Eden - Worth More, or Much More? - (EDEN)
Let's face it. None of us knows what Eden Research (EDEN) is really worth, no matter how long we have been watching, wishing, and hoping. When the issued capital was much smaller, ages ago, some of us paid many times the current price of 16.25p (up 1p) today. There are still hopes that we could see those levels, and more, again - but lending logic to that set of sums has always been elusive.
The latest, and much the most convincing, attempt to add substance to the dreams comes from new house broker Shore Capital, which has a highly-rated research team in the small company/ food producers area. Signed by analyst Phil Carroll, written with the shares at 15p, this suggests a fair value of 22.5p, backed by a full revenue potential analysis citing fair value at 79p by projecting revenues out to 2019 then discounting.
So we have the usual analytical guesswork which sticks a finger into a range of options, and pulls out a nice number. Peer more closely at the assumptions, and you arrive at anything between 63p and 16p (Shore chooses a conservative 22p) on the 'core' Eden business depending on whether you use a discount rate of 8% or 14% and a terminal growth rate of 1% of 4%.
Apply the same discount and growth boundaries to the 'full revenue potential', and you come up with anything between 58p and 223p. Shore picks a cautious 79p.
Do not assume that pointing to the vast variables in the Shore valuation method is a criticism. It is not. But it is worth emphasising that we are not talking absolutes here. We have a broker doing what brokers do, and attempting to give some measure of what Eden might be worth. We should be grateful for that, especially since predicting what might happen with Eden (or, rather, when it might happen) has never been easy.
Rather than attempt to wade through full 31 pages of the Shore report, it is sensible here to assume that subscribers already know the basic Eden story pretty well - it is developing a series of benign products based on using combinations of three natural terpenes, applied via a patented system of encapsulating them in yeast particles which effectively spreads the delivery time when they are sprayed. There have been long delays getting them through the regulatory system, but the first approvals are in. The most immediate applications are in agri-chem, with a vast range of other possible uses, including animal and human healthcare, food ingredients, cosmetics and home and garden products.
Five products are in various stages of development, led by 3AEY, which is about to start sales as a fungicide targeting botrytis, a disease which badly damages grapes. Then there is B2Y, a nematicide targeting soil pests and being evaluated by global giant Eastman (option until next March), 2EY, tackling powdery mildew, and GO-E, the encapsulation technology.
Shore expects approval for 3AEY from remaining southern EU states either before the year-end or early in 2016, allowing sales in the next growing season. Companies associated with Japanese giant Sumitomo are partners with Eden to sell in the key grape-growing countries of Italy, Spain and France, and one of them (Sipcam) is evaluating two new products - 2EY (to treat powdery mildew) and 1EY (for apple scab). The other Sumitomo company also has rights to develop other Eden plant protection products.
In Kenya, at last Lachlan has approval to sell 3AEY. Eden estimates the market for botryticides like 3AEY is $300m a year. B2Y, the nematicide being evaluated by Eastman and about to undergo the registration process adresses an estimated market worth $1.3bn a year (Eastman's market leader nematicide Metam is under significant pressure, says Shore). The powdery mildew product B2Y, going through registration and backed by a Sumitomo company, tackles a market worth about $750m a year, with particularly high value in Africa. There is a pipeline of other earlier stage products, including 1EY.
The broker suggests Eden has a significantly reduced risk profile now that 3AEY has reached commercial sales, and other approvals will trigger milestone payments, helping Eden move into profitability in 2016, a major positive for a biotech company. The business model has significant leverage potential, with further deal potential with other companies in the global Sumitomo network. The same applies to the current option deal with Eastman, and Eden can licence GO-E encapsulation technology for use in industries outside agri-chem. It is currently licenced for head lice treatment with TerpeneTech and with Bayer in flea, tick and shampoo animal health products. Disappointingly, the broker does not expect volume Bayer sales to begin until 2017, with some early initial sales in 2016.
Intriguingly, looking at GO-E, the broker uses the example cited in earlier Eden material. That points to Trifloxystrobin, one of Bayer's best-selling agrochemicals at $400m a year. That is now off-patent, but as an example could be used with GO-E to add benefits and extend patent life if co-encapsulated. Eden has often touted the potential benefits of such co-encapsulation opportunities for extending the life of chemical products for major companies, but has yet to conclude a deal, and has never formally said there were talks on such a deal with Bayer - but it keeps coming up (we know Bayer moves at the pace of a constipated tortoise). The broker suggests that Bayer Cropscience could be a potential source of deals in the future.
