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

Good afternoon, ladies and gentlemen, and welcome to the Mercia Asset Management PLC Interim Results Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received during today's meeting. However, the company review all questions submitted today, and we'll publish responses where it's appropriate to do so. Before we begin, we would like to submit the following poll. And I'm sure the company will be most grateful for your participation. It gives me great pleasure to hand over to Mark Payton, CEO. Good afternoon.

Good afternoon, and thank you, Mark. And I do encourage those questions to come through. We'll be looking at them throughout the presentation and trying seeing them at the end and look to address them all. So welcome, everybody, to our interim results. For those that we have not had the privilege of meeting yet, just a few introductions from those presenting to yourselves. So my name is Mark Payton, Chief Executive and Co-Founder of Mercia. I have strong background actually in venture and life sciences and still have a number of portfolio responsibilities as well as running the group in the life science space. Martin?

Yes. Hi, good afternoon, everyone. I'm Martin Glanfield, CFO. I joined Mark just over 8 years ago as employee #7 to help Mark float the business online. And my background is as CFO of multiple public companies in the technology space.

Good afternoon, everyone. Julian Viggars, Chief Investment Officer. So I joined Mercia on its acquisition of Enterprise Ventures back in 2016, and I've looked after many of Enterprise Ventures and now Mercia's venture funds. One of the first of those, going back to 2003/'04 was a fund that included, Blue Prism. We were the first investors in Blue Prism, which is a software business. And we ended up -- for our GBP 900,000 investment at the time we invested, we realized ultimately about GBP 95 million off the back of that. So again, 20 years or so in venture capital doing exactly the sort of deals that we're doing now.

