Today marks the publication of the Woodford Patient Capital Trust annual report. You can download the full report here, but below is Neil’s review of the trust’s progress in 2016.
We began 2016 with the money raised at the launch of WPCT fully deployed – and so the period under review started with a portfolio primed for its long-term patient capital journey. It is rich in quality, broad in terms of development stage and technology and, most importantly, high in potential.
The operational progress made during the year, across the majority of the portfolio, was extremely encouraging. Much of this fundamental progress has yet to be reflected in the net asset value of the Company itself, which declined 4.2 per cent in 2016. I understand that some investors may be disappointed at the net asset value progress thus far and, although I would have preferred to have been writing this review having delivered a positive return, it must be remembered that the investment strategy was never designed to deliver significant short-term wins.
It remains early days for this strategy, which is seeking to exploit very long-term investment opportunities. Indeed, it is the disconnect between the short-term focus of the modern stock market and the long-term needs of early-stage businesses that in part explains the Company’s performance last year and which has created such a compelling investment opportunity in the first place.
Long-term capital providers such as WPCT must work closely with the early-stage businesses they have backed in pursuit of commercial success, but this ultimate goal can take years, sometimes decades, to fulfil. While on the journey towards commercialisation, these companies need capital partners that are prepared to stay with them for the long term. For years, the UK has been failing to make the most of its knowledge economy assets, with increasingly adverse implications for the long-term health of the overall economy. Primarily, this is because the early-stage businesses that look to develop and commercialise the outstanding intellectual property that emanates from British universities have been deprived of the capital they need to succeed.
Encouragingly, the government does now seem to be paying attention to this fundamental problem. We are currently engaged in its Patient Capital Review, which was announced by the Chancellor in last year’s Autumn Statement – and we await its outcomes with interest and optimism.
In the meantime, however, the opportunity that exists for those capital providers that are prepared to take a long-term, supportive view towards investing in early-stage businesses remains compelling.
Barely a week goes by when I don’t hear of something coming to fruition within the portfolio. In my view, it is only a matter of time before this starts to be reflected in the net asset value and share price of the Company.
Indeed, some of this progress is already beginning to be reflected in the individual company valuations of our unquoted holdings. The unquoted portion of the portfolio, which accounted for approximately 40 per cent of the Company’s assets, delivered a positive contribution to returns of more than two per cent in 2016. In contrast, the quoted part of the portfolio, which accounted for approximately 60 per cent of assets, delivered a negative contribution of more than five per cent during the year.
To an extent, this is of course down to stock specifics as I explore below. However, broadly speaking, I do not believe that the operational performance of the portfolio’s quoted businesses was, in aggregate, so much worse than the operational performance of its unquoted holdings. There is a world of difference between the underwhelming progress of share prices last year and the underlying progress of the portfolio – which has surpassed my expectations. That such a wide disconnect exists serves, I believe, to highlight the problem that the Patient Capital Review is aiming to solve.
Ultimately, the probability of success or failure is no different for an unquoted company than it is for a quoted company. An issue for early-stage businesses is whether to remain unquoted or list on the stock market and, depending on the business, staying private for longer can make the journey easier. Indeed, for some there is little benefit to a stock market listing for an early-stage business that could still be several years away from generating revenues, let alone profits. But, for the patient investor, this source of market inefficiency can at least be exploited because it can lead to substantial valuation anomalies.
There’s more detail on the progress being made by each of the Company’s top 10 holdings at the end of this review but one stock I wish to highlight to demonstrate my conviction and investment strategy is Prothena – a company I have known for many years.
Having performed well in 2015, Prothena’s share price fell significantly in the first few weeks of 2016, primarily as a result of an increase in the short interest in the stock. Our investment focus is resolutely on the long-term fundamentals of the business, which, despite the short-term share price performance, have been improving all year. News from the company has significantly reinforced our positive view on the stock and we took advantage of temporary share price weakness to add to the Company’s position.
