The Trendlines Group Ltd. - Phillip Securities 2017-04-11: A portfolio of disruptive technologies in untapped markets

THE TRENDLINES GROUP LTD. 42T.SI

The Trendlines Group Ltd. - A portfolio of disruptive technologies in untapped markets

Company Overview

The Trendlines Group Ltd. (“Trendlines”) is an innovation commercialisation company that invents, discovers, invests in, and incubates innovation-based medical and agricultural technologies with a view towards a successful exit in the marketplace.
Operates principally through two technology incubators, Trendlines Medical and Trendlines Agtech, and an internal innovation centre, Trendlines Labs.
An intensely hands-on investor: Trendlines is involved in all aspects of its portfolio companies from technology development to business building

Exits may include among others, sales such as merger and acquisition transactions or listing on public stock exchanges
Not a venture capital firm: No management fees, no carried interest

Key Takeaways

Two portfolio companies will enter into revenue stage by end-2017 and two more by 2018. Portfolio values of these companies may increase as they meet certain developmental milestones in 2017/18. As at 31 December 2016, the Group has completed six exits, and taken two companies public; while 16 out of 46 of its portfolio companies are in revenue stage.
atTerm Technologies, one of the technologies developed by Trendlines Labs, is estimated to have more than US$2 billion market potential in developed countries alone. However, the technology accounts for zero value in Trendlines’ total portfolio value as they are developed in-house. Successful realization in investment would boost the Group’s revenue.
Continuous effort to expand portfolio value:
1. add more than 30 companies to its portfolio over the next three years;
2. provide support to accelerate the development of the portfolio companies;
3. explore opportunities to expand into new markets, in particular Singapore, China and German; and
4. grow Trendlines Labs to increase royalties’ income which will provide steady income streams to smoothen out the lumpy revenues arising from the volatile portfolio values.
Undemanding valuation. Trendlines’ Price-to-Portfolio Value and Price-to-Net Asset Value are trading at c.53% discount to its peers.

Potential catalyst:

Exit from portfolio companies

Risks

Risk of facing cash flow problem. Realization of investment in its portfolio companies is unpredictable and volatile, and there is no assurance as to the occurrence of timing of actual exits or realizations to meet its cash needs.
Difficult to value individual portfolio companies accurately. Main source of earnings is derived from net realized/unrealized gain in the value of its portfolio companies, which is unpredictable and volatile.
Subject to inherent risks associated with investing in early-stage, high-risk technology companies.
Regulatory changes, which could have adverse impact on operations, licensing and government loans and grants.
Exchange rate risk. Functional and reporting currency is US$, but a significant portion of its operating expenses are in NIS (principally, facilities lease expenses, salaries and related personnel expenses).

INVESTMENT THESIS

1. Supportive macro backdrop

Israel, the Start-up Nation, the hotspot of innovation

Significance of science and technology in Israel and its pro-business environment are conducive to technological innovations.
Science and technology is the country’s most developed sector.
World leader in fundamental scientific research
1. Percentage of Israelis engaged in scientific and technological inquiring: 17.4 researchers per 1,000 employed (vs OECD’s 7.8)
2. The amount spent on research and development relative to its GDP: 4.2% of its GDP are invested in R&D projects (vs OECD’s 2.4%)
A highly skilled workforce with 47.4% graduating from university or third stage education.
Ranked 1st in the world for innovative capacity and 1st in the world for entrepreneurship; Overall, ranked 5th among the most innovative countries in Bloomberg.
A pro-business environment with a comprehensive suite of government incentive programs and services to help investment process.
Robust and innovation-driven economy, coupled with supportive government attracted investments from over 270 leading multinational corporations, including Cisco, GE, Google, Hewlett-Packard, Intel, IBM, Johnson & Johnson, General Electric, etc.

Government’s funding: The technological incubator program

It offers early-stage companies a significant investment (up to US$800,000) for a period of 2 to 3 years.
The program underwent a significant change in 2012, where selection process for incubator licensees have tightened and thus increases competition.
Incubator licensees have been selected in a competition based on the significant added value they offer early stage companies.
The licensees invest only 15% of the project budget (the state invests the remaining), and receives in return 50% of the shares of the companies in the incubator.
The funds are to be repaid to the government only upon generation of sales.

(Source: Invest in Israel website, by the Ministry of Economy and Industry State of Israel)

2. Favourable global industry prospects

Medical Technologies (“Medtech”)

Rising healthcare demand: favourable demographics, ageing population, longer life expectancy.
Growth of emerging markets increasing health awareness, increasing notification of chronic diseases.
Rising demand for medical technology and services, demand for sophisticated medical devices.
Shift to value-based procurement: affordability and quality healthcare.
Increase in regulatory oversight could trigger more consolidation (e.g. merger and acquisition) opportunities.

