The Trendlines Group - CIMB Research 2017-05-22: Riding The Start-up Bandwagon

THE TRENDLINES GROUP LTD. 42T.SI

The Trendlines Group - Riding The Start-up Bandwagon

Technology incubator in Israel focusing on early stage medtech and agtech startups, offering them more holistic support than traditional venture capitalists (VCs).
10-year record of reviewing over 500 investment opportunities p.a., raising more than US$160m to date (follow-on capital), making six profitable exits and two IPOs.
Lumpy revenue and operating cash flow, but rising income from lab services and follow-on financing could offer some stability in future, according to management.

Currently trades at 0.7x FY16 P/BV and P/FMV, significantly lower than global peers’ average of 1.3x.

Intensely hands-on technology incubator based in Israel…

Established in 2007, Trendlines is one of eight technology incubators in Israel licensed by the Israeli Innovation Authority (until 2023) with 46 active portfolio companies (of which 15 are at revenue stage) and total portfolio value of US$84m at end Mar-17. Apart from investing in medical (medtech) and agricultural (agtech) technology start-ups, the company offers higher levels of support (relative to traditional VC firms), ranging from technology labs and staffing, to financial consulting and strategic guidance.

…With established record of operating history and divestments…

Helmed by an experienced management team and backed by strong government support (provides funding of up to 50% of Trendlines’ total investment per company), Trendlines seeks to add 8-10 new companies to its portfolio, and achieve 1-2 investment exits every year on average.
It has accomplished two IPOs and six M&As for its portfolio companies to date, grossing investment returns of 3-67x.

…But lumpy revenue and negative operating cash flow

Trendlines’ revenue fell from US$29.7m in FY13 to US$0.1m in FY16 due to:
1. changes in fair value of investments, and
2. unpredictable timing of disposal gains.
Investment exits can at times be opportunistic as management seeks to optimise each investment value, and this could weigh on its operating cash flow.
Medtech companies typically take 6-7 years to achieve commercialisation, vs. the 3-4 years for agtech firms.

Some recurring income from lab services and follow-on financing

Apart from the two life science incubators, Trendlines also owns an in-house innovation centre (Trendlines Labs), which invents and develops technologies for customers to address unmet market needs. These contracted R&D services (along with potential future royalties) provide some steady income stream, which Trendlines builds on by raising follow-on capital for its portfolio companies. This allows Trendlines to charge a fee for the services it provides to other equity investors.

Extending presence from Israel to Singapore

Management’s relentless efforts to increase overall portfolio value not only involves adding new companies annually and growing its Trendlines Labs, but also expansion into other geographical markets.
Trendlines recently set up its first overseas subsidiary in Singapore (76.4%-owned Trendlines Medical Singapore), which adopts a similar investment model, and has clinched a partnership with Singapore General Hospital (SGH) to develop and conduct clinical trials.

Cheaper valuation than peers At 0.7x

FY16 P/BV and P/FMV (based on last reported fair market value of investment portfolio), Trendlines currently trades at a discount to its global peers’ average of 1.3x.

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Target Price: N/A

Riding the start-up bandwagon

Building companies, commercialising innovation

Israel-based technology incubator for medical and agriculture start-ups Founded in 2007, Trendlines is a “seed stage” investor in medical and agriculture technology start-ups, providing them with higher levels of support such as technology labs, staffing, physical space, financial consulting and strategic guidance, in addition to funding unlike traditional venture capital (VCs).
Apart from the three life science incubators that Trendlines owns, namely Trendlines Medical, Trendlines Agtech and Trendlines Medical Singapore, the company also has an in-house innovation centre, Trendlines Labs, which works closely with MNCs to develop technologies to address unmet market needs. Management believes these start-ups are attracted to Trendlines for the following:
1. Experienced management team with expertise in various industries and technologies.
2. Established track record of 10 years’ operating history and divesting portfolio companies (two IPOs and six M&A transactions). The company had 46 active companies in its portfolio at end-FY16, of which 15 are revenuestage companies and 12 are projects under Trendlines Labs. The company had total portfolio value of US$83.8m at end-Mar 17, with the top 10 most valuable companies forming c.68%.
3. Vibrant start-up ecosystem.
4. One of the eight technology incubators in Israel licensed by the Israel Innovation Authority (previously known as Israeli Chief Scientist) until 2023F. Trendlines Medical was named the best incubator in Israel twice, in 2010 and 2014, by the Israel Innovation Authority.

Investment model and process

Under Trendlines’ investment model, each portfolio company typically receives US$1.24m of investment, of which 50% (US$0.67m) is in the form of government grants, US$0.12m from Trendlines capital, and c.US$0.45m of inkind investment at cost over a 2-year period. A similar investment funding structure also applies to Trendlines Medical Singapore. In cases where there is follow-on fund-raising, Trendlines seeks to retain its stake in the portfolio companies at a minimum of 20% (after dilution).
Israeli government grants are allocated directly to portfolio companies over a 2- year payment schedule, with neither equity stake nor rights to intellectual property given in exchange. However, portfolio companies have to pay sales royalty (grant plus interest) to the government upon successful commercialisation of their technology. Additional payments at exit may be required if the intellectual property (IP) is moved overseas.
Apart from providing ongoing support to its existing portfolio companies, Trendlines actively seeks to add 8-10 new companies a year in Israel (3-4 for Trendlines Medical Singapore) to its portfolio, from over 500 opportunities that it reviews annually. The company also targets to complete 1-2 exits a year on average, via M&A transactions or listing on public stock exchanges.
We note that not all initial investments translate into successful exits, as management explained that some may be written off due to lack of funding or changes in business viability. Agtech companies usually take 3-4 years to achieve commercialisation, which is a shorter period than the Medtech companies’ 6-7 years, as they require fewer regulatory approvals (like the US Food and Drug Administration, FDA, and Europe’s European Conformity, CE, marking).

