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Woodford Patient Capital: battered shares draw in bargain hunters

23 April 2018

(Update) Woodford Patient Capital Trust marks its third birthday with its shares still marooned below their launch price but with some investors spotting a buying opportunity.

(Update) Woodford Patient Capital Trust’s (WPCT) three-year anniversary comes at a crucial point for the investment trust following a period of disappointing performance.

Neil Woodford’s staunch supporters will argue that the trust’s name indicates that three years is too early to make a judgement. Nevertheless, the anniversary marks an appropriate time to reflect on the journey so far.

At this point in time, investors remain divided on the fund’s prospects. Some suggest that sentiment towards WPCT has soured so much that it could be a good time to buy in. This is because any good news could have a disproportionately positive effect on performance.

However, others suggest the trust’s 14% drop since launch underscores the major challenges that the manager faces as an investor in early-stage healthcare and technology companies.

Back on 21 April 2015, WPCT represented the UK’s biggest investment trust launch attracting £800 million to its initial public offer (IPO). Woodford’s stellar track record as a UK equity income fund manager and the trust’s innovative performance-based fee structure were key attributes, causing WPCT to move to a premium immediately after listing. As investors scrambled to buy into the exciting growth story, the shares reached a peak of 119p in August 2015, 15% more than their underlying net asset value.

Since then it has been a downward descent marked by two rallies. After the initial surge, the shares de-rated to hit 83p after the Brexit vote in June 2016, at a 6% discount below NAV; before recovering to 106p a year later close to NAV but plunging again to an all-time low of 72p and a 14% discount last month.

Today the shares stand back at 83.6p on a reduced 3.5% discount to their Morningstar estimate of 88p NAV per share, raising the question of whether this is another rally that will peter out or the start of a more significant recovery? 

The damaging news today from Prothena, its third largest holding, suggests the former. Its shares crumpled after announcing it had ceased research and development of a key drug for a rare disease called amyloidosis. 

The obstacles

So, what has held back performance? Allied Minds (ALML) has been one of the most painful investments. Since the trust was launched, the intellectual property commercialisation company’s share price has fallen by more than 80% as a result of a $146.6 million writedown on the value of seven of its portfolio businesses. A short-selling attack by US hedge fund Kerrisdale Capital has also weighed on its share price.

Likewise, Nasdaq-listed biotech company Prothena (PRTA.O) has fallen prey to a short-selling attack by Kerrisdale. Over the past 12 months, its share price is down 35%.

In spite of this, Prothena delivered positive news for investors in March of this year, announcing a tie-up with US biotechnology giant Celgene (CELG.O) for novel therapies for patients with neurodegenerative diseases. If the therapies are commercialised, the potential milestone payments and royalties could amount to $2.1 billion (£1.5 billion). At the time, Woodford described the partnership as a ‘hugely validating deal’ for Prothena, which is the second biggest holding in the trust.

Events have overtaken the company. A lot was riding on the results of Prothena’s phase two ‘Pronto’ trial for its amyloidosis treatment. Its failure is a huge blow and sent its shares plunging nearly two thirds, although Woodford has expressed confidence that value remains in the business.

Meanwhile, Vernalis (VER) has turned out to be a disappointment. The AIM-listed biotechnology company’s share price has fallen 85% over the past year. According to The Times, the business is up for sale and it has started to wind down its US operations, following disappointing sales of its products and regulatory hold-ups.

Bright spots

There has been other good news, such as Proton Partners successfully trialling groundbreaking proton beam therapy for cancer patients in the UK. 

In addition, cancer specialist Autolus, which accounts for 4.5% of the portfolio and is also held by life sciences trust Syncona (SYNC), is set to list on Nasdaq in May 2018. Similarly, AIM-listed Mereo Biopharma is planning to IPO on Nasdaq at some point this year.

Gigaclear represents another success story. It has received a cash bid from Infracapital, valuing the company at £4 per share. This is a 23% premium to Gigaclear’s last valuation and represents a price at which Woodford is happy to exit. Held across WPCT and Woodford Equity Income fund, the fund manager stands to make a 35% gain on this investment.