Agricultural Technologies (“Agtech”)

Increasing global demand for food, but limited arable land to farm on and resources for farming.
Growing awareness on clean, safe, and healthy food, as well as environmental friendly but cost efficient production.
Environmental challenges are expected to lead to an increase in demand for innovative and sustainable agricultural technologies and production methods to overcome such limitations and protect the environment.

It is inevitable that these industries will boom.

Trendlines offers investors opportunities to involve in revolutionising the healthcare and agriculture industries.

3. Opportunities to invest in pure incubator in the public market with low investment cost

Three ways to obtain exposure to these sectors: investing in public equities, venture capital funds, and direct investments. But, there are limited numbers of publicly listed incubators in the world. While other avenues to invest in incubators would be via venture capital firm or direct investments, which are usually out of reach for individual investors.
Also, since it is not a venture capital firm, there is no management fee, keeping investment cost low for investors.

4. Investing in early stage start-up companies by leveraging on an experienced management team and an extensive network of relationships

Investing in the start-up space is considered a high-risk investment and may not be suitable for all investors. It attracts investors who are forward-thinking and are compelled by the macro drivers that highlight the need for transformation. However, investors may not have in-depth knowledge and insights into the market.
Investors could leverage on Trendlines’ technical knowledge, industry experience and know-how to bridge asymmetric information, conduct due diligence as well as ongoing monitoring over its portfolio.
The Group’s senior management comprises a team of veteran entrepreneurs and businesspeople that understands global markets, possesses the ability to bridge cultures to build businesses, and has the expertise in broad range of industries and technologies.
Trendlines also has an extensive network of relationships with industry leaders, investors, lawyers, bankers, venture capitalists, and other professionals to help it generate quality deal flow as well as undertake fund raising activities.

5. Effective use of funds and disciplined investment strategy that focuses on expansion of portfolio value

Trendlines leverage its portfolio investments with non-dilutive funding, which could be from:
1. Government. Trendlines is one of Israeli government-licensed incubators and thus highly funded by the R&D grants from government through the Technological Incubators Programme.
2. Entrepreneurs, inventors, universities and research institutions, and needs identified by industry partners across various countries, including Israel, United States, Germany, China and Singapore.
Drivers for portfolio value expansion and Trendlines’ value building strategy

a. Increasing the number of companies in the portfolio

Target to add more than 30 companies to its portfolio over the next three years. This is in line with its deal flow strategy of c.10 new companies to be added to portfolio each year (please refer to Point 6 below).

b. Building portfolio companies’ value and building companies for exit

Intense support to help portfolio companies to achieve their full potential in the market. It also actively participates in follow-on investments in portfolio companies to accelerate the portfolio company’s development, demonstrate support and confidence, as well as to limit dilution.

c. Expand into new markets

Established Trendlines Medical Singapore, while exploring additional international opportunities in China, German, and Singapore.

d. Expand Trendlines Labs

Trendlines Labs is the in-house innovation centre of The Trendlines Group, focused on inventing technologies and products to meet critical unmet market needs.
It creates new IPs and new portfolio companies. It invests in selected innovations and create spinoffs, while generates recurring revenues in form of royalties.
It will continue to establish new joint ventures with multinationals and increase recurring revenue stream. The increased royalties will provide steady income streams, thus smoothen out the lumpy revenues arising from exits.

6. Prudent investment approach

Partnership selection

Trendlines reviews more than 500 opportunities annually. With about 30 years of experience and know-how in medical and agtech, combined with the data analytics from its machine learning system and Big Data platform, each business proposal will undergo intense due diligence.
In addition to being a passionate and committed leader, Trendlines will consider the business proposal on two levels:
1. Market demand for the product (in terms of unmet needs, unique and innovative technologies, and market potential for the product)
2. Evaluate whether it is focused on solving the problem at hand
After going through a comprehensive selection process, Trendlines will only establish and invest in about 8 to 10 companies (which is equivalent to c.2% of its total projects reviewed).
Till date, Trendlines has invested in more than 60 companies and has a portfolio of 46 companies as at 31 December 2016.

Deal flow process

All portfolio companies are located in Trendlines’ facilities and are extensively supported by its staff for at least their first two to three years of incubation. Currently all of its portfolio companies are based in Israel and the average size of the portfolio companies is very small, with 2 to 5 people.
High support-level allows portfolio companies to focus on developing their technology, product and market, thereby reducing risk and increasing the chances of success.
Average investment in these companies is about US$1.24 million
1. The first investment mainly finances initial technology development and market research
2. Second round of investment usually begins after 2 to 3 years of operation
3. The company’s growth and incubation usually needs US$4 million to US$6 million
4. Generally, total capital of US$5 million on average to support the company to maturity
Time to anticipated exit is slightly shorter at six years or less, as compared to industry average of seven years.

