The penny shares set to change the face of British science

As a new a new research funding initiative gets under way, Tom Bulford reveals the penny shares set to rake in the profits - and change the face of British science for good.

Some of the most excitingpenny share stories over the last year have been hatched in university laboratories in this country. As readers of Red Hot Penny Shares well know, a number of very excitingpenny shares have come to market recently with scientific breakthroughs that could yet trump the opportunity we saw in mining stocks last year.

Now I don't want to betray my Red Hot readers by giving away any names. Or even to mention which universities these companies have spun out of. But it is well worth pointing out that, from drug research to material science, there are some very exciting things happening in our university labs right now.

The trouble with scientists of course is that they don't always make the best businessmen. A great deal of money is wasted every year in the effort to convert innovation into profits.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But help is at hand. In recent years a number ofstock market vehicles have been set up to partner scientists with hard nosed businessmen. And these companies just got some brilliant news. A new initiative for research funding will soon be introduced - and it will radically alter the way research is funded in this country. It could open the door for these penny share companies in a big way.

A new era for scientific research in the UK

The Research Excellence Framework, to be introduced in 2014, is a new system for assessing the quality of research in UK higher education institutions. Assessment of research work is crucial to the provision of research funds, and the new approach will have one crucial new ingredient.

As well as simply counting up the number of research papers published in academic journals and making a subjective view of the quality of their work, grant donors to universities will judge whether the research work is having a real impact. As much as 20% of their continuing research funding could depend upon an ability to prove that work done in university libraries and laboratories is actually translated into some material benefit to the world outside. This is going to require some skills that may be in short supply at certain universities, but one man keen to offer a helping hand is Neil Crabbe.

Crabbe is the man behind Frontier IP Group (LON:FIPP) a £3m company that stepped up from PLUS Markets to AIM in January. He reckons that universities often lack a proper understanding of the demands of business and accordingly waste money and effort on fruitless projects that are never going to attract the support of partners.

While researchers do plenty of clever stuff, it is not necessarily going to be of interest to the commercial world. Big business is always looking for innovation and is willing to supply research funding. But it will not back blue-sky research. It has specific problems that it wants to solve; and it sees specific commercial opportunities that it would like to be able to take. It needs researchers to understand these commercial imperatives.

Crabbe believes that there is a role for a go-between, finding out what would be of real use to the industry and passing this back to the researchers. Frontier has already established partnerships with two Scottish universities, Dundee and Robert Gordon.

The former, with a £93m research budget and a high reputation in the fields of medicine and life sciences, especially pharmacology, is keenly aware of the value of research. It was here in 1975 that Walter Speare and Peter LeComber invented the amorphous silicon thin-film transistors that are the basis of today's liquid crystal display industry - but Dundee has never earned a penny from their work.

Now though all universities are under pressure to conduct relevant research and exploit it. Effective research leads to generous funding; generous funding allows universities to attract the best academics; and a line-up of good academics will attract students waving those £9,000 per year cheques. So this should be a good time for companies that can help.

How to tap the inspiration of our greatest scientists

Much the largest player on the stock market is Imperial Innovations (LON:IVO) which works with Imperial College, Oxford andCambridge universitiesand University College London. IP Group (LON:IPO) has partnerships with ten universities and Fusion IP (LON:FIP) works with the universities of Sheffield and Cardiff.

Frontier is the smallest of the group, but it hopes to add two more university partners to its roster, and sees plenty of ways in which these relationships can reward its shareholders. It can charge advisory fees to the universities themselves and it has also set up two new funds to invest in university spin-outs, for which it charges a management fee.

The real bunce, though, comes from the companies that it hopes will graduate from the universities to thrive in the commercial world. From these it can receive advisory fees, but it will also receive shareholdings and in some cases earn royalties. Already Dundee and Robert Gordon have thrown up some interesting candidates.

Take Advanced Underwater Surveys for example, which captures 3D images of objects on the sea bed. It is already employed by Government agencies and salvage companies to survey sunken wrecks and it is now winning contracts from theoil industry.

Counterweight is a business that equips general practitioners and practice nurses to produce evidence-based approaches to weight loss management, and is a play on the problem of obesity; while Nandi Proteins improves the functional properties of common proteins such as whey, egg and soy allowing them to replace fat and increase food shelf life.

Any one of these, or any other business that makes the journey from University lab to business success, could make good money for Frontier IP. Based on tenuous assumptions, broker Arbuthnot already believes that the shares, now at 50p, are worth 200p. But their true value over time will depend upon the inspiration of academic researchers, and Frontier's ability to help them into the commercial world.

This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund.

Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

Follow Tom on Google+.