Mercia Asset Management PLC (MERC.L) Earnings Call Transcript & Summary

Welcome to the Mercia Asset Management PLC final results investor presentation. [Operator Instructions] The company may not be in a position to answer every question it receives during the meeting itself. However, the company will review all questions submitted today and publish responses where it's appropriate to do so. These will be available via your Investor Meet Company dashboard, and we'll send you an e-mail to notify you when they're ready for your review. I'd also like to remind you that this presentation is being recorded. Before we begin, we would like to submit the following poll. And if you could give that your kind attention, we would be most grateful. And I'd now like to hand over to Mark Payton, CEO from Mercia Asset Management. Good afternoon to you, Mark.

Thank you, [ Mark ]. Good afternoon, everybody, and welcome to Mercia's 2021 preliminary results. For those that we have not met before, my name is Mark Payton, Chief Executive for Mercia, Co-Founder of Mercia back in 2010, 20 years of experience in predominantly life science commercialization and investing, also supported The Native Antigen Company by its first investment in [indiscernible] as well as OXGENE. On my right is Martin Glanfield, Mercia's Chief Financial Officer.

Yes. Good afternoon, everyone. I joined Mercia just over -- just under 7 years ago to actually help Mark float Mercia. And my background is the CFO of technology-enabled public and privately owned businesses.

Julian?

Good afternoon, everyone. I'm Julian Viggars, Chief Investment Officer. I've been a fund manager across Mercia's venture funds for the last 15 years or so. In that time, overseen many IPOs and trade sales, including our software business, Blue Prism, where we were the first investors back in 2004, investing GBP 1 million and ultimately returning a total of GBP 95 million in returns as we sold that asset down post its own listing.

