It’s not too easy for the average private investor to gain exposure to the high-growth potential of unquoted early-stage businesses. One option is AIM-listed Mercia Technologies (LSE: MERC), which has a portfolio of investments in 24 such businesses.
The company released its annual results today and I like the look of its business model, the progress it’s making and its current valuation.
Business model
There are two prongs to Mercia’s business model. It’s an asset manager, running third-party investment funds that nurture young businesses. It receives fees for these and other services by which it aims to cover a large chunk of the plc’s operating costs.
As the young businesses develop, it identifies ‘Emerging Stars’ among them and provides direct investment follow-on capital from its own balance sheet. This is the portfolio of 24 investments I mentioned earlier. It ultimately aims to exit these investments with rich rewards from lucrative flotations or trade sales.
Progress
In today’s results, for its financial year ended 31 March, it reported that funds under management increased to £336m from £220m, with revenue rising to £6.7m from £1.8m. Meanwhile, its portfolio of 24 direct investments increased in value to £52m from £38.1m.
The year also saw Mercia demonstrate the viability and potential gains of the direct-investment element of its business model with the trade sale of Allinea Software to ARM, providing an 88.4% uplift on the group’s direct investment cost. The IPO of Concepta (a digital fertility/pregnancy testing business) was another notable event.
Valuation
When Mercia listed on AIM in December 2014, it raised a net £66m at 50p a share and had a market cap of £106m. Pro forma net assets were just over £75m (34.4p a share), so it was valued at 1.41 times book value.
It raised a further £40m (gross) at 46p a share in February this year and today reported net assets of £121.4m (40.4p a share) at its March year-end. At a current share price of 34p — up 4.6% on the day — the market cap is £102.2m, so it’s now valued at 0.84 times book value.
Despite its increased scale, emerging proof of its business model and management saying today “we can already see several material value inflexion points arising in the coming year,” Mercia is considerably cheaper than at the time it listed on the stock market. It’s also cheaper than a much-higher-profile stock offering exposure to early-stage businesses: Woodford Patient Capital Trust (LSE: WPCT).
Patience
At a share price of 97p and with net assets of 100.3p a share, Patient Capital trades at 0.97 times book value. It also happens that Patient Capital has given Mercia the Neil Woodford seal of approval. It owns a 25% stake in Mercia and both companies are chaired by Susan Searle.
With 76 holdings, Patient Capital can be seen as a lower-risk proposition than this article’s other subject, particularly as only about half its holdings are unquoted businesses, with the portfolio also containing some relatively large and familiar quoted names, such as Purplebricks and US-listed Prothena.
Nevertheless, I see Mercia’s 24 investments as reasonable diversification and the company’s third-party fund management arm as providing a useful degree of relative stability. Both businesses have potential to deliver excellent long-term returns for patient investors and I would rate them as ‘buys’ at their current discounts to book value.