Risk mitigation with close monitoring

Monthly review of all portfolio companies
1. Status review: R&D, business development, patent issues, financial issues
2. Assign three-tier risk rating to each company
Quarterly review to identify exit candidates next 24 months. Main criteria include:
1. Product development: advanced stage or near completion
2. Meaningful real-world demonstration of product efficacy in clinical or field trials
3. Strong intellectual property (IP) position
4. Starting or close to starting sales
Israeli government oversight
1. Quarterly financial report and semi-annual qualitative report for each company that receives funding
2. Annual audits of incubators

7. Strong reputation, brand and track record

A strong track record to develop and execute exit strategies for portfolio companies.
In addition, about 16 of its 46 portfolio companies are currently in revenue stage.
Awards and accolades it has earned are good testament to its reputation as being one of the best incubator organisations in Israel.
1. Trendlines Medical has twice been named the best incubator in Israel by the Israel Innovation Authority, in Year 2010 and 2014
2. Five of its portfolio companies have been named the best start-ups of the year by the Israel Innovation Authority

8. Industry leaders as strategic partners: B. Braun and Bayer

B. Braun Melsungen AG

A German privately held company which supplies global health care markets. It was founded in 1839 and currently has 56,000 employees worldwide with global sales of €6.1 billion.
Invested c.US$5 million in Trendlines’ IPO Invested c.US$4 million in portfolio companies (US$2.8 million in ApiFix and €1 million in Gordian Surgical) Investor/founder of Trendlines Medical Singapore

Bayer AG

A global life sciences public company (with market cap at €89.2 billion as at 4 April 2017) founded in 1863 in Germany. It has 117,000 employees worldwide with global sales of €46.3 billion.
Invested US$10 million in Bayer Trendlines Ag Innovation Fund, which is managed by Trendlines. The fund will focus on investments in early-stage agtech portfolio companies of the Group that could be of interest to Bayer.

Japanese Medical Device Multinational

Agreement with Trendlines Labs to collaborate on clinical opportunities Trendlines Labs developing innovative products for manufacture and marketing by MNC

U.S. Medical Device Multinational

Successfully marketing product designed and developed by Trendlines Labs
Additional projects in development with multiple divisions

VALUATION

Management shared that Trendlines does not disclose valuation of individual portfolio companies as they are sensitive commercial information. However, the management guided us on how we could approach its valuation by
1. Simple reconciliation of its Portfolio Value; and
2. Industry or peer comparison using three different metrics.

(a) Breaking down its Portfolio Value.

As disclosed in its 2016 Annual Report, the most valuable portfolio company accounts for US$40.7 million. This implied that:
1. the average fair market value of the remaining 9 most valuable portfolio companies = US$1.8 million
2. the average fair market value of the other 36 portfolio companies = US$0.7 million
One of the common valuation methods to decide on a start-up valuation is “Valuation by Stage”. The valuation by stage method is often used by angel investors and venture capital firms to come up with a quick range of start-up valuation. This method uses the various stages of funding to decide how much risk is still present with investing in a start-up. The further the company has progressed along the stages of funding the less the present risk and the higher its value.
Such “rule of thumb” values indicate that start-ups with just a business plan will receive a small valuation, but that will increase as they meet developmental milestones.
The 10 most valuable portfolio companies include six portfolio companies in revenue stage while the others in business development stage. This suggest that the 10 portfolio companies, which are also in revenue stage and are not in the list of 10 most valuable portfolio companies, could be valued at less than US$1.8 million. That compared to c.US$5 million estimated company value as referenced from the table above, then Trendlines’ portfolio value appears to be undervalued.

