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IP commercialisation industry has fallen out of favour with investors... but for how long?
Thursday 06 Jul 2017 Author: Daniel Coatsworth

I t can sometimes only take a single company to cause ripples across an entire sector. That’s evident in the IP (intellectual property) commercialisation sector which has gone from regularly trading at a premium to now languishing at a discount to net asset value or par.

While that will be disappointing for investors already holding shares of sector constituents, it does also present an opportunity to buy a few companies in the sector (or increase existing holdings) fairly cheaply.

WHAT WENT WRONG?

The sector sell-off has primarily been caused by Allied Minds’ (ALM) significant write-down of assets earlier this year.

The US business saw its share price fall by 70% between January and June this year; first as a result of the shock departure of the company’s founder, and then on the write-down news as it stopped funding seven investee companies.

Investors started to worry there would be write-downs from other IP commercial firms, hence shares in the likes of IP Group (IPO), Touchstone Innovations (IVO:AIM) and Mercia Technologies (MERC:AIM) have all been in a downwards trend.

IP Group used this weakness as an opportunity to make a takeover bid for Touchstone. The latter is presently trading at a 7% discount to net asset value. Even cheaper is Mercia whose shares are trading at 17% below net asset value (NAV).

HOW DOES THE COMPANY JUDGE SUCCESS?

Mercia’s chief executive Mark Payton says his board is focused on NAV per share growth – which in Mercia’s case grew from 37.5p in the year to 31 March 2016 to 40p in 2017.

Payton claims Mercia is less reliant on one or two investments in its portfolio compared to its peers and says the business hasn’t incurred major write-downs like Allied Minds.

I note that two companies represent 40% of the entire value of Mercia’s direct investments and its latest results (3 July) did include two write-downs.

Its investments in virtual reality gaming group nDreams and e-procurement firm Science Warehouse are worth a combined £20.89m versus a total portfolio worth £52m.

With regards to the write-downs, it has reduced the value of its holding in Science Warehouse by 25% in recognition of a decline in peer group valuation multiples. It has halved the value of its stake in digital trading card platform VirtTrade amid slower market progress for the company than expected.

However, the £4m combined reduction in these equity valuations is nothing compared to Allied Mind’s $146.6m (£113.4m) write-down announced in April.

MULTIPLE SOURCES OF VALUE GENERATION

Also in Mercia’s defence is the fact that its business is much broader than simply having equity investments in a portfolio of early-stage companies.

Mercia also runs a fund management business which predominantly uses third party money to back up-and-coming firms which could potentially create lots of jobs in the future.

This is essentially a breeding ground for Mercia from which it cherry-picks the best businesses once they are more mature. Cash on the plc balance sheet is subsequently used to invest in these firms.

Progress includes its maiden trade sale. Mercia made an 88.4% profit on all the money it invested in Allinea Software which was bought last December by ARM, the former FTSE 100 technology group.

Ultimately investing in Mercia requires significant patience. Anyone looking to deploy cash in the markets should definitely consider this stock, in my opinion, particularly in light of the current valuation anomaly.

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