m (72p a share) since the start of 2021. PDS is a US$431m market capitalisation clinical‑stage immunotherapy company which has a pipeline of cancer immunotherapies and infectious disease vaccines based on its proprietary Versamune® T‑cell activating technology platform.

This means NetScientific’s net cash of £7m (33p a share), PDS shareholding and the value of EMV (excluding carried interests) cover 100 per cent of the company’s own market capitalisation of £24.5m. This not only leaves NetScientific’s carried interests in the price for free, but all of its direct equity holdings in 10 other unlisted portfolio companies (combined valuation of £16.2m). One of those investee companies, ProAxsis, a health and life sciences company with a focus on respiratory diagnostics, was only modestly loss-making in the first half and is commercialising five products for launch in the first quarter of 2022. 

A spin‑out of Queen’s University Belfast, ProAxsis has a growing base of clients in the pharma industry including AstraZeneca (AZN). Last summer, the company entered an exclusive licensing agreement to complete the validation and global commercialisation of a SARS-CoV-2 (the virus associated with COVID-19) serology ELISA (enzyme-linked immunosorbent assay) developed by AstraZeneca’s research team. In return for providing access to the required intellectual property and technical know-how, AstraZeneca will receive a royalty fee on future global net sales of the assay. Expect news flow in the coming months. ProAxsis has a fair valuation of £3.5m.

NetScientific's other major direct portfolio investment is a 64 per stake (worth £11m) in Glycotest, a US‑based diagnostics company that is commercialising tests for patients with life‑threatening liver diseases, targeted at early‑stage diagnosis to reduce mortality and increase survival rates for this large and growing patient population. Analysts at WH Ireland believe that Glycotest could commence commercial sales in 2023, pencilling in revenue of US$3.9m, doubling to US$8m in 2024 (excluding Chinese royalties of US$0.2m and US$0.4m, respectively), on an operating profit margin of 15 and 20 per cent.

The point is that even if you only value EMV’s carried interests at a miserly £2.5m, my sum-of-the-parts valuation of £41.8m (199p a share) is 70 per cent higher than NetScientific’s share price. So, having initiated coverage, at 102p (‘Alpha Research: Back life sciences tech with a hefty margin of safety’, 20 July 2021), I continue to see material upside to my raised target price of 180p (from 162p). Buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK].

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