Great. Thank you, Martin, Julian. This first slide really summarizes what happened for this first half of our year, a continued strong progress, strong progress in respect of the Mercia 2020 strategic goals, and I'll speak to those in a moment at our midpoint. I think importantly, in this period of uncertainty, very strong liquidity, just under GBP 300 million in free unrestricted cash across our managed funds and our balance sheet. And of course, those managed funds are long-dated, 10-year plus or evergreen funds that are subject -- are not subject to redemptions. In respect of the equity portfolio across the managed funds and the balance sheet, well-funded and modest capital needs as well. So that means that in times of uncertainty of other investors retrench, something we call syndication risk and move backwards from the portfolio of companies, typically, we're able to support and really preserve value in our own right in those businesses. The group itself is highly resilient, sustainable and profitable and continues to be so as we look forward. That's also reflected in the increase in net asset value per share now at 46.8p, that's up from 45.6p from the 31st of March, 2022. And in line with our progressive dividend policy, I'm pleased to say that we're proposing a 10% increase for the interim dividend at 0.33p per share. And to the right, you can see a schematic that has our offices across the country. We are talking to you today from our office in Henley-in-Arden. Following the acquisition of Frontier Development Capital, FDC, we now have an office in Birmingham, in the City Center, which is really important as we continue to grow through the Midlands as well. In respect of the model that Mercia operates, it's a somewhat unique hybrid model comprising of a profitable fund management operation, on the left there in pink. This has complementary asset classes under management, across private equity, debt and venture. Recurring and profitable and cash-generative fee income from that element and importantly, a series of scalable platforms where we foresee in the near to medium-term organic growth in funds under management. Working in symbiosis with that is our proprietary capital, our cash on hand. Very strong discipline that we operate there in respect of its deployment where we invest selectively alongside our managed funds into portfolio companies emerging from those. As we look to scale additional funds under management, we can invest as a limited partner in new funds and, of course, use our capital selectively for corporate activities. There's 2 pools of capital fully aligned as we look to drive both capital growth as we'll find in NAV per share and yield in [ prime ] to our progressive dividend policy. And in terms of corporate activities, ahead of today, we've made 2 acquisitions. Julian just alluded 2 Enterprise Ventures, our first one in 2016. And when looking at acquisitions, we have a very strict discipline, following what we call a value driver analysis. And what that means is we're looking for at least 20 defensible reasons why an acquisition should take place, and those form part of the integration planning exercise as we look to extract value from that acquisition thereafter. At the top of that list, a strong cultural fit and not part of that list are cost synergies. We are not looking at stripping costs out of businesses. We're looking at accessing capabilities to scale the broader group following the acquisition. We look to adjacent or complementary or more of the same asset classes through these acquisitions. It must, of course, be earnings enhancing. We are focused exclusively on the U.K. as a domestic market on a regional basis. So we're looking at funds under management scale to that point and looking at a strong fit with the internal capabilities and systems that Mercia's built over time and that drives the organic growth that derives from that acquisition. As I mentioned, 9 years ago now, 2016, Enterprise Ventures that was acquired on a structured deal of GBP 11 million in total, and that brought across GBP 200 million in third-party funds under management against a 7.9x PBT. From that acquisition, we saw a GBP 150 million of organic funds under management coming through. 3 years later, 2019, so 3 years ago, almost to-date amazingly, we acquired the 3 VCT fund management contracts from NVM and the team from those VCT operations came across to Mercia. That was on a structured deal, GBP 25 million. We acquired GBP 270 million in third-party funds under management against the 6.3 PBT multiple, and we've seen GBP 66 million of new funds under management come through on that acquisition. And it's pleasing today to announce the acquisition of Frontier Development Capital, FDC. Again, the entire group acquired, this time on a structured deal, GBP 9.5 million, bringing across GBP 415 million in third-party funds under management against the 7.3 PBT multiple. So you can see a consistent basis for acquisitions running across those 3 acquisitions. A little bit more detail on this slide in terms of the acquisition. FDC is an alternative national fund manager, exclusively focused on providing loans to both SMEs and property developers across the U.K. through the regions. Established in 2016, as I said, headquartered in Birmingham and 24 employees, which I am pleased to say all join us today. The transaction, in this instance, was cash-only. And now a total consideration of GBP 9.5 million, GBP 5.5 million being the initial part of that and GBP 4 million as part of the deferred consideration over a 2-year period driven against revenue forecasts, and GBP 100 million net in new institutional third-party fundraising. The business itself, FDC, typically lends GBP 2 million to GBP 10 million and above, can lend up to GBP 20 million. And we see this very much as a platform for future FUM growth. And in itself, it fits very tightly and neatly with what we call the complete connected capital where we see that interplay of the various pools of capital that we manage. So casting this back on the left side there is venture. Ahead of the acquisition of the VCT fund management contracts, Mercia used to deploy venture in the range of GBP 0.2 million to GBP 2 million, and we saw an opportunity to scale our capabilities through a further GBP 5 million. So up to the GBP 5 million end by acquiring the VCT operation. Now you look at what our debt used to do. Our legacy debt team here, which is GBP 0.2 million to GBP 1 million. FDC then extends that, as I said previously, to GBP 10 million, up to GBP 20 million. So the fit in the complementarity of that is highly attractive as well as the opportunity to further scale FUM. And when you look across the piece and add up the various FUM that we have now, that's grown to circle GBP 1.4 billion, which is quite impressive when you think we started the journey, and Martin alluded to our IPO, where we had something like GBP 30 million of funds under management at that point ahead of our IPO. Just in terms of the discrete pools of capital that we manage, and I think this is quite an important slide to put a fine point on where we see growth coming from. We've got retail, which is EIS and VCT. In each year approximately GBP 1.6 billion in EIS and GBP 1.1 billion in VCT is raised nationally. And put that in context, our VCT operation raised circa 40 and our EIS circa 2025 in the last year. And based on our track record of delivery, we would expect to take a significant portion of those annual fundraises going forward. The second pool of capital, British Business Bank, we currently manage approximately 40% of the regional venture and debt funds across the U.K. Recently, GBP 1.6 billion commitment was made to the next generation of these regional venture and equity funds coming through, and we expect to secure a meaningful part of that going forward too. Greatly facilitated by FDC. We don't have, for instance, a debt competence in the Midlands. We do now. So we would like to think we're well placed going forward in that regard. And then finally, the institutional capital, that discrete pool of capital. We see this through our private equity and our legacy debt operation. And this is predominantly through pension funds. And now these pension funds are typically allocating capital to Mercia through their impact allocations as a regional investor, and we believe that while strong track record now combined with FDC, places us in a strong position for future organic fundraising. And to the point on the Mercia 2020, at this midpoint, just to remind you, we've set 2 really broad strategic goals of, on average, over 3 years, GBP 20 million pretax profits. And again, on average, over 3 years, growth in AUM by 20% per annum. And that drives towards the NAV per share growth as well as our progressive dividend policy. And on the table on the right, you can see the progress at this midpoint as we drive towards GBP 1.6 billion AUM in total over the 3-year period. We're at GBP 1.4 billion there and GBP 60 million collectively over that 3-year period in terms of the pretax profits over the 3 years, and we're approximately GBP 35 million, GBP 36 million there. So strong progress against both those elements of strategic goals. And then finally, from me, and I mentioned about the impact allocations from the regional pension funds. Mercia is very much seen as a responsible impact investor, which is particularly pertinent and relevant for all 3 pools of capital we manage, both in terms of retail, British Business Bank and those regional pension funds. And these results and our previous results demonstrate that actually responsible investment were, so regional investor with the hybrid model, we've got delivery, delivers returns against the expectations of both investees and investors. We have a dedicated responsible investment team within Mercia. I'm part of that team. A little while ago, we launched our first knowledge-intensive Impact EIS Fund, and that closed much faster than we were expecting and hit its targets. And we've launched recently our second version of that. With the combination of FDC in the announcement today, we have 144 employees, 9 regional offices and 19 university partnerships. And those regional university partnerships, I think, will become increasingly valuable over time. When you look at the team, 41% of the total employees, 21% of the investment team and 2 of our 5 NEDs are women, and this very much reflects our focus as a responsible investment team looking at both diversity and inclusion. Martin?

