A biotech stock at an unwarranted discount

Arix Bioscience (ARIX:102p), a global venture capital company that holds a diversified portfolio of unlisted and listed investments in early-stage biotechnology businesses, has delivered annual results in line with the investment case I outlined when I selected the shares for my 2023 Bargain Shares Portfolio.

Last year’s decline in NAV reflects the losses on Arix’s investment portfolio of mainly Nasdaq-quoted small and micro-cap biotech stocks. It was caused by a confluence of macroeconomic and political events that drove up the cost of capital and created a challenging environment for the biotech sector. An equal-weighted index of US biotechnology stocks declined 26 per cent in 2022, the reversal coinciding with the steep rise in 10-year US Treasury yields, the preferred discount rate used for valuations.

Investors took flight to safety as capital dried up, financing costs soared and equity markets declined. The sell-off was broad-based, with many new and non-specialist investors reducing their exposure to the biotech sector. Inevitably, smaller biotech companies felt the effects more acutely. Even those companies with positive clinical trial data often failed to impress investors. The number of biotech companies trading below their balance sheet cash remains far above the pre-Covid norm, an indication of how the industry has reset valuations and is positioned for a recovery.

An opportunity for bargain hunting

The sell-off has created an opportunity for bargain hunters, hence why I included the shares as one of my bargain selections for 2023.

It was partly predicated on the belief that the US Federal Reserve has acted swiftly enough in raising its short-term federal fund rate to see off the inflation threat. Market expectations embedded in the yield curve are adjusting, hence why the US 10-year Treasury yield has fallen from a peak of 4.25 per cent to 3.43 per cent in the past six months. Further easing would undoubtedly be good news for biotech company valuations.

Chairman Peregrine Moncreiffe notes that while Arix’s investment team sees value in the public markets, they are beginning to see attractive valuations for high-quality companies in the private market and expect to add selectively to this part of the portfolio. He highlights the post-period-end acquisition of portfolio company Twelve Bio by Ensoma, a Boston-based genomic medicines company developing one-time in-vivo treatments that precisely engineer any cell of the hematopoietic system. The acquisition was accompanied by $85mn concurrent financing in which Arix participated.

Moncreiffe also highlights that while Arix has sought to take a lead or co-lead position on private company financings in the past, it now prefers to take smaller positions to give more “shots on goal” and introduce more liquidity into the group’s core portfolio. It’s a sensible strategy to adopt as it’s holding around five to 10 per cent of NAV in a public opportunities portfolio to exploit short-term investment opportunities.

Unwarranted share price discount to NAV

The share price has drifted from my 110p recommended buy-in price. However, the company has cash of £108.7mn (84p) and a listed portfolio of £42.9mn (33p) as of 31 March 2023. These valuations are already worth 15 per cent more than Arix’s current market capitalisation of £132mn (102p). And on top, there's an unlisted portfolio of £66.6mn (51.5p) and legacy investments of £3.1mn, which you're basically getting a free ride on.

The margin of safety on offer strongly suggests re-rating potential when investor risk appetite improves. 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. The books are priced at £16.95 each plus postage and packaging (P&P) of £3.95 [UK], or both books can be purchased for the promotional price of £25 plus P&P of £5.75.