Nanoco Group — Growing confidence

At £1.1m, H122 revenues were slightly higher than H121 and H222. £0.9m was attributable to services and materials supplied to ST. Adjusted EBITDA losses continued to narrow, from £1.5m in H121and £1.4m in H221 to £1.2m. This reflected a reduction in headcount compared with H121 as the business was restructured around its core competencies of R&D, scale up and production, lower patent maintenance costs as the group focused on protecting the IP most likely to generate a return in the short-to-medium term and general cost-control. The cost reduction programme, which includes consolidating all activities at the Runcorn site, has cut the average monthly cash burn from £0.4m in H121 to £0.3m in H122 (£0.7m in H120.)

Net cash (excluding £0.4m IFRS 16 lease liabilities) fell by £2.0m during the half-year to £1.8m at end January 2022. Following the delayed receipts of an R&D tax credit and a significant payment from ST, net cash increased to £2.6m at the end of February. There was no investment in tangible assets. Intangibles expenditure of £0.1m (£0.2m H121) related to patent costs. The revenues received from customer projects combined with the cost-savings have extended the cash runway for nanomaterial development and scale-up activities from calendar H222 into calendar H123, at which point there should be good visibility of both potential production orders and the outcome of the patent litigation. The cash runway could potentially be further extended by additional business wins in calendar H222 and H123. If none of the development programmes currently underway start to scale up during calendar 2022, management retains the option to remove the group’s R&D, production and scale-up capabilities, in effect becoming an IP shell company focused on pursuing the lawsuit against Samsung.

We made minor adjustments to our estimates in March following management’s statement that the revenues from the fourth ST work package meant that FY22 revenues were likely to be higher than the £2.1m generated in FY21. We have not changed them subsequently.

While Nanoco is providing an expanding range of materials to a number of customers for multiple potential use cases, including sensing materials for an Asian chemicals customer (see Exhibit 2), the company’s focus is on manufacturing scale-up for ST. Nanoco and ST have been working together for over three years. Originally this was as part of a supply chain for a major US customer, with Nanoco manufacturing nanomaterials that ST used to improve the sensitivity of its near- infrared (NIR) sensors. This programme was discontinued by the US customer in December 2019 for reasons wholly unconnected to the performance of Nanoco’s materials and service delivery. By this point Nanoco had commissioned its production facility in Runcorn, conclusively demonstrating that it could manufacture NIR materials at volume. In May 2020 ST signed a framework agreement with Nanoco covering both development work and commercial supply of nanomaterials for use in multiple infrared sensing applications over a five-year period. The agreement covers the supply of small-scale volumes of nanomaterials for NIR sensors. It also covered a project to develop a new generation of nanomaterials which we have previously inferred are in the short-wave infrared (SWIR) range. In May 2021 Nanoco announced that it was working on the second phase of the project, which is the optimisation of the new materials. A third work-package demonstrating how to scale-up production of the SWIR material for enhancing the sensitivity of silicon sensors was announced in November 2021. Most recently, in March 2022, Nanoco announced it had signed an agreement for a fourth work package, which is for the delivery of an enhanced and scaled up version of the SWIR material, indicating that the performance achieved so far merits scaling up the process. This progress is consistent with management’s goal of having visibility of production revenues during calendar H222.

The May 2020 agreement also committed ST to taking a specified minimum volume of nanomaterials from Nanoco if the enhanced sensors gain market traction and commercial volumes are required. These materials would be produced at the existing facility in Runcorn. The impact that a move to commercial production will have on revenues depends on what applications ST’s sensors will be used for. ST is engaged with many customers that could potentially deploy sensing chips incorporating Nanoco’s material. These potential applications are discussed in our August note. Deployment by a major mobile phone company in a key handset model could potentially generate c £15–20m annual revenues working a single five-day shift, while deployment in a more niche application, such as virtual reality (VR) glasses, would generate lower revenues, but is likely to catalyse take-up by other customers. Longer-term, should Nanoco’s material be widely deployed in multiple handset models or other high volume devices, we note that the existing production capacity in Runcorn could generate sensing application revenues of £100m/year working 24/7.

Until the development programmes with ST or other customers definitely move to commercial production, we believe that most of Nanoco’s value lies in a satisfactory resolution of the patent infringement dispute with Samsung which Nanoco instigated in February 2020. The lawsuit alleges that Samsung wilfully infringed the patents relating to Nanoco’s unique synthesis and resin capabilities for QDs. Nanoco is seeking a permanent injunction from further acts of infringement and unspecified but significant monetary damages. Nanoco and Samsung initially worked together to develop cadmium-free QDs based on Nanoco’s IP. However, in 2015 Samsung ended the collaboration and launched its QD-based televisions without entering into a supply or licensing agreement with Nanoco. Although the outcome of this litigation is by no means certain, we note that the large US litigation finance specialist funding the costs of the litigation undertook detailed due diligence before agreeing to provide finance. The lawyers, who are working on the case on a discounted fee basis, also carried out significant due diligence.

Nanoco expects a final decision on the validity of the patents in May 2022. If this is favourable, Nanoco will have cleared the first of two major hurdles in proving validity. The court hearing, which is likely to take place in calendar H222, will then focus on infringement and damages, with validity effectively a settled matter by then. The transcript of the oral hearing in the inter partes reviews (IPRs) of the five patents in the case, which took place on 23 February 2022, was released on 17 March 2022. While the transcript of the oral hearing is subject to interpretation, Nanoco believes that the judges’ lines of questioning appear, on balance, to favour Nanoco’s position on the majority of points. In the interim statement, Nanoco notes that, if the trial verdict is favourable, it is likely to commence further litigation in territories where it has registered its patents and where the legal process is faster than the US and, importantly, where injunctions are more commonly granted. (Injunctions are rare in the US unless an infringer is a direct competitor). While this could potentially result in payouts to Nanoco while the outcome of the US trial is still being appealed, it is more likely in management’s opinion to lead to additional pressure on Samsung to come to the negotiating table with a meaningful settlement offer covering all global markets.

Nanoco estimates that between April 2015 and the present Samsung has sold more than 14 million TVs deploying QDs based on Nanoco IP in the United States, which represents around one-third of its global sales. While Nanoco has not revealed its estimates of the potential payout if the litigation is successful, it has disclosed three possible damages models for calculating the value of the lost revenue to Nanoco:

There are further options as well. Applying the low-end valuation model, we assume the QD enhanced TVs had an average sales price of US$2,200–2,500 compared with the average price of a top of the range TV without QDs of c US$1,000. Had the alleged patent infringement not taken place, we believe that the volumes of QDs Samsung required would have been higher than Nanoco could have produced in Runcorn, so it would have licensed its technology to partners, primarily Dow Chemical, and would have received significant royalties. If we assume that the cost of the QDs in each TV is equivalent to 10% of the uplift in price between QD and non-QD TV displays, and that Nanoco would have received a 12% royalty (as per our May 2017 initiation note) on these QDs, this represents US$14.4–18.0 in lost revenue per TV display or US$200–250m between April 2015 and the present in the United States alone.

A damages award may also make an additional allowance for future sales of infringing TVs and a possible uplift of up to three times for wilfulness. While the ongoing litigation only covers the United States, we understand that Samsung would also be likely to seek a global negotiated settlement covering sales in other territories. Nanoco would retain 50–80% of the award, depending on its magnitude, and would have to pay UK corporation tax on the amount received, which could be offset against £36m losses.