IP Group — Several potential portfolio catalysts on the horizon

IP Group invests in and supports businesses predominantly based on research from universities, research centres and other networks, mostly in the UK (84% of portfolio value at end-2023), with its international investment platforms providing additional exposure to foreign IP. As a result, it offers liquid and diversified exposure to some of the most compelling long-term investment themes across life sciences, deeptech and cleantech (Kiko Ventures). The acquisition of Touchstone Innovations in 2017 significantly boosted IP Group’s life sciences portfolio, which at end-2023 accounted for 33% of total portfolio value, with a further 15% attributable to the listed Oxford Nanopore Technologies (ONT). That said, its top holdings also include deeptech and cleantech plays like Featurespace, Hysata, Oxa Autonomy and First Light Fusion (each of these four companies makes up c 6% of IP Group’s end-2023 portfolio, see below for details).

While IP Group’s total portfolio at end-2023 consisted of 86 different holdings (excluding de minimis and organic holdings), the 18 direct investments included in the top 20 holdings (the other two being holdings in limited partnerships) represented 70% of the total portfolio. De minimis and organic companies are those at a very early stage, or in which the group’s holding is of minimal value and takes up little management time. Organic holdings are investments in which the group has acquired a shareholding due to the technology transfer relationship with Imperial College (now expired), but in which it has not actively invested.

IP Group provides a blend of technical expertise, market knowledge and global relationships, as well as legal and IP expertise. Its tech know-how gives it the confidence to assume greater (calculated) risk when investing in disruptive technologies of the future ahead of their inflection points. We believe that this is well illustrated by the fact that several of IP Group’s employees have become board members of its portfolio companies. For instance, Paul Barrett (founder and CEO of Hysata) was previously partner and head of physical sciences at IP Group Australia; Dr Spike Willcocks (chief strategy officer at ONT) has previously led IP Group’s life sciences vertical and was responsible for the formation of ONT; and Stuart Gall (CEO of Intelligent Ultrasound) was a joint founder and executive director of Fusion IP (an AIM-listed university IP commercialisation company) before its acquisition by IP Group in 2014 (where he was senior advisor until 2020). Examples of how IP Group’s technical expertise can translate into solid returns are its full exits of WaveOptics and Ceres Power (see below).

IP Group leverages a wide investor network to provide capital to its portfolio companies, with only 13% of the c £667m raised across its portfolio in FY23 contributed by IP Group itself (vs 12% out of c £1.0bn in FY22), see Exhibit 3. Most of this additional capital has come from strategic corporate investors, Enterprise Investment Scheme investors, universities and institutional investors. Interestingly, the list of co-investors in IP Group’s portfolio also includes many of its closest competitors, some of which it co-founded and in which it is a minority investor (eg Oxford Science Enterprises and Cambridge Innovation Capital).

IP Group derives deal flow from its network of relationships, its broader ecosystem and through the team’s reputation in the market. It will only invest where it feels it has a competitive edge (such as strong relationships and a better understanding of the science) and where management can leverage its broader ecosystem to add value to the potential investee company. Historically, IP Group had exclusive rights to IP spin-offs from 14 UK universities. Although these rights have now largely expired (except for the exclusive relationships with Oxford, Cambridge, Bristol and Imperial for their alumni funds retained by Parkwalk Advisors, its wholly owned fund management business), the duration and depth of the group’s relationships mean that it remains well-placed to secure preferential rights even without contractual exclusivity.

Importantly, £650m in third-party capital is managed by entities in which IP Group is invested, most notably Parkwalk Advisors (£469m at end-2023) and IP Group Hostplus Innovation Fund (£163m at end-2023). IP Group derives regular fee income from these assets under management, which amounted to £5.9m in FY23 (FY22: £7.1m) and covered c 21% of its operating expenses (excluding share-based payments and carried interest plan charges). We note that Parkwalk Advisors and IP Group have been among the top investors into UK spin-offs (see Exhibit 4).