It all adds up, sort of, to a set of core revenue assumptions which the broker splits between current agreements and those under evaluation. Current goes from 2015 revenues of £710,000 to £680,000, then to £1.9m for 2017, £2.61m for 2018, and £3.33m for 2019. Deals under evaluation are reckoned to bring in revenue in 2015 of £21,000, rising to £990,000, then to £1.33m, £3.54m, and £5.6m for 2019.
It is these core assumptions, discounted cash flow analysis applied, which support the 22.5p fair value estimate.
Then we have the 'full revenue potential' model. That takes in the possible revenue streams based on products which are still being developed, such as 2EY for powdery mildew or the application of GO-E for use in animal health outside the USA. And they include products not licensed or under evaluation.
This is heavily loaded with revenues from ag-chem in 2019, when they leap from £3.23m to £15.94m, and form the bulk of the projected revenues of £24.83m for 2019 (up from £11.16m). In turn, the vast bulk of these 2019 revenues - £13.78m - would be generated by products still under development.
These assumptions are set against a background of an underlying costs base of £1m a year, growing at mid-single digits, so operational gearing is such that revenues quickly fall through to the bottom line with only modest deductions. Research and development spend is capitalised and then amortised through the income statement (£700,000 currently), and the broker assumes a continuing prudent approach to R & D which would allow the company to become self-sustaining on a cash basis by 2017.
There are trading losses of £21m, taking out the charge for tax for a while, and the broker assumes any short term cash need would be satisfied by debt rather than equity. Free cash flow turns positive in 2017 on the core model, a year earlier on the full revenue potential basis.
What else? The encapsulation process has opened up exciting opportunities in non-agricultural fields, such as medicine and dentistry, where the antimicrobial properties of terpenes can be effectively applied at controlled doses for wound healing and oral health applications.
Eden is at an advanced stage in developing a series of competitive antimicrobial and invertebrate-control agents suitable for use in vineyards and greenhouse and on a variety of high value field crops. The potential for finding further applications of terpene formulations in agricultural and health care is 'vast and clearly exciting' says the broker.
The collaboration and licence agreement with Intellectual Ventures protects existing patents, expands Eden's intellectual property portfolio, and using the strength of IV to provide new deal opportunities. IV has agreed to use its own capital to support Eden's objectives, and the deal should make Eden a more attractive potential partner to work with.
The ag-chem market has seen a reasonable level of merger and acquisition activity in recent years, Shore says. Over the next decade, the use of biological solutions is set to record double-digit growth, and by 2030 could represent up to 10% of the global crop protection market. This is positive for Eden's prospects. Listing several deals, Shore points to Bayer's acquisition of Agraquest for Euros 340m (£230m) plus milestone payments in August 2012. Shore thinks Agraquest had revenue of $7m in 2012, so it is probably the most comparable company in the chosen deals to Eden. At 16.25p, Eden is capitalised at £26m. Shore says it could be a potential target in sector consolidation.
That is a summary of the broker comments, and they point up the attractions of Eden to investors who may have been hanging on, grimly believing, while a tight financial position has brought risks galore to an otherwise enormously attractive proposition. Few shareholders would want to see Eden taken out by an early bid, given the modest share price in recent years. Medium to longer term, however, that is a clear prospect.
The potential applications of terpenes, coupled with the encapsulation process, appear massively wide-ranging. The Shore note fills in some of the gaps, but must remain vague on just what might accrue from which deal. So far, the numbers have been small. But the markets Eden's products could be addressing are massive, and a big money partner could help move things fast.
There is little mention in the report of opportunities in America, where the market must be vast. There appears to be general confidence that Eastman will go ahead and exercise the option next spring, pulling in a decent milestone payment, and covering some of the American opportunities. But the lack of comment about America, north and south, is surprising. Could there be big new opportunities there, and in the Far East, where Sumitomo is an obvious player. If anything, the Shore sweep of potential developments looks on the conservative side, which is where it should be.
Eden itself remains constrained by a shortage of cash. It is debt free and ought to have cash in the bank after the recent TerpeneTech deal, while Lachlan will bring what will presumably be a modest milestone payment. No-one would, however, welcome a dilutive fund-raising at close to current prices.
Hopefully the Shore note and marketing presence will help bring more institutional investors into Eden, perhaps reducing the volatility of the shares. The problem remains the glacial pace of regulatory approvals, despite the obvious environmental benefits of Eden's products. Even now, we are not completely clear of all of the red tape holding 3AEY back in Europe. Though the process ought to be somewhat faster for subsequent products, no-one can be sure of smooth and timely progress.
As it has for so long, Eden still looks an excellent growth opportunity. No guarantees, but much of the risk has gone. Go for it.
I have a holding in Eden Research.