(b) Industry or peer comparison in three different metrics

Method 1: Industry Comparables Price to Book
- Multiple based on Book Value is less representative as:
  1. Majority players are manufacturers instead of incubators;
  2. Does not reflect the company’s money generating potential or future monetisation (revenue in form of royalty or exit) strategies; and
  3. Does not capture intangible assets on their balance sheets
Method 2: Price/Portfolio Value
- Multiple based on Portfolio Value is more relevant as Trendlines’ main source of earnings is generated from net realised and/or unrealised appreciation in the value of its investment in portfolio companies.
- Portfolio Value takes into account of the progress of the portfolio company’s technology, receipt of patent technologies, receipt of patent protection, commercialisation and partnering, market acceptance of new products and sales, and the methodologies and opinions of independent valuation specialist.
Method 3: Price/NAV
- NAV takes into account of readily available capital to invest in the portfolio companies.
Nonetheless, all three methods unambiguously suggest that Trendlines is currently undervalued.
Furthermore, all three methods exclude valuation for products developed by Trendlines Labs. The balance sheet does not account any value for the portfolio of technologies invented by Trendlines Labs as they are developed in-house. However, these inventions record R&D expenses on income statement.
For example, at Term Technologies, one of the technologies developed by Trendlines Labs, is estimated to have more than US$2 billion market potential in developed countries alone. However, the technology accounts for zero value in Trendlines’ total portfolio value as they are developed in-house.
This indicates that Trendlines is further undervalued if the inventions from Trendlines Labs are included under Portfolio Value.

DEVELOPMENTS IN 2016

Renewal of Israel incubator license.

The Israel Innovation Authority renewed its incubator license for an additional eight years and approved its request to include both medical and agricultural technology investments in the renewed license (ending in 31 December 2023).

Started 10 new companies.

Bringing the total number of portfolio companies, net of write-offs, to 46. 17 of the portfolio companies raised a total of US$20 million in follow-on capital in 2016.
Definitive cooperation agreement signed with B. Braun Melsungen AG. B. Braun also invested c.US$4 million in two of its portfolio companies, ApiFix and Gordian Surgical.
Another major European partner, Bayer AG. Bayer Ag joined Trendlines in April 2016 to form and invest US$10 million in the Bayer Trendlines Ag Innovation Fund to invest in Trendlines portfolio companies.

Breakthroughs in Trendlines Labs.

Revenues from Trendlines Labs almost tripled to US$1.14 million in 2016, from US$0.4 million in 2015.
Trendlines Labs has successfully grown two of its units to reach out to multinationals in Europe, Asia and North America. It has signed framework agreement with large Japanese medtech multinational, and received new order from large US medtech multinational.

Establishing footprint in Singapore.

Established Trendlines Medical Singapore, its first incubator outside of Israel, in 2016.
Received support both from B. Braun in its role as an active minority shareholder and from SPRING Singapore, the enterprise development agency of the Singapore Ministry of Trade and Industry, which awarded a S$2.2 million grant to the new incubator.

DEVELOPMENTS IN 2017

Investment in Trendlines Medical Singapore Pte. Ltd.

PrimePartners Corporate Finance Holdings Pte. Ltd. (PrimePartners) joins Trendlines and B. Braun as the third investor in Trendlines Medical Singapore. PrimePartners will be a minority shareholder in Trendlines Medical Singapore, holding approximately 3.57%, and B. Braun holding approximately 20.00%, with Trendlines being the majority shareholder with approximately 76.43%.
Trendlines Medical Singapore will receive a grant of up to S$2.2 million under the Incubator Development Program administered by SPRING Singapore.

Established ad invested in three new medical companies in Israel

Ceretrieve Ltd.: Developing a device for treating ischemic stroke
Seger Surgical Solutions Ltd.: Developing an anastomotic closure device for laparoscopic bowel resection
ZygoFix Ltd.: Developing a miniature screwless spinal fusion implant

Updates from Portfolio Companies

Gordian Surgical Ltd.: Completed 17 successful surgical procedures in January, marking the first time the system had been used in the United States, and bringing the total number of successful surgeries to nearly 75. The Company was recently granted a patent in the United States and received its first purchase order from a European distributor.
S.T. Stent Ltd.: Completed a successful first-in-human pilot study.
CoreBone Ltd.: Received the Israel Ministry of Health certification to enable the company to market its bone-graft product for dental and orthopedic procedures in Israel.

WHAT'S NEXT?

First investment in SG soon

Trendlines Labs is in partnership with the Singapore General Hospital (SGH) on product development and clinical trial of its Stress Urinary Incontinence (SUI) device.
It will receive a grant from the Singapore-Israel Industrial R&D Foundation (SIIRD) up to 50% of the US$400,000 required to fund the development and clinical trial for its SUI product.
The SUI device is non-surgical, non-pharmaceutical solution to mitigate SUI, providing women who suffer from SUI with a simple-to-use, self-administered home treatment.
50 women are expected to participate in the clinical trial starting mid-2017 at SGH facilities, where the management and collection of clinical data will take place.
Large market potential. SUI affects approximately 15 million women in the United States alone. At commercialization of the device, both Trendlines Labs and SGH will enjoy royalties from the development.

Soh Lin Sin Phillip Securities | http://www.poems.com.sg/ 2017-04-11

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