The group’s permanent balance sheet capital provides a level of flexibility to accompany businesses on their development path which a traditional fixed fund life general partner (GP)/limited partner (LP) structure typically lacks, while allowing the group to retain influential shareholdings. Before IP Group’s recent shift in capital allocation (see below), its initial investment in a given early-stage business was usually low (a few hundred thousand pounds), often alongside university funds. From there, it nurtured and supported the investment to refine the proposition and build a team to exploit the IP. It normally took an initial large minority stake of the equity at the outset, with its shareholding then steadily reducing through subsequent funding rounds. IP Group is still a large shareholder in many of its companies, including ONT (9.8%), Featurespace (20.1%), Istesso (56.5%) and First Light Fusion (27.5%).

Early-stage IP-based companies have typically taken 10–15 years to commercialise and mature. As a result, despite IP Group being set up more than 20 years ago, the maturity of its portfolio has only been demonstrated over the last few years. Management believes there are multiple near- to mid-term catalysts across IP Group’s portfolio, including:

The company has typically committed up to £3m to an individual funding round (with some exceptions, eg investments in ONT of £14m and £18.7m as part of larger funding rounds in 2016 and 2021, respectively). However, the group is now increasingly focusing capital allocation and team efforts on its priority list, which it believes it can build into companies worth more than US$1bn within the next three to five years. These include Istesso, First Light Fusion, Featurespace, Garrison Technology, Pulmocide, Hysata, Genomics and Oxa Autonomy, in addition to the three unicorns already created (ONT, Ceres Power and Hinge Health), see below for details.

We understand that overall, the company’s preference will be to invest in new businesses at a somewhat later stage (ie post-seed). IP Group aims at leveraging the increasing amount of funding provided to spin-out companies at the earliest stages, partly in the form of government grants through university technology transfer offices and Innovate UK, and partly through the UK tax system as (Seed) Enterprise Investment Schemes eligible investments, which provide incentives to invest capital at this very early stage. In staying close to universities and other centres of innovation, but encouraging the flow of such capital into high-risk opportunities, IP Group can achieve the best of both worlds – de-risking its investments while still maintaining access to the best deals.

While impact has always been at the heart of IP Group’s model, this is now set out more clearly with the group’s evolving purpose to contribute to a better future through the impact of science and technology-based businesses. IP Group integrates ESG using a bottom-up approach, looking at each deal individually, using the dual lens of potential positive impact to the world and incorporating sustainability factors/ESG materiality, as well as financial metrics. For more details on IP Group’s approach to ESG, see our initiation note and IP Group’s 2022 impact report.

Following a stabilisation in valuations in H123, IP Group’s NAV fell in H223 on the back of a further softening in the valuations of early-stage companies across the broader market. This translated into a 13% NAV decline in TR terms in FY23 (after a c 20% decline in FY22). We note that the downward revaluations across IP Group’s portfolio were mostly driven by a reduction in fair value of the holdings which faced delayed funding (£116m impact, see Exhibit 6), such as First Light Fusion. The current valuations of these holdings may therefore already discount potential down rounds in the near term. The negative effect of actual down rounds completed in FY23 across IP Group’s portfolio was less pronounced at £27m and was more than offset by the £55m contribution from up rounds, most notably in the case of Hysata. Market-based adjustments accounted for £22m of value reductions and included, eg a lower revenue multiple applied to Hinge Health (despite continued double-digit revenue growth). Finally, £11m came from company-specific factors, eg Oxular’s clinical setback.

IP Group’s share price remained broadly stable in 2023, but has seen a c 19% de-rating since end-2023 to date. As a result, IP Group’s shares now trade at a wide 59% discount to NAV. Other listed VC/growth equity investment companies (eg Molten Ventures, Seraphim Space Investment Trust and Augmentum Fintech) have also recently experienced depressed share prices and deep discounts to NAV. This likely reflects investor anxiety related to: 1) the valuations of early-stage private companies amid interest rate normalisation and macroeconomic headwinds, 2) the cash runways of portfolio companies and 3) the amount of holding-level liquidity required to continue participating in subsequent funding rounds. That said, we note that IP Group’s discount to NAV is much wider than the average 32% discount in secondary market transactions for LP VC portfolios in 2023, according to the latest Global Secondary Market Review by Jefferies. In the following sections, we discuss IP Group’s valuations, cash runway and holding-level liquidity in more detail.