Thank you. So Slide 4 nicely really summarizes what has been a strong and positive year for us in this reporting period, with assets under management rising from GBP 800 million to GBP 940 million, so that's 18% rise over the period. Adjusted operating profit at GBP 3.3 million, and I should just point out that, that excludes performance fees, realized gains and fair value movements on the balance sheet. In terms of realized gains, we've seen GBP 20.3 million. That's up from nothing last year. And in terms of our direct investments' fair value movements, it's been a positive GBP 10.1 million versus a negative GBP 15.8 million loss last year. Liquidity is very important for any investor in the market. GBP 314 million in unrestricted free cash across the group is an exceptional place to be in terms of making new investments as well as supporting existing portfolio. And that's broken down into GBP 259 million across our third-party managed funds and nearly GBP 55 million cash on hand on our own balance sheet. And there is no debt in the group. And in terms of that no debt in the group, the business has traded extremely well during this difficult period. We've made no redundancies, no use of furlough, no use of CBILS either. And the business has continued to deliver. And against that concept is the fact that we had 3-year strategic objectives set 2 years ago in 2019, all of which have now been achieved ahead of schedule, a year ahead. That was to grow assets under management from GBP 500 million to GBP 1 billion; move the group from loss-making to a sustainable, profitable position; and to evergreen the balance sheet. And by evergreening the balance sheet, what we mean there is investment realizations. Cash realizations from balance sheet activity exceed our run rate in terms of investment activity. ESG is something that we often hear about in the press. It's something that's at the heart of everything that Mercia does, including our investment philosophy as a regional investor with a mantra of responsible employer, responsible investor. ESG is an important part of our operation. And it's pleasing also to report that we started our initial maiden dividend, our interims, 0.1p per share. We're upping that at our prelims to 0.3p per share. So that's 0.4p per share over this reported period. And in effect, what Mercia does is 3 particular areas that we focus on: find value, add value, extract value. Find value, we are a regional investor embedded in the regions across the country. We've seen something like just under 3,000 inquiries. And importantly, of the 170-plus companies we've backed in this 12-month period, over 70 of those were brand new to us. And that's important as we continue to build momentum across the group by growing the portfolio. And the portfolio is in excess of 400 companies now across the group. Add value is what we do in terms of being a proactive investor. We're over 100 employees now, strengths in sector disciplines, et cetera, but also centralized resources. We do searches for C-suites, for senior managers, nonexec directors and chairs through a team internally. And that is at Mercia's cost, not the portfolio cost, as we look to grow those businesses. And back to making those new investments, this year, across the regions, our investment activity has created 467 new jobs across the regions, which I think is a great place to be when it's such a difficult trading period for many. We've seen 10 profitable exits. So in terms of extract value, we're continuing to do that, 10 profitable exits across the group. That's up from 5 last year, and that momentum continues into this year. Just to remind you what the addressable market is that we are looking to exploit and grow. It's the small- to medium-sized enterprises. These are businesses that typically are employing less than 250 people. When we're investing usually, it's somewhere between 5 and 50 people, our initial investment. They're predominantly private businesses, and we're investing anything from GBP 300,000 up to collectively across the funds and balance sheet to GBP 10 million. And these are sorts of businesses that typically need less than GBP 20 million in their total finance. And the reason why that's quite important is that when we come to sell these businesses or list these businesses, they are at enterprise values of somewhere between GBP 20 million and GBP 200 million. And actually, if you look at those 10 profitable exits that we've made, they fit within that range. In terms of market penetration so far, we've taken about 3% of the regional equity market, 0.3% of the debt market, so plenty more to go off. So we remain focused on the regions and on the U.K. The model that we're operating is a hybrid investment model, third-party funds combined with proprietary capital. A majority, over GBP 700 million of our assets under management, are in our third-party funds. These support the businesses across private equity, debt and venture capital. Our proprietary capital then coinvest with these funds or invest in portfolio emerging from these funds. And just to repeat what I just said, there's over 400 companies across the portfolio, approximately 23 on our balance sheet, so a very selective approach in terms of balance sheet capital work. The other point of the balance sheet proprietary capital is selectively, we're a limited partner, an LP, in a number of the funds that we manage. And that's important when we're trying to grow places where we are doing well or looking to new regions that we want to exploit in terms of our early-stage funds. And of course, the other function of our proprietary capital is that of being used for acquisitions as we look to grow our sales beyond organic. Which takes us nicely on to the next slide that just shows our own growth. So our portfolio are performing well and growing well and, we would argue, so are we. And this is from our IPO through to this financial year and our declaration of our initial dividend. And you see on every metric, our growth during that period, that 6-year period, has been, I think, quite admirable in terms of turnover. It's gone from GBP 0.5 million to over GBP 19 million; assets under management from GBP 100 million to GBP 940 million; free cash, for instance, GBP 53 million up to GBP 314 million, strong growth driven by organic growth in terms of fundraising but also through acquisitions. In 2016, acquired Enterprise Ventures. And in 2019, we acquired the fund management contracts of the Northern VCTs from NVM. And to reflect the maturity of Mercia, as it grows, it, too, has a mature share register, a very broad share register, a deep share register and one that's there to support our own growth as we go forward. You'll notice that there's a lack of concentration at any one institutional holding. And the largest, actually, is that of the Board, management and employees group together with a 17% ownership of the business. And that, I think, presents very strong alignment with our other owners of Mercia. So we've achieved our 3-year strategic objectives a year ahead of plan. And so the management team and the Board met, and we tried to work out what is an ambitious hurdle for us to head for, for the next 3 years. And this is where the Mercia 20:20 vision has come from. And by this, what we mean is 20% growth in AUM year-on-year over a 3-year period on average and a GBP 20 million pretax profit year-on-year for 3 years, again, on average. And the reason why I stress average is on the one side, we've got a very profitable fund management business that's contributing towards -- in fact, delivering the progressive dividend policy that we have developed and are growing. Then on the other side is really the balance sheet activity through realized gains and fair value movements, which provides, I guess, what one would describe as super profits for the group. And that is less dependable in terms of occurrence, but we would expect over a 3-year period to be meeting and beating that GBP 20 million per annum pretax profit. Thank you. Martin?