Israel: a start-up nation

The tech scene in Israel is thriving and second only to Silicon Valley, in terms of number of initiatives, according to Eric Schmidt, ex-CEO of Google. Based on statistics from Israel’s IVC Research Center, the nation houses as many as 3,000 tech-related start-ups and saw 104 exits worth US$10bn in 2016.
Some of the notable exits over the past five years include the IPO of Mobileye (MBLY US), Google’s purchase of navigation tool Waze and Singtel’s acquisition of Amobee.
Israel’s favourable business environment and successful ecosystem for start-ups is often attributed to the following factors:
1. More than 270 leading multinational companies from the US, Europe, China and India, such as Cisco, Microsoft, Google, HP and GE have set up offices with R&D presence in Israel.
2. Highly skilled workforce that boasts of 140 technicians, scientists and engineers for every 10,000 Israeli employees, vs. 85 per 10,000 in the US. Israel was also ranked 5 th on the list of most innovative companies by Bloomberg, and placed 21st among the top 100 countries in world innovation rankings compiled by the UN’s World Intellectual Property Organisation, INSEAD Business School and Cornell University.
3. Supportive government initiatives, including funding for a period of 2-3 years for early-stage companies.

Enlarging its presence in Singapore

Trendlines Medical Singapore was officially launched on 22 Feb 2017, marking Trendlines’ first overseas subsidiary to invest in, develop and nurture earlystage medical technology companies to improve human conditions. The 76.43%-owned subsidiary has successfully secured a grant of up to S$2.2m under the Incubator Development Programme (IDP) administered by the Standards, Productivity and Innovation Board (SPRING) Singapore to support its operating activities. The remaining stake is owned by B. Braun Singapore (20%) and PrimePartners Corporate Finance Holdings (3.57%).
On 29 Mar 2017, Trendlines Labs announced a partnership with the Singapore General Hospital (SGH) to develop and conduct clinical trials for its stress urinary incontinence (SUI) product. This joint research effort will be partially funded by a grant (of up to 50% of the US$0.4m required) from the Singapore Israel Industrial Research and Development Foundation (SIIRD).

Financials

Lumpy revenue characteristic of business model

Revenue visibility for Trendlines is limited, as management stated that the company is susceptible to:
1. unpredictable timing of disposal gains, as well as
2. changes in fair value of investments,
as investment appreciation could come from either a new portfolio companies or progress in development phase, but these are offset by investments that are written off due to lack of funding.
Such fair market valuation is conducted by an external valuation specialist, PricewaterhouseCoopers (PwC) and audited by Ernst & Young (EY), which uses conservative valuation methodology, according to management. Even for an investment that has been spun off via public listing but in which Trendlines retained a stake in, changes in its market value would be accounted for using the equity method.
According to management, the only components of revenue mix that offer some income stability are:
1. income from contracted R&D services, contributed by Trendlines Labs, and
2. income from services to portfolio companies,
as Trendlines charges other equity investors in the portfolio companies a commission in exchange for the services it provides.
Management seeks to expand these steady income streams in the years to come.
Management believes the following initiatives would help to expand portfolio value:
- Aims to add 8-10 companies to its portfolio each year, over the next three years.
- Intensifying support to accelerate development of its portfolio companies.
- Expanding into new markets such as Singapore, China and Germany.
- Growing Trendlines Labs to increase its revenue contribution from services and royalties, by creating new IP and portfolio companies.

Operating cash flow subject to timing of investment realisation

Apart from lumpy topline, Trendlines has reported negative operating cash flow since inception. However, management pointed out this is typical for its business model, which involves investing in early-stage companies for the medium-to-long term.
Operating cash flow for the company is largely dependent on the timing of investment realisation, which tends to be unpredictable and subject to the availability of buyers, negotiation process, etc.
We note that the company was in a slight net cash position at end-Mar 17.

Valuation

Currently trades at 0.7x FY16 P/BV vs. global peers’ average of 1.3x

An SGX-listed technology incubator that could be considered one of Trendlines’ peers is DeClout (apart from Hotung Investment), which has cashed out of two companies since its IPO in 2012: the sale of Acclivis to China’s Citic Telecom and Mainboard listing of Procurri in Jul 2016.
According to DeClout’s management, the firm attained 71% internal rate of return (IRR) over the past four years, with Beaqon (its Internet and data centre company) potentially the next in the spin-off pipeline.
In terms of valuations, Trendlines currently trades at 0.7x FY16 P/BV, significantly lower than the global industry average of 1.3x. Based on the last reported fair market value (FMV) of each company’s investment portfolio, Trendlines also lags behind peers’ average of 1.3x P/FMV at 0.7x. We note that the company has the smallest market capitalisation among its global peers.

Risks

Renewal of incubator franchise and continual government funding

Trendlines’ business operations are contingent upon it:
1. securing the incubator franchises issued by the Israeli Innovation Authority, and
2. government funding of up to 50% of total investment amount per portfolio company.
The company has successfully renewed its incubator franchises for Trendlines Medical and Trendlines Agtech for eight years until 2023F.
Any cutback in the Israeli government budget could adversely affect the availability of government funding for Trendlines’ portfolio companies. This, coupled with lack of follow-on investments, could threaten its business operations.

Regulatory changes and IP rights protection

Operating in the medical devices and agricultural technology fields subject Trendlines and its portfolio companies to various regulatory requirements, from clinical trials, manufacturing and marketing authorisation, to pricing and thirdparty reimbursement.
Failure to obtain the necessary regulatory approvals and protect their IP rights could lead to the portfolio companies not being able to develop or market their products.

NGOH Yi Sin CIMB Research | William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-05-22

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