The UK has an excellent footprint in terms of top-tier universities producing technology spin-offs, with top players in this respect being the University of Oxford (64 equity deals secured by its spin-offs in 2022), followed by the University of Cambridge (50) and Imperial College London (26), according to the Equity investment into spin-offs 2023 report by Beauhurst and Parkwalk Advisors. This is well illustrated by the growth in equity investments in UK spin-offs, with the annual number of deals doubling and deal value increasing sixfold between 2013 and 2022 (see Exhibit 8). In this context, we also note that, according to PitchBook, the UK and Ireland remained the key VC deal market in Europe with a c 34% share in 2023.

Interestingly, two of IP Group’s portfolio holdings (Oxa Autonomy and Nexeon) made it into the top seven equity deals into spin-offs by investment value in 2022 (with Nexeon represented twice given its two deals in 2022). While c 75–80% of the equity deals involved exclusively UK investors in 2013–20, the share declined to c 63–64% from 2021 at the expense of UK/foreign co-investments and deals with foreign investors only. Beauhurst and Parkwalk Advisors highlighted that this was likely a function of a few large life sciences funding rounds, as well as a potential value arbitrage between the UK and other deeptech hubs internationally, partly driven by sterling depreciation.

In March 2023, the UK government launched the Science and Technology Framework to cement the UK’s position as a science and technology superpower by 2030. It earmarked more than £370m in government funding to support infrastructure, investment and skills for the UK’s growing technologies, such as quantum and supercomputing and AI, among others. The government has also announced a further extension to end-June 2023 of the financial guarantee provided to the UK’s Horizon Europe applicants. Furthermore, last year it confirmed its commitment to spend £20bn on R&D in 2024–25. The UK government also continues to execute its agenda with respect to changes to the R&D tax regime reform (which supports R&D-intensive SMEs). Finally, in July 2023, the chancellor presented a series of new Mansion House reforms, which are aimed at, among others, unlocking capital to fund high-growth businesses through reforms to the more than £2.5tn UK pension market. The government announced an industry-led compact, whose signatories (the UK’s largest defined contribution pension providers) committed to the objective of allocating at least 5% of their default funds to unlisted equities by 2030, which could unlock £50bn of capital.

Recently, deteriorating macroeconomic conditions, along with a de-rating of public equity markets and a normalisation of monetary policy after the ultra-low interest rate environment of previous years, have had an impact on both deal volumes and valuations in the VC market, given that VC-backed companies are long-duration assets and therefore more sensitive to a changing rate environment. As a result, VC markets remain soft, with longer due diligence processes extending deal timelines and limiting exit activity.

European VC deal value declined sharply by c 46% y-o-y to €57.1bn in 2023 (with venture growth hit the hardest). That said, it is still higher than the levels seen before the exceptionally strong 2021/22 period (see Exhibit 9). European VC fund-raising stood at €17.2bn in 2023 compared to €28.2bn in 2022. PitchBook highlights that 2023 was the worst year in terms of European VC exits since 2013, with an exit value of just €11.8bn compared to €40.4bn in 2022 (see Exhibit 10). That said, we note some tentative signs of revival in the IPO markets (as illustrated by the listings of Arm, Reddit, Klaviyo and Instacart) as well as in private M&A markets (including some notable transactions in the pharma industry). Moreover, recent fund-raising volumes, coupled with cautious capital deployment in 2023, left VC funds with a significant amount of dry powder (c €45bn as indicated by PitchBook in its 2023 European Private Capital Outlook: H1 follow-up report), which may support deal activity in 2024.