In particular, my increasing conviction is due to the progress that Prothena has made with its leading drug development candidate, which is for AL amyloidosis, a rare and often fatal organ disease affecting fewer than 10,000 patients a year. Results from its phase I and II trials have been outstanding, while patient advocacy groups have been calling for its urgent approval. There are currently no approved drugs for AL amyloidosis and in 2018 we will learn the results of two late-stage trials, which, if positive, would result in a significant revaluation of the company.
From a fundamental perspective, the AL amyloidosis opportunity on its own would warrant a valuation far above that of today’s, in my view. Meanwhile, Prothena has also made significant progress on two other development candidates, one in Parkinson’s disease and the other in psoriatic arthritis. The speed with which it has identified and developed these three assets suggests that there could be more to follow in time.
The company’s rapid progress and its positive share price performance in the second half of the year are the principal reasons why its position in the portfolio has grown significantly from 6.3 per cent of assets to 14.4 per cent at year end.
In the world of equity investment, nothing is certain. As with any therapy in clinical trials, there is a risk that one or more of them fails to deliver the positive outcome that we hope for and expect. However, I am convinced that this business is poised to deliver incredibly attractive long-term returns to its shareholders and to improve the lives of patients suffering from these awful, debilitating diseases.
Some businesses in the portfolio have encountered problems and, undoubtedly, others will too. This is part of the territory when investing in early-stage businesses. What’s important, in my opinion, is how one reacts to these hurdles when they arise and the lessons one learns.
For patient capital investing to be a success, one has to work through the difficult periods. My approach has always been to favour voice over exit, which means overcoming hurdles to continue to support and nurture businesses that I retain my long-term faith in.
This was the case with Circassia, which announced results from a late-stage trial into its cat allergy vaccine in June. Although many aspects of the trial data were highly encouraging, further evidencing the drug’s strong therapeutic benefits, the results also showed that a placebo had broadly the same impact on symptoms. This development led to Circassia’s share price declining by more than two-thirds during the period, making it a significant negative contributor to performance. More recently (and outside the period under review), it announced similar results for its house dust mite vaccine and has now decided to stop investing in the development of its allergy portfolio.
We share the management team’s obvious disappointment at these trial results but remain supportive shareholders. There is much more to Circassia than its allergy platform and it remains in a strong position. It continues to successfully develop the asthma and respiratory assets that it acquired in 2015, with three new pipeline candidates added in the second half of the period under review. In March 2017, it announced a commercial collaboration with AstraZeneca, which significantly strengthens the company’s strategy as a speciality biopharma business.
Several new holdings were introduced to the portfolio during 2016, primarily funded by reducing the Company’s exposure to larger, more liquid companies early in the period.
These new holdings included Thin Film Electronics, a Norwegian company that specialises in printed electronics, an innovative new technology with a huge range of commercial applications, especially in relation to the ‘internet of things’. I have known the company for a long time and I am confident that it is poised for substantial growth as its technology becomes more widely adopted.
We also participated in the IPO of Draper Esprit, a leading venture capital investment company involved in the creation, funding and development of high-growth technology businesses with a like-minded investment approach to our own.
Among new unquoted positions were Metalysis, a titanium materials company serving the 3D printing industry, Nexeon, a battery technology company with enormous potential to improve battery performance across a wide range of industries, and Accelerated Digital Ventures, a newly-formed business that aims to provide patient capital to young British digital businesses with significant growth potential.
The WPCT has evolved in 2016, but the original investment hypothesis remains in place. In fact, I believe it is stronger than ever. That statement may surprise those investors that have been eager to see an early return on their investment or those that are frustrated by the lack of net asset value progress seen thus far. To an extent, I share those emotions, but they are insignificant compared to the confidence and excitement that I have in the opportunity from here.
I know how much fundamental progress our businesses are delivering and I hope I have managed to convey some of that progress in this update. In my view, it is only a matter of time before this progress is reflected in valuations. As for how long this takes, it is difficult to be precise. I said towards the start of this review that it is still early days for this long-term investment strategy but I acknowledge that I can’t say that for ever.
At launch, I set out to deliver double-digit annualised long-term returns. It is, of course, critical that I do so and I remain absolutely confident that I will.
In the meantime, I’d like to thank investors for their continued support.