Thank you, Mark. Our first half results are shown here in the slide, and they are strong results, notwithstanding the macroeconomic backdrop and the general sentiment currently towards the tech sector overall. Headline revenues were GBP 12.2 million, but that did include GBP 1.3 million of revenues relating to the VCT fundraise in April 2022. So the underlying like-for-like growth was, in fact, 8%. We've had another strong progress in our adjusted operating profit, in part, from further interest coming from our balance sheet portfolio in the finance income line. And together with positive fair value movements in the first half, we've achieved profit before tax of GBP 7.4 million. If you plow through the interim statement, you'll see towards the end, an interim audit report from our auditors BDO. Although, we don't have to, we do subject our half year fair values and our income statement to scrutiny by our auditors. We believe that, that adds credibility to our half year results and also transparency for our shareholders. As Mark has mentioned, we have strong liquidity on the balance sheet at the half year of GBP 56.1 million. And as a result of the positive first half performance overall, our NAV per share has grown to 46.8p. This next slide shows the movement -- first half movement in our assets under management by asset class. And in the first half, we generated new investor inflows of GBP 54 million, being predominantly the VCT fund raise of GBP 41 million in April, including the dividend reinvestment scheme and GBP 13 million from 2 successful EIS fundraises, one of which was our first knowledge-intensive Impact Fund. As is true with the general market, our asset classes have suffered some performance reductions in terms of fair value movements, predominantly those few investments that we have that are on the public markets in the VCT portfolio. And we've also continued to sell investments and return capital to our investors and also pay dividends to our VCT shareholders and our own plc shareholders. And overall, therefore, at the end of September, our total assets under management were GBP 979 million. And then, of course, post year-end, we've increased our assets under management by GBP 415 million from the acquisition last -- yesterday evening of FDC, and we just recently been awarded an additional GBP 12 million from the British Business Bank Midlands Engine Investment Fund. So still further good progress there too. On an international financial reporting standards basis, this slide shows our income statement for the first half. And you can see there the significant fair value -- positive fair value movements of GBP 5.6 million, which Julian will talk to in much more detail in a moment. As I mentioned, a strong finance income line. And as we are now sustainably a profitable group, we've used up our historic tax losses and are now tax paid. Over the 8 years since our IPO, we've built incredibly strong balance sheet, which is debt free. And you can see there the balance sheet portfolio that Julian will talk to is now up to GBP 132 million from a circa GBP 10 million standing stocks. And you can also see GBP 56 million of unencumbered cash sitting on the balance sheet at the half year. And finally, from a cash flow perspective in the first half, we had positive operating cash inflow and the largest number in our cash flow statement was the GBP 6.4 million invested into the balance sheet portfolio. Thank you.

