A couple of warnings before we begin - (i) this article is for entertainment purpose only and no part of it should be considered an investment advice, (ii) we have no financial position in the mentioned companies.
It is time for another update on the War and Peace between our favorite sequencing businesses. A number of news articles came out since our last post - “Woodford’s WEIF Dead, Oxford Nanopore IPO Doubtful”. Some of them were surprising in their content, and the others were surprising in their timing. We will discuss the implications and also add a bit of “conspiracy theory” at the end, but first the news.
Oxford Nanopore (ONT) Seeks Gullible Investors
Within days after our last post on Oxford Nanopore IPO being doubtful, UK Telegraph reported -
One of Neil Woodford’s star biotech holdings is in the midst of a secret £1.6bn private fundraising — despite reportedly telling investors it was planning to float.
Oxford Nanopore, a gene analysis “unicorn” set up 14 years ago, is understood to be courting investors. The company, which counted Woodford as an early backer, received £50m a year ago from Californian biotech giant Amgen, valuing it at £1.5bn. The latest fundraising could allow Woodford’s stake to be sold.
Pitchbook further expanded in “Oxford Nanopore fundraise plans offer possible exit for troubled fund” -
If successful, the fundraise halts any possible IPO plans. April reports suggested that the company may have been planning a dual stock market listing in Hong Kong and London. Analysts reportedly predicted that it could achieve a valuation of between £4.5 billion and £7 billion.
Scaling down from “between £4.5 billion and £7 billion” to £1.6bn means the company does not expect the IPO to be successful, but where does that magical £1.6bn valuation come from? We will explain that later in this post and argue that even £1.6bn is ridiculously high for this company.
UK’s Competition and Markets Authority Blocked Illumina-Pacbio Deal
On Oct 24, news came out that UK’s Competition and Markets Authority (antitrust agency) blocked Illumina’s acquisition of Pacbio. From their report -
In its provisional findings on the reference notified to Illumina and PacBio (the Parties) on 24 October 2019, the CMA, provisionally concluded that the Proposed Merger if carried into effect was expected to result in the creation of a relevant merger situation and that the creation of that situation may be expected to result in a substantial lessening of competition (SLC) in the market for next generation sequencing (NGS) systems in the UK.
They further expanded -
The CMA’s current view is that a structural remedy involving a divestiture of part of PacBio (or part of Illumina) either functionally or geographically would not be effective at addressing our concerns. This is because of the degree of operational overlap between functions in each business, the complete integration of sequencing systems within the businesses, and the fact that R&D and innovation-related activity is a centralised process which affects each company’s global offering.
What is going on here? Stay tuned for our analysis section later in the post, but let us continue with relevant news.
Pacbio Financial Report
Pacbio’s financial report, released on Nov 7, included a detailed paragraph on its current financial arrangements with Illumina -
On September 25, 2019, the Company, Illumina and Merger Subsidiary entered into Amendment No. 1 (the “Amendment”) to the Merger Agreement. The Amendment, among other things, extends the End Time (as defined in the Merger Agreement) to December 31, 2019, subject to Illumina’s unilateral right to further extend the End Time to March 31, 2020. In addition, the Amendment provides that Illumina will make cash payments to the Company of $6 million on or before each of October 1, 2019, November 1, 2019 and December 2, 2019 and we have received the October 1, 2019 and November 1, 2019 cash payments. If Illumina elects to further extend the End Time to March 31, 2020, then Illumina will make cash payments to the Company of $6 million on or before each of January 2, 2020, and March 2, 2020, and a cash payment of $22 million on or before February 3, 2020. The Company will use these payments, which are collectively referred to as the “Continuation Advances,” to fund its continuing operations. Up to the full amount of the Continuation Advances actually paid to the Company are repayable without interest if (1) the Merger Agreement is terminated and (2) within two years of termination, the Company enters into certain change-of-control transactions with a third party (in which case the entire amount will be repayable) or raises at least $100 million in equity or debt financing in a single transaction (with the amount repayable dependent on the amount raised by the Company).
In a nutshell, Illumina continues to pay $6M every month to fund Pacbio’s continuing operations.
Illumina’s Offer to UK
UK CMA gave Illumina until Nov 7 to respond, and Illumina submitted this document on Nov 7. The company offered -
(i) A perpetual, royalty-free, irrevocable, sole licence of PacBio’s patents listed in Annex 1 to Oxford Nanopore Technologies (“ONT”); or
(ii) A perpetual, royalty-free, irrevocable, licence of PacBio’s patents listed in Annex 1 to any interested third-party undertaking for use in the nanopore field
They further expanded -
A perpetual, royalty-free, irrevocable, sole licence of PacBio’s patents listed in Annex 1 would enable ONT to further improve its native long read systems offering. While ONT has technological and competitive advantages over PacBio, one significant perceived weakness of its technology is the accuracy of its systems. All of the patents offered for licence to ONT in this proposal entail methods that improve accuracy. In particular many of the patents cover methods of single-molecule consensus sequencing. A license of the patents listed in Annex 1 would enable ONT to become a significantly stronger competitor in various ways:
(i) First and with almost immediate effect, it would enable ONT to commercialise its 2D products which it has agreed to refrain from offering in certain European countries until 2023 as part of a settlement of patent infringement lawsuits alleging infringement of one or more of the patents identified in Annex 1. Reports from the Genome Sciences meeting in Edinburgh in September 2019 indicate that ONT has a new proven-to-work version of 2D chemistry ready to be brought to market in a matter of weeks.