Mark, thank you. Notwithstanding the challenging year that it's been for everybody, I'm pleased to say that Mercia has come through unscathed, and these results reflect that fact. And it's also, I think, worth noting that throughout the entire year, almost all of our staff have been working remotely. So these results are a great tribute to their efforts as well. As you can see, we've increased revenue by just over 50% during the year. And that's quite good news, not least because our operating costs have only increased by 28%. So notwithstanding lockdowns, the benefits of operating leverage have still been invisible. As Mark mentioned, we achieved adjusted operating profits of GBP 3.3 million, again, a significant increase on the prior year. But that excludes the net performance fees we've also received of GBP 3.8 million. And those fees have come from the strong performances of both the VCTs and also, for the first time, our EIS funds. Those profits and fees, plus the realized gains and fair value movements, have resulted in profit after tax of GBP 34.5 million, which is some GBP 52 million, believe it or not, better than the prior year of GBP 17.5 million loss, which, of course, was 8 days into the pandemic. This encouraging income statement performance leads to net assets increasing significantly to GBP 176 million from GBP 141.5 million at the prior year-end. And as a result, I'm pleased to say that our net assets per share has significantly recovered to 40p from 32.1p this time last year. And again, as Mark has mentioned, we're very -- we have very strong liquidity on our balance sheet now for investment and other corporate purposes. And again, with our strong cash generation, we are able to recommend to shareholders a final proposed dividend of 0.3p per share. This next slide summarizes the movements in our assets under management from the beginning to the end of the year. And what you can clearly see here in the performance column is the very strong recovery in the values of our portfolio led by our 3 excellently performing VCTs. And that's taken us 18% up to GBP 940 million, just under the GBP 1 billion target we specifically set 2 years ago. The next slide presents the income statement under IFRS, International Financial Reporting Standards. And so therefore, the revenue number here is higher than the GBP 19.2 million. That, of course, is because the gross performance fees are included in this top line. But the rest of the numbers, hopefully, in that table should be familiar to you. And at the bottom, as you can see, is the GBP 34.5 million posttax profits. We are -- we continue to be nontax-paying, and we continue to have tax losses thusly. Our very strong balance sheet now is dominated by the portfolio of the investments, notwithstanding the 4 exits that we had in the year, just over GBP 96 million and, of course, also the very strong cash balance as well. And in our cash flow statement, you can see the top line there. We do generate cash as a trading business. We're not just reliant upon our trade exits to generate cash. Thank you.