Below we discuss IP Group’s approach in its three core investment segments.

Thematically, IP Group’s life sciences team invests in understanding disease, focusing on disease cure and prevention rather than investing in companies that simply treat symptoms, thereby helping to create healthier, rather than just longer, lives. Its investments provide exposure to drugs developed for a variety of indications, including different types of cancer, autoimmune diseases (eg rheumatoid arthritis), as well as respiratory and kidney diseases. The four pillars of IP Group’s approach in the life sciences sector are:

ONT is IP Group’s largest life sciences holding (making up 15% of its end-2023 portfolio value). The company developed a new generation of nanopore-based sensing technology. Its first products enable the real-time, high-performance, accessible and scalable analysis (sequencing) of DNA and RNA in patients and pathogens. IP Group was its founding shareholder in 2005 and held a 14.4% stake in the run-up to the IPO in 2021. ONT achieved a five-year CAGR in underlying life sciences research tools (LSRT) revenue to FY23 of 39%. However, growth in FY23 alone was 16% y-o-y to c £170m, below ONT’s earlier expectations of 18–25% growth at constant currency (which had been revised down from 29–50% implied by the previous FY23 guidance of £190–220m). The company now expects 20–30% growth in FY24 to £180–195m at a gross margin of 57% (vs 53.3% in FY23 and 56.3% in FY22). Moreover, it maintains its medium-term (ie FY27) target growth rate of more than 30% per year on a constant currency basis. It is aiming for an LSRT gross margin of more than 62% by FY27 (vs more than 65% by FY26 previously) and to reach adjusted EBITDA break-even by end-FY27 (previously expected by end-FY26). The company’s cash, cash equivalents and liquid investments stood at £472m at end-2023.

As highlighted above, another of IP Group’s priority holdings in the life sciences segment is Pulmocide, which is looking to treat common acute and chronic respiratory tract infections associated with serious complications.

We note that seven of IP Group’s life sciences holdings were recently featured in PwC UK’s The Life Sciences Future50 report. For a detailed discussion of IP Group’s life sciences portfolio, see our report Deep dive into the life sciences portfolio, published on 10 May 2023.

IP Group has built a commendable portfolio of businesses developing breakthrough technologies, mostly across four key focus areas: applied AI, next-generation networks, human-machine interface and future compute. According to its mission statement in the deeptech domain, IP Group is working towards a tech-enriched future by investing in assets that will deliver digital resilience, create prosperity and enable new human capability (therefore contributing to the United Nations Sustainable Development Goal 9: industry, innovation and infrastructure). Importantly, around 90% of the deeptech portfolio (by fair value) has already started to generate revenue. For instance, Featurespace reported £34.4m in FY22 (last available data), with recurring revenues of c 80% and a customer base that includes blue-chip financial institutions like HSBC, Worldpay and NatWest.

Three of its largest deeptech holdings (Featurespace, Garrison and Ultraleap) made up 59% of the total deeptech portfolio value at end-2023. Featurespace deploys its proprietary machine learning algorithms (based on adaptive behavioural analytics) to monitor customer data for real-time fraud and financial crime detection. Garrison Technology provides a remote web browser and related hardware, allowing enterprises and government agencies to prevent local machines from accessing malicious data sources by keeping all activity in the cloud (by means of web isolation). Finally, Ultraleap is one of the leading IP owners in spatial computing and natural user interface technology, with its two complementary core technologies being hand tracking and air haptics.

For further details on IP Group’s deeptech portfolio, see our Detailed look at the deeptech portfolio, published on 3 October 2023.