A host of companies held in the portfolio have recently completed successful fundraisings. They include top holding DNA sequencer Oxford Nanopore, which accounts for 10% of the portfolio. In March, new overseas investors took part in a £100 million fund raising, valuing the company at approximately £1.5 billion.

Meanwhile, Benevolent AI (accounting for 7.6% of the portfolio) has completed a $115 million fundraising, which Woodford participated in. This investment values the artificial intelligence-powered drug development company at a little over $2 billion.

Turning unicorns into elephants

With close to 80% of WPCT’s gross assets invested in unquoted companies, there are some important implications to consider. At a conference organised by Winterflood Securities in January, Woodford explained that ‘multiple’ levels of discount are applied to the future cash flows that are expected from an unlisted company when it its valued.

The implication of applying a conservative valuation is that the upside - if it comes - can be significant and sudden. At the time, Woodford concluded that so-called unicorns held in the portfolio ‘will become elephants soon’.

On the other hand, unquoted companies are not valued on a daily basis and will only see their valuation revised if there is a milestone event, such as a fundraising round or plans to IPO. This means that the fund’s NAV can lag the stock market.

A new dawn

A number of wealth managers believe the tide may finally be turning for Woodford after a torrid period. They include Gavin Haynes, managing director of Whitechurch Securities in Bath, who recently bought WPCT for clients when it was trading at a double-digit discount.

The team had previously invested at launch, selling out after WPCT moved to a sizeable premium.

‘The trust’s performance has been disappointing since launch, but we have bought it recently based on an opportunity to gain exposure to a broad range of exciting unquoted long-term growth stories, trading at a discount with a low fee structure,’ Haynes explained.

Over the next 12 months, he hopes to see progress in the underlying portfolio of companies.

‘With a number of companies at a crucial stage of development, it needs to deliver some positive stories over the next 12 months to boost NAV otherwise investors’ patience will run out,’ he added.

WPCT is also on the radar of James Burns, a fund picker at wealth manager Smith & Williamson. His team has started buying it selectively for investors who believe there could be a recovery but understand the risks.

‘It has not had a good time, but its discount looks quite attractive. It seems that sentiment has become so negative that if there are any positive changes there could be a reversal,’ Burns explained.

‘We are not putting it as a recommendation yet, but we do think it looks interesting for a few clients,’ he added.

If Prothena’s phase two ‘Pronto’ trial results are positive, this could represent an attractive entry point to buy into WPCT, he said.

WPCT’s performance fee structure represents another draw. Woodford will only be paid if he can deliver an NAV return of more than 10% in a year and then beats a hurdle which rises by 10% each subsequent year.

‘There is about 40% upside before any management fee is charged on this, so it is a free ride from this point of view,’ he added.

Question marks

Other investors remain sceptical about whether Woodford has the relevant expertise to back early-stage companies, particularly in the biotech space. One also questioned whether an investment trust was the right way to tackle the area.

‘If you want to be involved in start-ups over the long-term and you are sufficiently familiar with the risks and the potential to lose capital, the most efficient way is to use a VCT [venture capital trust] or EIS [enterprise investment scheme].

'That way you get a tax break on the investment and tax allowances to go with it. It is inefficient to invest in this product through an investment trust,’ he said.

Nigel Moore, a senior wealth manager at Pilling & Co, has concerns about the way that WPCT’s portfolio is structured.

‘The top 10 holdings now account for over 60% of the fund with significant biotech and healthcare exposure. I am concerned about the concentration effect. The long tail of 79 holdings account for the balance of the portfolio will be less material to returns moving forward,’ he said.

Given the risks associated with investing in the underlying companies, as well as the potential rewards, he would like less stocks to be held in the portfolio and a ‘tangible timeframe for exit’ outlined. He has held the trust since IPO for clients with a growth mandate.

‘We are now approaching the three-year anniversary with many investors in negative territory. How much more patient can investors be?’ he asked.

Annual results, which are due from the investment trust shortly, will doubtless hold some pointers. 

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