Okay. Thank you, Martin. So my first slide really shows how and where we invested GBP 95 million across the year, also shows the split of our GBP 940 million of assets under management and the significant liquidity that Mark was talking about. So we have talked before about the importance of investing through the cycles. And we did that last year, investing in 76 new companies, 173 in total. Many of those new ones were in our debt division, where we achieved CBILS accreditation during the summer period but also 26 new venture deals. And we worked really hard on the origination piece again during last year, a lot of efforts around our digital engagement platforms, webinars, outreach, Meet the Funder-type events. And that's really enabled those new deals. So into our private equity division. We really focused on our portfolio. In the period, the start of the year, we saw increasing activity. And we're now in a position where we are close to completing a couple of new deals in that division. And I guess to finish on this slide, I'm really pleased with the significant liquidity that we have. And that will enable us to continue to make good investments going forward. So this next slide shows the geographic split of those 173 investments that we made. As you can see, a wide spread across the U.K. regions, but concentration in Mercia's heartland, which are the Midlands and the North of England. And the spike or the larger bar, Yorkshire and Humber, does reflect those contributions from our debt deals that we've done. So last year was a really successful year for exits. So 10 profitable exits across the group, as Mark has said, compared to 5 in the previous year. Those exits returned over GBP 100 million back to our investors. GBP 37 million of that came back to our balance sheet. Now clearly, successful realizations are key to our business, but that's by no means the whole story. So as Mark has already said, we do need to buy well, hence, the focus on origination, and manage well as well. And the assets on the left-hand side here were all very early-stage investments or indeed start-ups when we first invested. We've helped with advice around strategy, input on recruitment and shaping those businesses along the way and indeed helped at the point of exit itself. The right-hand side shows the great year that our VCTs have had. Standout performance there is from Agilitas, which was sold to private equity, given an 8x return. But those realizations have continued this quarter as well and the largest being musicMagpie, which listed on AIM in April at 12x cost. And our VCTs sold half the stake. They're returning a further GBP 25-or-so million back on that one as well. So the next slide shows the summary of performance across our equity classes. And just to bear in mind, we operate some 40 funds, various ages, various sizes, remits and geographies. And we use TVPI as a measure. And you can see we're showing some good performance here. We expect these percentage numbers to increase over time, acknowledging also that the newer funds, we expect these numbers to be lower and below cost in the early periods, given the fee drag and the effects of the J Curve. Also to note, our retail funds, our EIS funds, the figures quoted here do ignore the substantial tax benefits as well available to the investors. Onto our VCTs. Again, we're showing some really top quartile performance here. The total returns include the cumulative dividends to date. And I guess the really interesting thing is the NAV growth seen. So we're showing some really strong performance over 12 months. But also, I guess, more representative is the 24-month numbers, which are showing 13% to 16% increase, I guess, before and around the pandemic. The next slide, we are into our proprietary capital, so our balance sheet. So 23 direct investments now, 2 new added in the year. As Mark said, we have had 4 exits, GBP 37 million of cash generated from those exits and providing GBP 20 million of gains. And our proprietary capital is currently delivering an IRR of close to 15%. That's measured on a portfolio basis. And again, that's through our continued investing activity in those areas that we have always invested in. So in terms of investment focus, clearly, we'll continue to support our portfolio. We've got some really exciting assets in there that are maturing well. We also have the firepower now to add new deals with some 400 to select from, and we're carefully monitoring a number of those. There are some logos down below. And those kind of are from software in Pimberly to deep tech, Tribosonics, and life sciences with Newcells. Now we're already an LP investor in our current funds. We'll also look to seize new funds as we grow our funds under management. And we're also seeing some opportunities to provide that total capital solution alongside our funds to provide some cash-outs possibly to exit its founders or indeed existing managers in deals. And this is quite interesting for us because many funds just can't do this. So these are 3 profitable exits from our balance sheet last year. Now these -- all 3 of these are different. They were strategic acquisitions for the buyers. So The Native Antigen Company was sold in the middle of 2020, Clear Review in the autumn and then our largest exit to date in the spring where we sold OXGENE to WuXi in a just under GBP 100 million deal for a figure that represented something like 16x revenue on that business. So all 3 sales above carrying value and at significant multiples for both the funds and our balance sheet. Okay. So this slide really does show in numbers the story of the year. So on the left-hand side, starting with a portfolio value of GBP 88 million, to which we added a further GBP 15 million of new investments. Next 2 columns show the GBP 37 million of cash returns and the P&L effects of that. Together, those 2 columns mean that GBP 17 million of forward value has been effectively removed from the portfolio. The next column is our fair value uplift, so GBP 10 million of movements there, and you'll see the largest movements really across that 6 assets. Those movements are reflective of third-party indicators of value and clearly of the progress made across a number of those assets. Impression Tech, also, we did purchase a coinvestor share at a favorable price. And MyHealthChecked, which is an AIM-listed business, its share price has recovered from sub-1p to over 4p at the end of the period. And that's really changing -- widening the focus of that business and also reflecting some management changes. And that leaves us with a portfolio of GBP 96 million at period end. Okay. So a little deeper look at our top 10 holdings. So just to recall, we do look to build our stake over time, so some substantial holdings there. We do look also to take Board seats across these assets, and the main message here is that there's been some significant progress across all of these assets. And that's measured in terms of growth in revenues, new license deals, partnership deals in the case of Impression Tech and Medherant. Just to spend a little bit more time on our largest asset, which is nDreams. So some very strong revenue growth, and this is our VR games developer. So the revenues have not just been from [indiscernible] significant increase in amount of actual gains revenues and we are now selling about 100,000 units of two games, [indiscernible] next game which is called [indiscernible] in August and [indiscernible PS VR and console. So also, just to note, in the year, we signed our first third-party -- sorry, our first third-party publishing deal. This is where we've partnered with an indie developer of games, and we will publish that game in return for a revenue share as it's launched. So just to touch on a couple of others. Intechnica, which is our e-commerce efficiency and security business, some very strong growth in the consultancy part of that business, up to now GBP 10 million of revenues. And Netacea, the bot management side, again, is doing very well, $3.5 million or so of ARR and some exciting new customers added. Voxpopme, our video analytics business, is growing strongly. It is now also interestingly re-signing customers that churned during last year, and it's doing very well. Impression Tech is an asset looking at the automotive sector, so lightweighting of aluminum, again, now has 4 licenses covering U.S., China and Europe and seeing some significant inbound interest from OEMs. Medherant in life sciences, doing very well as well, new pharma deals across the period. Okay. So the second part of our top 10. So Faradion is our sodium-ion battery play. And again, the progress really is significant here. So some technical progress made where energy density and cycle life is now very comparable to other technologies. But more importantly, it's now into revenues and shipping battery packs. So a huge market opportunity here, and we're happy with the progress. Intelligence Positioning, again, is an asset where we did take an impairment in the first part of last year as we saw some churn. That thankfully has now stopped, and we're back into growth. MyHealthChecked, I've already just touched on that. But over the course of the last year and into this year, they've made 2 acquisitions and really changed the focus of that business to be helping you take control of your own health. And we've now stepped off the Board of that business. Warwick Acoustics is again seeing some deeper and wider OEM engagements. The existing OEM relationship is really looking for weight savings in the cars in the future, range extensions and the sound quality of its speaker systems. Last but not least, Soccer Manager, which is another games business, seeing some strong growth. And we have the launch of the 2022 game coming up in September. And again, we're hoping for some incremental growth again, given some further licenses that we've -- in the process of securing for that business. Thanks, Mark.