Thanks, Martin.

And thanks, Martin. So as always, some key stats from across the group to kick off. I think the message really is steady as we go at this point. So the top box here shows our deployment levels in H1, and they are very similar to the corresponding period a year ago. What it does show is our deorigination activities continue to deliver us around 200 opportunities per month, which is very strong, and that's enabled us to deploy GBP 56 million across 80 businesses, of which 35 were new to us. The lower box also shows that our performance continues to be solid, another GBP 25 million returned across the equity side of the business. And we have undertaken some specific portfolio consolidation, I guess, across our funds, kind of weeding out some of the older or underperforming assets. And this perhaps is why we've got a slightly greater volume and lower multiple on the exits this time around. But those realizations have continued. They're now up to GBP 33 million, GBP 34 million with that multiple closer to 2%. Now we are seeing some processes -- exit process is slowing or indeed pausing in the current environment. So I think we're unlikely to see the record GBP 155 million of realizations that we saw in the year to March. So on to our direct portfolio. So we have recently added 3 companies to our balance sheet. So one was in the first half, 2 in October, just post the period end. So in the period, it was Uniphy, which is a deep tech asset, and this really is working at the human machine interface. So this technology allows any surface or any form of surface to become smart. So if you think about kind of controls for appliances or in vehicles, with now no need for moving parts. So exciting one, we think. Axis Spine is a GBP 10 million deal where we've put syndicate together to include a new sector-specific U.S. investor, but also money from our own VCTs and EIS funds. And this is an FDA-cleared spinal implant cage system. And again, this is already doing surgeries in the U.S. And we are excited about this one. Nova is a deal from the Northern Powerhouse region, and it comes from our Northern Powerhouse Equity Fund. And it is a business that uses -- it's a process, technology that converts biomass, woody materials into bioethanol and carbon residue. And again, some interesting uses for this in sustainable aviation fuel. So again, we have significant, what we call, our proprietary deal flow that comes out of our funds. So we will be looking to add further new investments over the course of time. So this is our balance sheet in numbers. So if you were to look at the first column on the left-hand side, our brought forward carrying value of GBP 120 million, to which we added GBP 6.4 million of new cash. And then about GBP 5.6 million of fair value movements that Martin talked about, leaves us with GBP 132 million carrying value at the end of September. So in terms of the fair value movement column, we have 2 large equivalent numbers of GBP 12.2 million, and this is the result of a business that we had -- and still have, in fact, it's called Intechnica, which split in April into 2 businesses at the old, if you like, original consulting business, but also a new business that was formed a few years ago called Netacea, which is a product business in security bot management. In terms of the positive movements, we have 2 uplifts, at games businesses Invincibles and VirtTrade, and that really is as a result of revenues growing across the period. We also saw significant progress at Warwick as OEM reengagement continues, but we also put together another third-party funding round back in the summer. Now those are balanced by lower growth software businesses, W2 and Ton UK, which is also called intelligent positioning, where we've applied lower sales or ARR multiples to those businesses. We also got a downward movement on Edge Case Games, which really is a holding company now for a future royalty stream from a game, which is being developed by war gaming, which we believe is likely to be later in terms of its release times. So overall, I think our portfolio, though, is in good shape. Yes. So this last slide for me shows our record to-date of realizing and on average 50% above carrying value for our direct assets on exit. So what does this say? It says either our valuations are conservative or more so probably that many of our assets are actually quite hard to value. But it certainly does say that I think these -- some of our assets are very attractive, strategic buying opportunities to corporates who are willing to pay over perhaps the normal kind of valuations you get by applying valuation metrics. So we've seen this very recently with the GBP 100 million exits from both Faradion and Oxford Gene. Yes, Mark?

