Karolinska Development: valuation update

Karolinska Development continues to make commendable progress across multiple fronts as the portfolio rationalisation and greater commercial focus bear fruit. The past month alone has seen a string of positive outcomes for several the portfolio companies, notably encouraging results in Umecrine Cognition’s Phase Ib clinical trial. Updating for these events, and including Umecrine Cognition within our DCF-based model for the first time, sees our valuation rise from SEK566m (SEK8.92 per share) to SEK1,042m (SEK16.44 per share). The convertible debt and the complexity of the Rosetta Capital dividend split remain an overhang on the shares; nonetheless, we would argue these factors are well documented and already more than discounted in the price.

Karolinska Development is expected to report its results for Q317 on the 31 October. In this Update note we recap the various pieces of news that have been reported by a number of the portfolio companies and have updated our DCF-based valuation model to reflect these. Importantly, the progress seen at Umecrine Cognition means that we include its contribution to the model for the first time. Our updated model sees the valuation rising from SEK566m (SEK8.92 per share) to SEK1,042m (SEK16.44 per share). In line with our philosophy, we continue to employ conservative assumptions throughout; for example, we have not included the additional oesophageal cancer indication for APR-246 within our rNPV for Aprea. Similarly, the earlier stage portfolio companies and retained interests and potential earn-outs should be viewed as possible upside.

In our recent Outlook note (Portfolio companies delivering as planned – September 2017) we detailed how the past two years has seen a revitalisation of the company, with material changes to the investment philosophy, the adoption of a greater commercial outlook, and the creation of a more focussed portfolio. The consequences of these changes have started to show through into the performances of the individual portfolio companies and, importantly, within Karolinska Development itself.

Management’s focus is now firmly on the effective execution of the strategy, with the priority being delivery on critical milestones ahead of potential exits (either through trade sales, IPOs, or licensing deals). Although timings are difficult to predict, the improving visibility suggests that, assuming current progress is maintained, the first major value realisation could happen within the next 12 to 18 months.

The convertible debt and, to a lesser extent, the complexity of the Rosetta Capital dividend split understandably remain as overhangs on the shares. The set-off issue of the convertible bonds saw SEK 67m converted into 10.9m new B shares, which means SEK 384m worth of bonds remain outstanding. The balance sheet is currently sound and has funding in place for the known investment and operational needs, with SEK 189m in cash and equivalents at June 2017. The re-valuation of the portfolio holdings, notably Umecrine Cognition, has strengthened the equity position (allaying a concern we raised in our Outlook note). Nonetheless, we would argue that these issues, although valid, are well documented and more than discounted in the share price.

Portfolio company progress in the past quarter

Aprea Therapeutics is a private Swedish company that is developing novel small molecules targeting the tumour suppressor protein p53 pathways. A Phase II trial of the lead compound, APR-246, in platinum-sensitive high-grade serous ovarian cancer is underway, with the results of this pivotal study expected in 2018. A similar programme examining platinum-resistant ovarian cancer patients is in Phase Ib. A Phase Ib/II trial is also underway in myelodysplastic syndrome, whilst in October the first patient was enrolled in a Phase Ib/II study in oesophageal cancer.

Modus Therapeutics was previously known as Dilaforette until it changed its name in October 2016. Its lead compound, sevuparin, is in Phase II trials in sickle-cell disease. This important study, involving around 150 patients, is expected to produce results in 2018.

OssDsign makes bespoke craniofacial implants, where complicated or difficult cases require individualised implants. The distribution infrastructure has been expanded, with new partnerships in Italy, Spain, Austria, Switzerland, and The Netherlands (adding to those in the UK and Nordic region). Following 510(k) clearance earlier this year to market OSSDSIGN Cranial PSI in the US, a distribution agreement has been signed with Matador Medical Inc.

Promimic has developed a unique coating, known as HA^nano Surface, that is used to improve the integration of implants into bones. Commercialisation is now underway, notably in the important US market. Management has been strengthened with Tord Lendau elected Chairman and Magnus Larsson appointed CEO, replacing Ulf Brogren, who relocated to the US to lead the new sales operation in North America.

Dilafor is a drug development company that is developing pharmaceutical products for obstetric indications. Its lead compound is tafoxiparin, which is currently undergoing Phase II studies with first results expected in Q1 2018. A Phase IIb clinical trial with tafoxiparin in women with protracted labour was started in January 2017.

Umecrine Cognition is developing compounds that act on endogenous CNS-active steroids (GABA-steroids). GR3027 is an orally active first-in-class agent that acts to counter the increased GABA_A signalling that is believed to cause the clinical symptoms of cognitive and motor function impairment in hepatic encephalopathy (HE). In September 2017 it announced positive Phase Ib data from 18 healthy males at doses ranging from 50 mg once daily to 100 mg twice daily for five days. GR3027 was well tolerated; adverse events were mild and no dose-limiting toxicity was seen. In October 2017 it raised SEK20m to finance an exploratory Phase IIa for GR3027 in idiopathic hypersomnia, a severe orphan disease characterized by excessive daytime sleepiness. These developments have resulted in Karolinska Developments raising the value of its holdings by SEK196m and our including Umecrine Cognition in our valuation model for the first time (see Exhibit 1). This maiden contribution is SEK453m (SEK7.14/share).

Additionally, in October BioArctic was successfully floated on Nasdaq Stockholm. Karolinska Development has a 3.17% holding, which at the time of listing (12^th October) was worth SEK48m (updated value is shown in Exhibit 1).

Valuation

We employ a sum-of-the-parts DCF-based methodology (including rNPV models where appropriate) as we consider this to be the most appropriate way to value Karolinska Development. Importantly, we employ conservative assumptions throughout and only value the key late-stage investments. The inherent value of the other investments in the portfolio and potential earn-outs from previous investments are viewed as additional upside to our valuation. The progress being achieved across the portfolio is reviewed regularly and adjustments made to reflect this.

Exhibit 1: DCF valuation of Karolinska Development

Source: Trinity Delta; Note: ¹ % owned by Karolinska Development directly or by KDev Investments; ² Companies owned by KDev Investments, in which Rosetta Capital owns 7.5% of the equity, ³ Karolinska Development’s fully diluted stake in OssDsign is now 20%, as OssDsign has recently revised its strategy to target a yet-to-be-disclosed larger opportunity; for the time being we continue to value OssDsign on its initial strategy with KDev Investments owning 28% of OssDsign. ⁴ The valuation of BioArctic and Karolinska Development’s shares in the company are based on BioArctic’s market cap on 26 October 2017.

The main factors driving the uplift in our valuation (as indicated in Exhibit 1) are the first-time inclusion of Umecrine Cognition into our valuation model and the successful flotation of BioArctic on Nasdaq Stockholm. The new valuation is SEK1,042m, or SEK16.44 per share, which compares to our previous valuation of SEK566m, or SEK8.92 per share.

Exhibit 2: Summary of financials

Source: Karolinska Development, Trinity Delta  Note: Adjusted numbers exclude changes in the fair value of portfolio companies and exceptionals. Forecasts exclude potential investments or divestments.