Thank you, Julian. The next slide quite rightly says, "Responsible employer, responsible investor." And Mercia is a services business, a people business, and we are dependent on a high-quality team here operating at mostly about 100 people across 8 regional offices here. And because of that, we look towards things that focuses and aligns their activities and also retains these good people as we start to develop and train them within Mercia. We have a dedicated ESG team. We have had for some time. And that has representations from all parts of the group, led by Jill, Jill Williams. And that group reports to myself. And that group is guided by the UN principles of responsible investing, and there are a number of facets to that. But the important focus for this particular year is one of diversity both within Mercia and within our portfolio and just building that out. Looking at our entire staff, 36% of our staff, 17% of our investment team and 40% of our Board are women, which for the financial services is good but personally, I think, needs work to be done. And that is a strong focus in one aspect of diversity. There are other aspects of what we're doing here in terms of further developing the team as we continue to grow the business. We have a thing called Mercia of Spirit. That's where we're dedicating our own time towards initiatives such as Cancer Research and a thing called The Skills Builders Partnership where we work with schools and helping them understand financial discipline, et cetera, and what it means if you were to start your own business, for instance. Other things that we're doing like Mercia Knowledge and Mercia Academy, Mercia Knowledge is connecting up the various databases that we have within the business and AI systems within the business, connecting those up and joining those across the group so everyone can input and access that information. The Mercia Academy is a training system supporting our staff develop as we continue to grow as well. And in conclusion, just to summarize these results. We've had a very strong year. But this is very much the sort of, as I've heard Martin say to me, the end of the beginning but the beginning of much, much more. And there's more to come from this group. The strategic targets that we selected back in 2019 have been met a year ahead of plan. And we're drawn now to the Mercia 20:20 vision, and there's a couple of questions on that, that we will talk to in a moment. The fee income of the business -- of the fund management business, I think, is important to dwell on. 85% of that is contracted and recurring, so a good long sight of future income. And that underpins our progressive dividend policy. And that's important because a number of our funds are either evergreen or long dated, 10-, 12-year funds. So that fee income goes out many, many years. Assets under management growing, GBP 940 million, up from GBP 800 million, growing predominantly on an organic basis in that period. And a lot of free cash across the group, but not too much. That reflects the opportunities, the investment prospects we've got as well as the existing portfolio as we look to grow our presence, grow our portfolio size and grow our portfolio value. And in respect to the direct investment portfolio, that is maturing, starting to deliver exits, 3 profitable exits from the balance sheet, 10 across the group in this period. And we expect that to continue. And that all underpins our firm belief in the business and our statement in terms of taking the interim dividend 0.1p up to the prelims level of 0.3p per share to a total 0.4p per share for the year. Thank you very much for your attention.