Thank you. So just bringing this presentation to a close, actually, as I hope you agree with us that the acquisition has been highly complementary. A lot of advantages now but also for scaling funds going forward. It's an earnings-enhancing acquisition and also provides a broader debt footprint. And back to the point on scalable distribution, we think with opportunities such as the British Business Bank regional funds it places us well in terms of securing future opportunities there. The acquisition itself moves us closer to the 2020 strategic vision at this midpoint. And it's another long-dated managed fund operation that we've added to the managed funds stable. And that's really important as we plan capital group deployment over the long-term, both in terms of preserving value as well as growing value within the portfolio. The fund's portfolio and importantly, the direct investment portfolio are well-funded, diversified portfolio companies, which actually have quite modest capital needs. And I know we've said this over the years, but now more than ever as capital retrenches, it's really important to be able to preserve value within those investments. The 2% fee margin remains intact in terms of our scaling fund management funds after this acquisition and importantly strong liquidity across the group. Now assume no EIS, no VCT, no top-ups to the existing BDB funds. Not securing the next generation of regional funds or indeed additional institutional funds, we still have well in excess of 2 years' cash to invest across our portfolio and our balance sheet. However, we do expect most, if not, all of those different pools of capital I just talked about to deliver further organic fundraising in the near term. So thank you very much for all of your attention. We've got a whole load of questions which I've just been grouping and we're going to ask in the forward time.

That's great, Mark. Thank you very much indeed. And just to give you guys just a couple of moments to look at those questions. I'd like to remind investors on the call that a copy of the slides along with the published Q&A and the recording will be available via the Investor Meet Company dashboard and we'll notify you when that's ready for your review. Mark, I've given you absolutely no time. So I'm not quite sure why I jumped in. But either way, hopefully, you've got one question to ping at, but you've received a number of questions. So firstly, thank you to everybody on the call for today's -- for your engagement today. And maybe if I may, Mark, just ask you to read out those questions where it's appropriate to do so, and then I'll pick up from you at the end.

Absolutely, absolutely. So I've grouped to number as that was going on, and I'll take you through those groupings and then there's a few at the end. And please do add additional ones because we do have time to take your questions. So the first lot I've grouped together are to do with the direct investments. The first question, which actually I'll take, because it's a quick answer, which is will the -- because we can write check sort of up to sort of GBP 20 million with the Frontier Development with FDC acquisition, does that mean our direct investments will be larger as well? And the short answer to that is, no. And that's because, actually, if you look at our balance sheet portfolio, they comprise almost exclusively of businesses that we've co-invested with our venture funds. So it will be unusual, if never really, in terms of debt funds being co-investments. So that does not influence the direct investment strategy, doesn't change that at all. The next question in regard to the direct investments, Julian, if I can pass to you. Well, there's 2 questions here. The first one is Axis, which is mentioned as a nice-looking business. What is the size of our equity holding in that? And are there other co-investors, and in which case, who are the other co-investors with us on that?

Yes. So I'm going to get slightly caught, Mark, I'm afraid. But so in terms of Axis, our percentage holding from memory is somewhere between 10% and 15%. But our funds also hold another sizable chunk, perhaps 30%. I can get the -- I can publish the exact details at some point. But yes, it is -- I think as I said, we do have a U.S. strategic investor in that syndicate now. And it is a substantial opportunity, many hundreds of millions of dollars. And the company does also have the ability to do slightly adjacent surgeries as well. So yes, we are very excited about it. It's a big opportunity.