IP Group’s cleantech vertical, now branded Kiko Ventures, has a team that exhibits a solid track record with a gross internal rate of return (IRR) of more than 30% and gross realisation proceeds of £150m since the establishment of IP Group’s cleantech theme. Kiko Ventures seeks to position itself as the UK’s leading cleantech VC player and has recently become the founding member of the Cleantech for UK initiative, backed, among others, by Breakthrough Energy, which was founded by Bill Gates. Kiko Ventures’ areas of thematic focus include: 1) renewable electricity and alternative fuels, 2) mobility and transport, 3) land use, greenhouse gas capture/removal and storage, 4) climate risk and change management and 5) food and agriculture. Its portfolio consisted of 15 holdings at end-2023, with the top five covering 85% of fair value. These are:

Since it was launched in the UK in 2001 (see our initiation note for details), IP Group’s model has expanded to include investment platforms based on university ecosystems in the United States, Australia and New Zealand. However, it recently made a decision to deprioritise the US investment platform (a fund in which it holds a 58% stake, managed by Longview Innovation) given that the latter scaled back its overheads and decided to focus on maximising the value of its existing holdings amid a challenging funding environment. As a result, IP Group marked down its stake in the US platform by 50% to £46.0m. That said, IP Group still expects to realise value from this portfolio. It also abandoned its plan to launch a growth fund in China. At end-2023, IP Group’s platform investments consisted of holdings in two companies and three LP interests valued at £90.8m (or 8% of portfolio value), most of which was attributable to the above-mentioned US platform, as well as an interest in the UCL Technology Fund.

Given the longer development cycle of the businesses in which IP Group has historically invested, it is yet to build a long-term track record of delivering strong NAV TR. An indication of the growing maturity of its portfolio in recent years has been the pick-up in exits, which translated into net realisations of 12% and 9% of portfolio fair value in FY20 and FY21, respectively (see Exhibit 14). This includes the following notable full and partial exits, of which ONT, Ceres Power and Hinge Health became unicorns (ie reached a valuation above US$1bn):

We believe IP Group’s current track record should be evaluated since the acquisition of Touchstone Innovations in 2017 in a share-for-share merger, whereby Touchstone shareholders received c 34% of the enlarged group. IP Group’s NAV TR in both FY18 and FY19 was affected by write-downs following the Touchstone acquisition (as part of the portfolio rationalisation/clean-up process), resulting in a 14% NAV decline between FY17 and FY19 (see Exhibit 15). The company’s performance rebounded in the next two years, culminating in FY21 with the listing of ONT.

The subsequent de-rating of IP Group’s listed holdings (primarily ONT), alongside the broader equity market decline from the 2021 peak, overshadowed valuation gains across its private portfolio and brought its NAV per share to 114.8p (ie close to end-2018 levels). IP Group’s NAV TR between end-2019 and end-2023 was c 10% (c 2.3% annualised). This includes 3.97p in dividends per share paid since 2021 when IP Group’s board updated its dividend policy, encouraged by increasing portfolio maturity, cash realisations and continued strong holding-level liquidity (IP Group recently revised its distribution policy, as discussed below). It is worth noting that IP Group normally invests in plain equity rather than preferred shares (given it often invested at the seed stage) and therefore has not enjoyed downside protections such as liquidation preferences or anti-dilution clauses.

As discussed above, the valuations of early-stage private companies have been affected by recent macroeconomic developments. Of the 21 new funding rounds completed across IP Group’s portfolio in 2023, 62% and 14% were up rounds and flat rounds, respectively, although there has been an uptick in down rounds in late 2023. Within the portfolio of Parkwalk Advisors, there were 13 up rounds, six flat rounds and nine down rounds. While further downward revaluations cannot be ruled out, we note that at end-2023, only 14% of IP Group’s portfolio was valued based on a funding round completed more than 12 months ago, with 16% based on more recent funding rounds and c 26% derived from an adjusted financing price based on past performance (see Exhibit 16). IP Group employs a third-party specialist to value some of its holdings, especially the larger unquoted portfolio holdings that have not completed a new funding round recently.

