Patient Capital Trust update, February 2017

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Mitchell Fraser-Jones 17 March 2017 Est. reading: 7 min read

The Woodford Patient Capital Trust delivered a positive return in February, with the largest contribution to performance coming from Prothena, the portfolio’s largest holding. Shares in the company rose by more than 25% (in sterling terms) during the month, despite the absence of any major fundamental developments. Prothena did announce its full-year results in the month but, as is typically the case for biotechnology businesses with no on-market products and therefore no revenues, results statements are rarely as important as clinical trial updates which can arrive at any time during the year. The company did use its results as an opportunity to remind investors of the meaningful progress it made throughout 2016 across its three key development candidates but the strong share price performance was probably more to do with improved market sentiment rather than anything fundamental. Although this was beneficial to performance, we continue to believe that Prothena’s share price continues to massively under-appreciate the company’s long-term potential.

Purplebricks also performed very well. The company continues to attract an increasing number of customers in the UK and, with its launch in Australia progressing well, Purplebrick’s disruptive business model is beginning to demonstrate its international viability. Towards the end of the month, the company successfully raised further capital to enable it to expand its footprint into the US market, prompting a further significant positive reaction in its share price, which increased by more than 50% during the month.

Within the unquoted part of the portfolio, we saw a valuation uplift for Gigaclear during the month, which reflects the positive progress the business has been making. Gigaclear builds and operates superfast, pure fibre broadband networks for rural communities around the UK. The company continues to grow its client base, with more community networks being rolled out and better penetration in existing ones. Meanwhile with improved market intelligence capabilities, Gigaclear is now better-equipped to assess customer demand and allocate its sales and marketing efforts. Also, the company plans to further improve its outsourced model for deploying its broadband, which should result in cost reductions, more efficient broadband roll-outs and, ultimately, enhanced shareholder value.

On a less positive note, Vernalis was one of the main detractors from performance. Its share price has more than halved over the course of the last 12 months, partly as a result of the negative market sentiment towards early-stage healthcare stocks for much of this period, but also in part as a result of a slower-than-anticipated ramp up of sales of Tuzistra, which was approved as a prescription cough-cold medicine in the US in 2015. Although sales of newly approved drugs often build slower than analysts initially forecast, the most recent update from Vernalis has failed to assuage market concerns about the gap between the level of current sales and that which sales are ultimately forecast to reach. We had also hoped to have seen greater progress by now but we believe that its management team is taking the right steps to ensure the product does ultimately fulfil its potential.

Furthermore, it is important to put the Vernalis share price into an appropriate fundamental context. It has a market cap at the time of writing of £129m, but with around £75m of cash on its balance sheet, it has a current enterprise value of just over £50m. By the end of this year it should have three prescription products on the market and a pipeline of other products from which it is realising value through out-licensing deals. Indeed, in focusing on Tuzistra, the market chose to completely ignore an announcement last month, of a new agreement with Corvus Pharmaceuticals which represents the largest out-licensing deal in Vernalis’ history. This involves an upfront milestone payment of $3m for CPI-444, which is currently in Phase I/Ib clinical trials in patients with advanced cancers. In aggregate, this deal has the potential to earn Vernalis up to $220m in milestones – that is more than three times the company’s current enterprise value which, in our view, highlights just how profoundly undervalued this business is. We remain patient and supportive shareholders.

In terms of portfolio activity, Arix Bioscience, an evergreen investor in early-stage businesses with a focus on life sciences, successfully made the transition from unquoted to quoted during the period, courtesy of its initial public offering (IPO). This resulted in a modest uplift to its valuation and an opportunity to add to the position.

Company spotlight: Atom Bank (by Paul Lamacraft)

Atom Bank is a Fintech company which was formed in 2014 as a challenger bank, aiming to revolutionise the oligopolised, traditional banking industry. The company was built as a mobile-first bank and, by using modern, cutting-edge technology, Atom has developed a completely digital platform that enables it to deliver superior services to consumers and businesses, without bearing the heavy costs of a branch network.

