The fledgling industries emerging from our universities
Science and engineering departments are innovation incubators, and regularly launch companies involved in a wide range of exciting new fields. Dr Mike Tubbs explains how to invest in spin-outs.
People don't usually think of universities as seedbeds of the start-up scene. Students in dusty libraries would be more like it. And until fairly recently, many academics wanted nothing to do with business. In 1970, a left-leaning Warwick history lecturer published Warwick University Limited, which insisted that links between industry and universities should be discouraged to prevent research being exploited a common view at the time.
Luckily, things have changed. New companies now regularly emerge from ground-breaking research at the science and engineering departments of British universities. Warwick itself, for instance, soon became more deeply involved with industry and now hosts the internationally recognised Warwick Manufacturing Group (WMG), which comprises seven research and education centres and over 600 staff.
As a senior lecturer in physics at Warwick before leading research and development for three multinational companies, I have been heartened to see the close links my former employer has established with industry and the many spin-out companies it has generated.
One of Britain's most famous spin-outs is Oxford's first, Oxford Instruments, founded in 1959. This company produced one of the world's first superconducting magnets, devices now used widely in research and in all MRI scanners. That gives you a good idea of the potential of these companies, which typically start out in three ways.
How spin-outs emerge
Direct spin-outs such as Oxford Instruments receive funding for the early stages of development from one or more of the university, the staff's friends and family, or angel investors. Examples of the first type include Oxford Instruments and Kromek, which came from Durham University's Physics Department. Another common route is through an intellectual property commercialisation company (IPCC), such as IP Group. Listed examples include IP Group, the oldest in the country, Allied Minds, Arix Bioscience, Mercia Technologies and Frontier IP Group.
Finally, spin-outs can emerge from a partnership between the university and an external company. A good example is BioScience Ventures, which is commercialising medical diagnostics research at Birmingham University. It is a joint venture between the university and diagnostics group Abingdon Health. Both parties contributed £1m into the joint venture. However a spin-out develops, it doesn't happen in a hurry. Mercia Technologies points out that it takes nine to 14 years from start-up to listing or trade sale.
Investors will be interested mainly in listed IPCCs spin-out funds which are largely a British phenomenon. Two British ones even invest in spin-outs from American universities (Allied Minds concentrates purely on US spin-outs, while IP Group has eight of them). We will exclude the likes of Oxford Sciences Innovation and Cambridge Innovation Capital from this discussion, since they are unlisted (though note that IP Group has stakes in both).
The five listed spin-out funds highlighted in the previous section have market caps ranging from £27m (Frontier) to £1.4bn (IP Group). Three of them have listed spin-outs in their current portfolios, while their unlisted holdings range from early-stage ventures to unicorns rapidly growing private companies worth over £1bn.
Some opt to focus on just one area (Arix Bioscience), while others dabble in a wide range of different technologies. IP Group is by far the largest; in the past few years it's scooped up Fusion IP and Touchstone Innovations, which both had portfolios of UK university spin-outs.
IP Group's portfolio of 239 companies consists of a main portfolio of 155 and 81 very small investments. The main 155 are at various stages of development. The value of the top 20 holdings accounts for 74% of the total value of the main portfolio of 155 firms.
IP Group's stakes in its top 20 firms have a total estimated fair value of £765m, as of the end of last year, and include seven listed companies. The top three in both life sciences and technology are shown in the table on the below:
|Table 1: IP Group's top six portfolio companies|
|Company||Description||IPG stake||Value of IPG holding|
|Oxford Nanopore Technologies Limited||DNA & genome sequencing||19.6%||£274.1m|
|Istesso Limited||Reprogramming metabolism to treat autoimmune diseases||61.1%||£51.1m|
|PsiOxus Therapeutics limited||Viral therapeutics for cancer||26.3%||£44.5m|
|Ceres Power Holdings plc||Next generation fuel cell technology||25.4%||£31.5m|
|Actual Experience plc||Optimising human experience of networked applications||22.2%||£28.4m|
|Xeros Technology Group plc||Polymer bead cleaning systems||10.9%||£25.8m|
A wide range of cutting-edge technologies
The table shows that these six firms account for £455.4m, or fully 43.9% of the £1,038.4m value of the 155 firms in the main portfolio. Oxford Nanopore alone accounts for 26.9% of it. The total value of Oxford Nanopore is £1.4bn. That makes it a unicorn.