As at end-2023, 11 of IP Group’s largest private holdings (c 46% of private portfolio value) were valued by a third-party specialist. Finally, we note that IP Group’s auditor reviews its valuations for the purpose of its annual reports, and historically considered IP Group’s valuations ‘mildly cautious’. This seems to be confirmed by the average c 70% uplift to the last carrying value on IP Group’s £404.4m total realisations in 2020 and 2021. As discussed above, most of the FY23 downward revaluations came from companies which faced delayed financing rather than companies which completed down rounds, which suggests that IP Group aims to capture fund-raising risks in advance.

While valuing early-stage, innovative businesses is a difficult exercise, we believe that the above factors suggest that most of IP Group’s portfolio valuations should be largely up to date and at least moderately conservative. Nevertheless, we estimate that (assuming IP Group’s ONT stake is valued at a c 10% discount to the current market price, which IP Group may have to accept when selling a larger ONT stake) IP Group’s current market capitalisation implies a wide c 62% discount to its gross private portfolio value (excluding cash and deposits, see below) at end-2023. Moreover, the market cap only captures c 57% of the end-2023 carrying value of its top 18 holdings excluding ONT. This provides a good base for a potential share price re-rating if some of the above-mentioned portfolio catalysts materialise in the near term.

We acknowledge that in the above calculation of the implied discount to IP Group’s portfolio, we account for net cash in full at par, which may not fully capture the need to provide funding to those holdings that have a limited cash runway and a weaker funding syndicate (ie those that are more reliant on funding from IP Group). IP Group maintained a strong holding-level balance sheet, with gross cash and deposits at end-2023 of £227m or c 19% of NAV (£91.7m net of borrowings) and total gross liquidity, including listed holdings (based on their end-2023 valuations), of c £431m. Furthermore, we note that IP Group’s funds managing third-party capital had £109m of dry powder at end-2023.

Importantly, the interest rate on IP Group’s £120m private debt raised in August 2022 (which made up most of its £135.2m gross debt at end-2023) is fixed at 5.25%, which is lower than current three-month sterling Libor. Given the higher interest rate IP Group now receives on its deposits, the credit facility is cost-neutral. The debt will mature in three equal tranches in 2027, 2028 and 2029 and its main covenants include a minimum cash balance of £25m at any time (£100.9m at end-2023), equity of at least £500m (£1,190.3m at end-2023) and maximum gross debt less restricted cash at 25% of total equity at end-June and end-December in any given year (c 11% at end-2023).

IP Group invested £73.2m during 2023, including a £15m convertible loan note investment in Istesso (a further £10m convertible loan investment was made in January 2024) and £8.1m across the North American platform, as well as £4.7m in Hysata. While it seeks new investments to expand its cleantech portfolio, management highlighted that valuations in this sector are holding up strongly, and therefore no new cleantech investments were made in 2023. Meanwhile, IP Group collected £38.6m in gross cash proceeds in 2023, primarily from the second tranche of the consideration for the sale of WaveOptics in 2021.

Given the wide discount to NAV, IP Group launched a share buyback programme in December 2023, allocating up to £20m of its FY23 cash realisations. It intends to focus on this form of returns to shareholders when the discount to NAV exceeds 20% and therefore decided to pause paying dividends (its last payment was the interim FY23 dividend of 0.51p per share in September 2023). The group’s capital distribution policy still assumes that the majority of cash proceeds will be reinvested, with a smaller proportion used to deliver cash returns to shareholders.

IP Group’s portfolio companies raised total funds of c £667m in 2023 (vs £1.0bn in FY22), including a £226.5m Series C round for Apollo Therapeutics, as well as a £42m funding round completed by Quantum Motion, the largest-ever single investment in a quantum computing start-up in the UK. As a result, most of its direct portfolio holdings with an investment value above £4m had a good cash runway at end-2023, with 35% by value (including ONT) funded to profitability and only 13% requiring funding before end-2024 (see Exhibit 18). A large part of IP Group’s portfolio (41%) has a cash runway until 2025, therefore fund-raising efforts across IP Group holdings would benefit from an improvement in deal activity across VC markets at some stage during 2024.

For a detailed summary of principal risk factors relating to IP Group, see our initiation note.