At the company’s helm sits an experienced management team with a clear strategy and a strong track record of success in the banking sector. Its Chief Executive Officer, Mark Mullen is the ex-CEO of First Direct (the UK’s first branchless bank) and Anthony Thomson, its Chairman, is the ex-founder and former Chairman of Metro Bank which he led through the regulatory process to become the first bank approved in UK in over 150 years.

Atom Bank joined the CF Woodford Equity Income Fund in December 2014 and in August 2015, it became a part of the Woodford Patient Capital Trust. Our due diligence concluded that the regulatory outlook was favourable, the management team was strong and the business model compelling. Also, we deemed its valuation to be attractive enough to compensate for the risks involved with investing in such an early-stage business concept. Consequently, we decided to provide Atom with enough initial capital required to support the regulatory approval process and to develop their technology platform, with the prospect of subsequent funding dependent on achieving appropriate milestones.

Since we first invested, the company has made great progress. In June 2015, Atom became the first UK bank designed for mobile to be authorised by the regulator. This important achievement attracted further investment from us and from other shareholders with a reputation for innovation in the banking industry, such as the multi-national Bank, BBVA. During 2016, Atom Bank successfully launched its mobile banking apps for both Android and iOS (the two most used operating systems for smartphones), bringing its online banking platform directly into its clients’ smartphones throughout the UK.

The company’s business model, although highly disruptive, is simple – through its smartphone applications, Atom offers a range of fixed-term saving accounts and, with the support of its broker network, it provides loans and mortgages to businesses and private consumers. Atom’s digital-only approach enables its consumers to manage their money easily and transparently while removing the time consuming and laborious procedures that are common when applying for a loan (or a mortgage) with a large bank.

Additionally, as it scales up, the company aims to operate at a significantly lower cost base than traditional banks, giving it the confidence to offer market leading rates of interest to its customers, whilst also maintaining a low risk approach in generating value for its investors. That’s it – no legacy issues, no aging IT systems, just a focus on comprehensive mobile applications to enhance banking.

That being said, the commercial opportunity that lies ahead of Atom Bank is truly vast. For example, according to the Building Societies Association, there were roughly £1.3trn of outstanding mortgages in the UK as of the end of January 2017, while the British Bankers Association estimates that there were around £450bn of outstanding loans in the SME lending market as of the end of September 2016. Capturing just a small fraction of these enormous markets will enable Atom to create substantial, long-term shareholder value.

Atom Bank also benefits from a strong competitive moat. It has a good relationship with the regulator, a first-mover advantage and supportive shareholders who back the management team and have provided significant capital to enable the business to develop faster than its competition and stay ahead of the curve.

The future is very bright for Atom Bank, in our view. In the near term, the company will focus on building its products but longer-term, Atom Bank has more ambitious plans which could change the face of banking as we know it. We are excited by Atom Bank’s long-term prospects but, as is always the case with early-stage businesses, there are still risks and many challenges ahead. We are confident however that the company’s experienced management team together with its competitive, digitally-based business model will help Atom Bank to successfully navigate these potential difficulties and create substantial shareholder value as it matures.

We also introduced a new position in the form of Novabiotics, a clinical-stage biotechnology company focused on developing first-in-class therapies for difficult-to-treat diseases, which has been a constituent of the CF Woodford Equity Income Fund since January 2015. The company has a robust pipeline with potential treatments for a wide range of conditions, including fungal nail infection, bacterial infections and cystic fibrosis.

Additionally, we provided further funding to Ombu, the investment company focused on UK early-stage businesses that operate in various industrials sectors, such as water and energy. The additional capital will enable Ombu to continue to nurture its portfolio which includes Open Energy (a young company that has developed an innovative technology platform which enables more efficient electricity consumption) and Bluewater Bio (a business which specialises in technologies for cost-effective water and wastewater management).

Looking forward, there’s a great deal of positive progress throughout the portfolio at the moment. In our opinion, it is only a matter of time before this progress becomes more appropriately reflected in valuations. As such, we continue to look forward to delivering very attractive returns to investors over the long term.

Woodford Patient Capital Trust plc
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