These companies encompass a wide variety of technologies. Oxford Nanopore uses nanopores (nanometre-scale holes) to electrically analyse single biological molecules such as DNA/RNA. One of its products is a MinION sequencer, a cheap portable device allowing researchers who previously had no access to DNA technologies to use it in a wide range of fields.
Scientists in over 70 countries can now far more easily monitor how a disease is developing, or to what extent superbugs are becoming resistant to antibiotics. In the environmental context, the MinION makes it much easier to assess immediately the state of everything from crops to animals' food chains.
Istesso is another highly promising outfit. It produces treatments that attempt to reprogramme people's metabolisms to combat autoimmune conditions such as multiple sclerosis and rheumatoid arthritis. Ceres Power is working on a new fuel cell, made of widely available and inexpensive materials, that can generate power from both natural gas and renewable fuels such as ethanol or hydrogen.
Then there's Actual Experience, which uses its patented analytics to monitor data patterns in companies' digital supply chains (everything from routers to internet performance) to assess how users are experiencing a product or service and address any hiccups. Of course, there is also plenty going on outside IP Group. Portfolio company investments from other IPCCs are shown in the table here:
|Table 2: portfolio companies worth £9m or more from four IPCCs|
|IPCC||Company||Description||IPCC's stake||Value of IPCC holding|
|Arix||Iterum Therapeutics||Anti-infectives to combat multi-drug resistance||6.8% (to rise to 8.2%)||£5.7m|
|Mercia||nDreams||Interactive VR entertainment||45.6%||£13m|
|Mercia||Oxford Genetics||Synthetic biology for biological therapeutics||40.6%||£9.1m|
|Mercia||Science Warehouse||Spending management & procurement software||62.6%||£9.9m|
|Frontier IP||Exscientia||AI-driven drug design & discovery||5%||£2.2m|
|Frontier IP||Nandi Proteins||Protein technology for food manufacturing||20.8%||£2.1m|
|Stake sold in March 2018 for £10.6m|
Allied Minds does not give individual company valuations, but its top six portfolio firms account for $375m, or 95% of the overall portfolio value. These six are Spin Transfer Technologies (next-generation RAM memories); HawkEye (data analysis of radio frequency signals); BridgeSat (satellite communications); Federated Wireless (spectrum for cloud-based software); Precision Biopsy (real-time tissue characterisation), and SciFluor Life Sciences (new drugs for ophthalmology, neuroscience and fibrosis). Allied has stakes of 48% to 98% in these six firms.
What investors should look out for
We can use IP Group's portfolio to understand some of the typical characteristics of an IPCC and the guidelines these suggest for investors. Firstly, most of the value of an IPCC is concentrated in a few of the largest companies in its portfolio. In IP Group's case, just six companies account for 44% of the value of the main portfolio of 155 companies. An IPCC's share price can therefore be markedly affected by events changing the value of a few of its largest companies.
Secondly, the short-term value of an IPCC depends on the performance of a few of its larger portfolio companies, but the longer-term value depends, as for a pharmaceutical company, on the size and attractiveness of its pipeline. That in turn rests on the IPCC having close links with top university departments and research institutes.
For instance, IP Group has links with the key Russell Group UK research universities as well as with five prominent US universities (including Princeton) and three US national laboratories, including Argonne National Laboratory. In Australasia, IP Group has links with eight Australian universities and one in New Zealand.
Thirdly, a successful IPCC should have enough cash on hand for new investments and be able to source matching investments from other institutions. An IPCC with limited cash may well need a share placing to raise more. IP Group, for example, had net cash of £326m at the end 2017.