That's brilliant. Mark, Julian, Martin, thank you very much indeed for updating investors this afternoon. Ladies and gentlemen, please do continue to submit your questions using the Q&A tab situated on the right-hand corner of your screen. I just want the company to take a few moments to review those questions submitted already. I'd like to remind you that a recording of this presentation, along with a copy of the slides and the published Q&A, can be accessed via your Investor Meet Company dashboard. I'd also like to remind you that your feedback is important to the company. And immediately after the presentation has ended, you'll be redirected for the opportunity to provide feedback in order that the company can better understand your views and expectations. Mark, Julian, Martin, if I could ask you just to have a look at the Q&A tab, you'll see there's a number of questions that have come in. If I could just hand back to you and ask you to read out the question, if you'll be so kind, and give a response where it's appropriate. And I'll pick up from you at the end.

Great. Thank you very much, [ Mark ]. And everybody, what I've done is I've just grouped them together, and then I'll pass them amongst Julian, Martin and myself to answer. There was one question we received in respect of whether or not we had a regret in terms of the NAV impact on the VCT fund management contract acquisition. I'd just like to pass that over to Martin, actually.

Yes. Thanks, Mark. I thought I'd perhaps provide some comparable facts between where we were before the placing and the acquisition in December '19 and where we are today. So if we go back not that long ago, some of you may recall that the share register and the dominance on the share register of 1 or 2 institutions. And we only had a free float back then of 28%. And you will have seen today that free float is at 69%. Back then, NAV per share was at 42.3p. And today, we're at 40p. So we are within spitting distance of getting back to where we were from a NAV per share basis. However, if one then looks at other metrics, performance metrics since then, obviously, we weren't profitable back in December 2019. We were on a run rate of losing GBP 1 million a year, what we used to call net expenses, whereas, of course, now we have declared adjusted operating profits of GBP 3.3 million. And because we were not profitable at the adjusted operating profit line, we were not dividend paying either, whereas now, of course, we're able to recommend a payment of not just the interim but also a final dividend. We weren't receiving performance fees in December 2019. And of course, this year, we've been able to report GBP 3.8 million of performance fees, largely coming from those acquired VCTs. And we weren't at critical mass. We had GBP 490 million of assets under management, which has now grown by 92% to GBP 940 million. So in many respects, we would argue very strongly that in fact, the fundraising, discounted though as it was at the time, has resulted in a considerable progress for Mercia. And I think finally, that's reflected in today's current share price, which, at 37.5p, is only at a 6.25% discount to NAV per share, whereas back in December 2019, just before the placing was announced, the share price was at 32p per share. But that was then a 24% discount to NAV.

Thank you. Thank you, Martin. And Julian, there's one question -- there's a question here with 2 parts, which one part, I'm pretty sure you won't be able to answer or not allowed to answer. But the question is, where are the next direct investment exits coming from? And do we sell 100% of our holding assets here?

Yes. Thanks, Mark. So you're right. I can't give a specific answer to the first part of that question. I guess what I can say, though, is we certainly are expecting exits over the course of the next 3 years. And that's really why we are comfortable with the 2020 plan and, of course, evergreening the balance sheet. I can also say that the 3 exits that we have had in the year are all strategic ones for the buyers. So they are looking for expertise, perhaps intellectual property and the growth potential for those assets, not necessarily profits. So if we look across our portfolio, we've got the likes of Voxpopme, Intechnica, nDreams all in markets that are growing extremely fast and in markets where there's significant corporate activity. And I guess if you look a little bit further out, we are starting to see some of the OEMs taking a look at what is required for 2030 kind of electric revolution, et cetera. So there's inbound interest for the likes of Faradion, Impression Tech and Warwick. So that's a long answer to your question. Hopefully, I've given you some flavor. And do we exit all of an asset in one go? And I guess that depends because we certainly did completely exit those 3. As I've said, our VCTs have exited partially or indeed half their holding in Entertainment Magpie (sic) [ musicMagpie ]. And indeed, that's how we ultimately exited from Blue Prism where we sold progressively over time. So I suspect in the future, we'll see a combination of all those things happening within our exit landscape.