Why I’d never recommend this dodgy biotech stock
Just as the Portugese Man O’ War reaches its long tentacles to snare unsuspecting minnows into its deathly maws, so is the mighty machine of the City of London stretching out to lure you, my friend, into a wonder of the financial depths called Arix Bioscience. This creature would love you to buy its shares. Sycophantic brokers have been corralled to write effusive buy notes while hacks such as I, seen to be a mouthpiece to the private investor, have been treated to its siren voice.
I took a call from Arix this week, and one thing I can safely say. This company is going to make a lot of money for some people. In fact it already has. But probably not for you. Since the primary purpose of the financial services industry is to pull the wool over the eyes of the average Joe, you need to know about this sort of thing. So let’s start at the beginning.
Arix came on to the Stock Market last February, raising £112m through the sales of new shares priced at 207p. Added to £52m of funds raised before the IPO, this gave it £164m to invest in early stage businesses in the life sciences industry. We got the usual shtick. Accelerated innovation is revealing a stream of potential new therapies. The great majority of these breakthroughs are being made in academic environments and these need finance and expert guidance to reach the promised land of clinical approval and paying customers. Arix’s team, needless to say, is replete with the necessary experience, skills and contacts to make this happen, and as they grow small academic acorns into mighty oaks you and I can make the mouth-watering, 20% plus, returns normally reserved for the priviledged circle of venture capitalists.
Since this management team is crucial to the whole enterprise and apparently worth a huge amount of investors’ money, I should tell you who they are. Chief Executive Joe Anderson was once a pharmaceuticals analyst at Dresdner Kleinwort Benson but for the last twelve years has been a VC investor at Abingworth. Chairman Jonathan Peacock was in corporate finance before seeing Big Pharma close up as Chief Financial Officer of Amgen and Novartis. But the biggest fish is Deputy Chairman Professor Sir Christopher Evans OBE, the godfather of British Biotechnology, who, we learn from his modest CV in the Admission document ‘has positively impacted many millions of lives with his work.’ Now, doesn’t that make me feel a failure.
Then we have the finance director James Rawlingson, formerly of Charles Stanley, and a host of worthy non-Execs including former Government minister Lord Hutton. Now obviously you cannot expect to get such luminaries on the cheap, so let us dive into the numbers.
Let me start with that war chest of £164m, raised in February to invest in the life sciences industry. By June 30th, when Arix drew up its interim accounts, this had mysteriously shrunk to £146m! Where had the missing £18m gone? A massive £9m was paid out to financial advisers and intermediaries in the course of fund raising. As for the other £9m, this was the cost of assembling the team, buying photocopiers and paper clips and running offices in London (Berkeley Square) and New York (Mid Town, just a few blocks from Central Park).
But much of this went straight into the pockets of the directors. I don’t know exactly how these things are reflected in the accounts, but here are some facts. Joe Anderson is on a salary of £500,000 per year. Jonathan Peacock gets £38,000 for being a director as well as $543,000 per year under a service agreement. Sir Chris Evans gets £250,000 in addition to which Arix pays £20,000 per month to his company Merlin Scientific. James Rawlingson receives a mere £270,000 per year. The senior non Executive Director is on £100,000 per year and the others are on £50,000.
That is just the start. The Executive Directors get pension contributions, private health cover, life assurance, a car allowance and income protection. But these are a drop in the ocean. The real bunce comes in the form of bonuses and share awards. The Executive Directors can receive cash bonuses of 100% of their salary. Then there is a Executive Incentive Plan, designed to ‘ally their interests with those of all shareholders.’ Frankly if I was on this sort of gravy train I would need no extra incentive to stay firmly aboard, but it has been deemed necessary to give the Execs shares up the value of 150% of salary.
Now it is starting to mount up, isn’t it? Let me continue. For no obvious reason 170,287 shares, worth £352,000 at the issue price, were presented to the non-Executive Directors, while the founders, Jonathan Peacock and Joe Anderson have received options over 5.5m shares exercisable at £1.80. Then there was the Stock Market float. I don’t know about you, but I would have thought that this was just part of the day job, but evidently not. ‘In recognition of their contribution to the Offer and Stock Exchange Admission’ the Executive Directors were given options, with a Nil exercise price, over 1,062,799 shares worth £2.2m. Not content with that they were also given ‘exceptional’ cash bonuses totalling £755,000.
Adding up the Directors remuneration in cash and benefits (excluding share awards) for 2016 we arrive at a figure of £3.75m. For 2017 I dare say it will be a lot more than this, but we won’t know about that just yet. For one thing the bonus awards will be calculated according to ‘financial and non-financial measures that will support shareholder value creation’ – in other words they are discretionary and could be anything. And for another, we won’t know how they have been calculated until we see the 2017 Annual Report next Spring.
Arix is not alone in paying its directors a disgustingly large amount of money. But when you only have assets of c.£150m to start with you need to be a bit frugal. In the latest reported six months Arix’s Administrative Expenses were £5.335m, on top of which there was a £1.76m share-based payment charge. Add the two together and over 4% of shareholder’s funds have disappeared in just six months. Analysts are not forecasting any diminution of these running costs, so at this rate Arix has got to make an 8% return on its assets each year just to stand still.
So far Arix has made 11 investments of which 7 are in the hot areas of oncology, gene therapy and orphan diseases. In subsequent financing rounds two of these have achieved a slightly higher value than Arix’s initial investment. But only one of the investments is in Phase III of clinical trials while seven are in either Phase I or preclinical, and for these any conservative investor would attribute no value at all. None of these programs has, as yet, achieved anything of commercial value and we have no way of knowing whether any of them ever will. But this has not stopped brokers (all of whom either have already been in receipt of largesse from the Arix altar, or hope to be so) from placing a value on the shares, now trading at 180p, of 245p-310p. How so?
Well the first trick is to double the value of money as soon as it is invested. In other words, if Arix has £1m in the bank it is valued at £1m. But as soon as it is invested in a biotech concern it immediately becomes worth £2m! The other trick is to project the revenues of the various investee companies five years hence and then discount this to reflect time value and the probability of the company achieving commercial success. As one of the brokers says ‘we believe this method is appropriate in capturing the value of the clinical stage pipeline by allowing us to flex multiple assumptions, including chance of success, peak sales estimates, and year of commercial launch.’ In other words by ‘flexing’ our assumptions, we can come up with whatever figure we like.
All week I have been really angry about all of this. I am angry that obsequious research analysts should attempt to justify a higher share price using absurd equations. I am angry that anybody could be so self-important to think they are worth these vast rewards before they have made even a single penny for shareholders. When I told Arix’s representative that this was a disgrace, his reply was that Arix is only doing what everybody else does – which never makes anything right. I am angry that institutional investors, led inevitably by Neil Woodford, have sanctioned these arrangements.
And I am angry that anybody should have thought that I would commend this share to you, my faithful reader. Maybe one day Arix will get lucky. Maybe one of two of its investments will come good. But anybody who buys shares in Arix is condoning sheer, unmitigated, voracious greed and I will never do that.