And another question was, that they were under the belief that Warwick Acoustics WA had gone into insolvency, which it clearly hasn't. But I wondered if you wanted to just broaden out what is shown about Warwick Acoustics and perhaps shed some light on which one -- I'm not aware which one that is, but which one they could be alluded to?

Yes. So Warwick Acoustics is certainly not in insolvency. It's doing really well actually. It's -- this again, it's a deep tech asset, looking at, it's kind of flat speaker technology, which are very high quality, very lightweight, flexible that they can go in vehicle headrests or above drivers and create sound [ pods ]. So it's a really interesting opportunity for us, particularly in the kind of cabins of the future and light weighting arguments. And we are currently undergoing 4 different kinds of partnerships with different OEMs at the minute. So some exciting times for Warwick actually.

Thank you. So the next questions relate to the interplay, Julian, between the funds and the balance sheet. So one question is, how do the returns, broadly, of the funds compared to the returns broadly of the balance sheet? Is there a comparison that come out there?

Yes. So given that the funds going earlier than the balance sheet, on successful exits, in particular, for example, we -- if you look at Ox Gene and again, I'm not going to quote the exact numbers. But the funds would have made substantial multiples of returns, so 10x to 14x, I believe. And the balance sheet would have also made significant returns, but lower, because the balance sheet would have gone in later, and that is very much the model. So when both the funds -- and it's right that the funds take higher returns, because they typically take higher risks. So it is our model and key intent that both the funds and the balance sheet makes those very solid returns when we invest in any asset.

Thank you, Julian. And then another question sort of relating to that asks, so I think very kindly says about the net asset value of our direct investments has been preserved and is in good shape. However, if you compare that to what's happened with the Northern VCTs, they seem to have had a degree of NAV erosion. Is that because we have a different valuation policy between the Northern VCTs and the balance sheet? Or is this just a result really of the balance sheet selectively investing in fund assets rather than in all assets?

I mean, I think that -- I mean, it's all of either of those because we certainly don't have any different valuation policies. The fundamental reason for the declines in the VCT is really down to particular exposures. We've got a small number of exposures to listed assets within our VCT operation. And it's that that has caused the relative or, if you like, relatively larger falls in the VCTs versus our balance sheet.

Yes, actually, you make a very good point there. We have just one listed investment -- only a small one in MyHealthChecked on the balance sheet. And then the final question to you, Julian, and then Martin I'll turnover to you, is to do with the investees themselves that we support. So do we play an active role with the investees? And if we are playing an active role, do we think that, that track record helps us secure additional opportunities going forward?

Yes, I think that's right. So yes, we do play an active role. And we typically take board seats on every asset, certainly all the balance sheet assets. And that clearly involves a monthly meeting with the business. That's clearly not it either. We're typically on the phone or the Zoom at least every week with our businesses. But I guess in many ways, more importantly, we have the ability to help those businesses, when they are looking at recruiting, be it key non-exec directors or chair or adding to the financial capability of those businesses. So we have, what we call a talent network, which leads the warheads up for us. So we have over 1,000 non-executive and executive directors within our database. So we can choose and introduce those experienced entrepreneurs and operators to our businesses. And in fact, also what we are doing a lot more of recently is adding, again, perhaps for more shorter-term assignments, some operating partners in where if we need to tweak the business model or we'd like them to look at the route to market or the marketing [ cluster ] or processes or whatever it might be, then we can find individuals that we can add in to help in that way. So on top of that, we also have portfolio seminars where we introduced CEOs and chairs together. We provide information across the portfolio. We do newsletters, and we have a whole group of shared services that our portfolios can access, which typically saves them money as well. So yes, I would say that we do provide quite significant other levels of support to our businesses.