(ii) Second, the licenses would remove the threat of an injunction potentially preventing the sale of all ONT sequencing products in the U.S.
(iii) Third, the licenses would enable ONT to improve the accuracy of all of the instruments that ONT currently markets and to develop and market new products without fear of litigation regarding these technologies. The patents offered to ONT or to third parties in paragraph 5 above, for instance, include patents for base calling using n-mers (as opposed to calling individual bases). ONT’s accuracy will be significantly affected if it is unable to call bases using n-mers. Likewise, ONT’s chief executive has described multiple approaches to single-molecule consensus that ONT is considering but which might be challenged as infringing by PacBio. The licenses being offered would remove the threat of litigation.
I will skip over another piece of pertinent news and mention it in the following section.
Our Analysis, Speculation and Conspiracy Theory
What is going on?
Origin of the Magical £1.6bn Valuation
Have we seen the £1.6bn valuation before? Curious readers may check Woodford holding Benevolent AI sees valuation halve.
One of Neil Woodford’s main holdings, Benevolent AI, has seen its valuation halve on the back of investment from a Singapore wealth fund far lower than its $2bn (£1.6bn) valuation.
Isn’t it perplexing that several of Woodford’s companies reached the identical £1.6bn valuation? Not at all, if you convert the number to US dollars and find it to round perfectly to $2B. Would you like to buy a car for $100K just because its price rounds up nicely? That simple rule for cars does not hold for unicorns, which are are valued for their perceived beauty.
Now that these companies are being valued as cars and not unicorns, how likely is it for that round number to stick? Not at all, unless the company finds more gullible investors (and we agree that the pool is not yet empty).
Oxford Nanopore Valuation is Too High
That brings us to the next point that the asking price of $2B for Oxford Nanopore is too high. We can argue in three ways.
- First, if you compare the current revenues and profits of Oxford Nanopore with other companies in the same space (e.g. Pacbio, BGI), it is impossible to come up with anything more that $700M-$800M. One may counterargue based on this news article-
Biotechnology startup Oxford Nanopore has tripled its revenue to £32.5m in 2018, providing a boost for its major investors the IP Group and veteran fund manager Neil Woodford.
What gets completely missed is the second part -
Despite revenue growth and a £100m cash injection led by Singapore sovereign wealth fund GIC, the company is not yet profitable, and posted losses of £53.1m for the financial year, down from £56.5m in 2017.
Repeated cash injection made the company completely wasteful.
Second, all other Woodford companies got 50% or more haircut from their previous valuations. It is hard to argue that Woodford overvalued all of his other gems, but somehow had been diligent with Oxford Nanopore.
Third, an interesting comment from the Pitchbook article mentioned earlier caught my attention.
Whether it’s an IPO or a capital raise, there is a group of investors eagerly awaiting the opportunity to exit the business: those who backed Neil Woodford’s Equity Income Fund. Once referred to as “Britain’s Warren Buffet,” the star stock-picker closed down its flagship fund fourth months after its suspension.
Who in his right mind will pay top price for a company for which a group of investors are “eagerly awaiting the opportunity to exit the business”?
What is UK’s CMA up to?
Needless to say that the British government did a poor job even in regulating ferries. Due to the actions of UK’s CMA and supreme court, Eurotunnel had to stop MyFerryLink, its previously successful Ferry service. Later the British government awarded ferry contract to a company with no ships and eventually ended up paying a fine of 33 million pounds to Eurotunnel.
A number of people complained about UK CMA’s decision about Illumina’s acquisition of Pacbio. You can take a look at this article written by Stephen Simpson in the investment site Seeking Alpha as well as the deposition of Shawn Baker, who has extensive experience with the sequencing services marketplace. We will not go into detail here, but the main point is that the agency completely ignored two giant players Roche ($256B market cap) and Thermo Fisher ($120B market cap), and the sequencing company BGI with large market-share in Asia.
But what if “anti-monopoly” is a ruse and CMA is forced to save ONT for bigger reasons? Famous investor Woodford is one big piece of this puzzle. The article “Screwed Investors Still Stuck in Woodford’s Imploded Mutual Fund Get a Glimpse of Their Losses” reports -
Hundreds of thousands of investors trapped in the imploded and shuttered Woodford Equity Income (WEI) fund, which is now down to £3.1 billion, could lose a third or more of their remaining investment by the time the fund is wound up, according to an analysis commissioned by the fund’s administrator Link Fund Solutions.
I suspect “a third or more” is way optimistic and it uses unicorn-level valuation of Oxford Nanopore. What if Woodford investors learn that they will lose 3/4th of their remaining investments? They will not treat UK government kindly for sleeping at the wheel. Moreover, based on early press releases from Oxford Nanopore, the company’s stock was purchased by other funds including Invesco, a financial giant. Worried investors are already leaving Invesco as you can learn from this report.
Invesco’s UK-focused funds, which suffered the biggest wave of redemptions in September — £967 million — and is down £8 billion over the past 12 months.
Further bad news may create a panic of magnitude bigger than 2008, because these funds are not like money in the bank with some kind of implied guarantee. May be CMA’s actions are directed to save the UK financial industry and prove our earlier post - “Will Companies Like Oxford Nanopore be at the Epicenter of the Next Financial Crisis?” - wrong.