Finally, it is misleading to judge an IPCC by the usual investment measures of profits and the price-earnings ratio. It is the potential value growth of its portfolio companies that is important, although gauging this is hardly an exact science: portfolio companies developed to a stage where they are floated on the stockmarket often show a valuation at their initial public offering (IPO) of up to several times the "fair value" ascribed to them shortly before. Prices may fall back as the market reassesses the company's longer-term potential.
Which ones are buys?
The main way for retail investors to take a stake in spin-outs is buy the shares of an IPCC, which lowers risk by providing diversification across all the spin-out companies in the portfolio. You could also make a direct investment in the listed companies within an IPCC's portfolio in which the IPCC normally retains a substantial minority stake. In both cases, share prices tend to be very volatile we are talking about fledgling technologies.
Direct investments in individual, listed IPCC portfolio companies are risky and it is safer to select from those of reasonable size after they have moved into profit. So don't go for initial public offerings (IPOs), but wait until the company has established itself; keep an eye on its news and results to determine its odds of success.
Opting for an IPCC provides diversification and therefore lowers overall risk, although you will still need to be able to deal with some sharp ups and downs. The other important aspect of an IPCC is the sector breadth of its investments. Arix focuses only on bioscience, Allied Minds has both life sciences and technology, Mercia, Frontier IP and IP Group have life sciences, technology and materials, with IP Group also invested in "cleantech" and three multi-sector platforms (one is Frontier IP).
In selecting investments, the diversification inherent in the larger IPCCs is an advantage, and IP Group (LSE: IPO), with its wide range of technologies and large portfolio, is worth considering. It is currently on a slight discount to its net asset value, although the discount or premium will be less significant in determining its appeal than the fortunes of Oxford Nanopore, which is worth over one quarter of the portfolio.
Mercia Technologies (Aim: MERC) is an interesting option too. It focuses on investment opportunities in the Midlands, the North and Scotland and has links with 19 UK universities. It takes a broader approach, with university spin-outs accounting for about one quarter of its investments. It has the 20 significant direct portfolio investments on its balance sheet, some of which have been highlighted above, but it also operates a range of funds investing in promising start-ups. The ones that show promise and thrive are promoted to the portfolio of growth companies it invests in directly.
All of these started out as fund stakes that are now being scaled up. There are 170 businesses being nurtured within its venture funds. Mercia receives around 1,700 business propositions a year but only invests in 6% of them. Firms its funds have successfully nurtured include software groups Blue Prism and Allinea, spun out from Warwick University and sold to ARM in December 2016. Mercia has £0.5bn of assets under management.
(Dr Mike Tubbs holds shares in IP Group and Allied Minds.)
Oxford Instruments: a top university spin-out success
Martin Wood, who is now 91, was running the Engineering facilities at the Clarendon Laboratory of Oxford University when he founded Oxford Instruments in 1959.
The Clarendon specialised in low-temperature physics (which typically encompasses areas including cryogenics and superconductivity) using high magnetic fields those strong enough to change the properties of objects you put in them. The idea for a company arose when former students who had moved to other laboratories started asking him to make equipment for them.
Oxford gave him permission to start the company, provided he did not leave his tenured position at Oxford for ten years. He therefore worked in evenings and weekends on company marketing while his wife did the finance. Early equipment was built in a garden shed before the company moved to its first building.
In 1961 Wood decided to move into the new field of superconducting magnets (where Oxford is still a leader). The company grew rapidly to 100 employees by 1970 and to 1,300 by 1982, when the profit was nearly £20m and the product range included superconducting magnets for MRI scanners. The firm was floated on the London stock exchange in 1983. By 2003 sales had reached £231m, and today its market value has reached approximately £580m.
Oxford's current product range includes tools for nanoscience and the analysis and characterisation of materials. It supplies the plasma technology equipment used to build nanostructures and atomic force microscopy for materials and bioscience applications. In 2013 Oxford Instruments acquired Andor Technology, which makes high-performance digital cameras for astronomy, life science and quantum-imaging applications. This added new customers in bioscience.
Oxford Instruments's products are now used in industries ranging from semiconductors, quantum technologies and life sciences to advanced materials, crime forensics and battery technology.