Core portfolio thriving

Tern hosted an investor presentation and Q&A session on 26 March. Each of the four presentations from the portfolio companies highlighted increased commercial traction, with configuration work turning to repeat licencing through the SaaS models, a growing high-profile customer base and important strategic partnerships. The presentations reinforced the chairman’s statement that Tern has created, and continues to support, a portfolio of businesses where 80% are not just surviving but thriving, compared with the industry venture capital norm of a 40% success rate. Operating costs have been cut by 40% but Tern remains focused on supporting the companies to grow, which ultimately should create significant shareholder value when there is a liquidity event.

Core portfolio thriving

Today’s trading statement from ZOO highlights a ramp-up in demand following the end to the industry-wide strikes of last year. ZOO struck a note of caution in its January update regarding the timing of orders. However new productions are starting to translate into a healthy order pipeline, with a good recovery in revenue anticipated in H1 FY25. The update guides to revenue of at least $40m for the year to March 2024, ahead of our estimate at $36.8m. We have improved our adjusted EBITDA loss marginally to $13.4m. ZOO has also announced a significant new contract with a major studio, operating as preferred partner for subtitling and primary vendor for dubbing. This demonstrates ZOO’s quality as a services vendor and provides evidence that ZOO is emerging post supplier rationalisation as one of the few trusted end-to-end (E2E) suppliers.

Recovery underway and a significant contract

Tern’s portfolio company Talking Medicines, the data science/AI specialist, has raised a total of £440k via the issue of unsecured convertible loan notes (CLNs). The raise will provide funding for the next stage of development and expansion in the US. Talking Medicines is on a positive trajectory with significant momentum, and we see huge potential in the next phase of growth. Already at the forefront of AI, Talking Medicines is well placed to take advantage of Large Language Models (LLMs) following the media attention given to Open AI’s Chat GPT. This was highlighted with the recent launch of the company’s Drug-GPT, which stands apart as a specialised ‘Curated Large Language Model’. In our view, Talking Medicines has evolved quickly to address the marketing-driven reality of US Big Pharma and has built relationships that could become very lucrative in short order.

Talking Medicines…and revenue potential

Thruvision has issued a positive update on current trading, reiterating the message at the interim results in November that there is good momentum in demand from new and existing clients. The group’s diversified business model, with a broad customer base spanning a number of international markets, is continuing to bear fruit. Retail Distribution, its largest market, is winning notable contracts, including a recent order for WalkTHRU from a global sportswear brand for use in its US operation and further WalkTHRU lane orders from two existing FTSE 100 clients. In Customs, additional systems have been ordered by an Asian agency customer. The renewed focus on Entrance Security continues, with further units ordered by a European prison service and a Gulf state. We are encouraged by this secured pipeline, with orders totalling £1.3m since November’s interims, all of which are expected to be delivered in H2. We maintain FY24E estimates.

Reassuring trading update

This morning’s trading statement from ZOO confirms that production companies are taking longer than expected to complete projects. This follows the resumption of new production after the industry-wide strikes ended in November 2023. The anticipated January ramp-up has yet to fully materialise, with entertainment projects expected to complete in January now moving into February and beyond. However, ZOO has been notified by its largest customer of a pipeline of orders that provides good visibility for the next two quarters, an improvement on the usual quarterly order certainty. These orders, coupled with workflow from ZOO’s other major clients, are expected to deliver ‘a strong recovery of revenues’. We have adjusted our estimates for FY24E to reflect the slight delay in workflow resuming for ZOO, but maintain estimates for FY25E, with a return to profitability.

Update flags delays in production completions

Tern recently took part in an interview with DirectorsTalk following the announcement in late December that portfolio company Device Authority (DA) had received a US$7m strategic investment from Ten Eleven, a global leader in cyber security with a strong foothold in automotive and medical devices. The next step to accelerate growth for DA’s KeyScaler is to expand the sales footprint, particularly in the US. Having Ten Eleven as a partner marks a significant milestone for DA in this respect, attracting ‘intelligent growth funding’ from a partner with substantial experience and reach across the US, complementary to the Tern structure. In our view, pressure to realise cash through an exit is unfounded given the timeframe required to deliver maximum value to shareholders by preparing a business for harvest. Tern remains focused on the route of value creation and ultimately exit at the appropriate time.

Supporting investee secured for DA

SDI has indicated that a slowdown in the life science / biotech market, and some resultant destocking, is likely to impact its expected FY24 revenue, leading the group to moderate current year guidance for both revenue and adjusted EBITDA. SDI notes that FY24 represents a short-term phenomenon, due to the over-ordering of the past three years caused by inflated Covid demand. However, we remain confident for the long term, given the strength of SDI’s ‘buy and build’ business model, with a number of smaller niche autonomous businesses operating in different end markets.

H1 24 – well-placed for the post-Covid normal

ZOO has announced H1 24 results in line with guidance at the recent AGM. We welcome the news earlier this month that the US actors’ strike has ended. This suggests that revenues could return to historical levels in the relatively near term, and that ZOO was correct to maintain capacity and capability to deliver during the recent hiatus. Subdued workflows have led to a significant EBITDA loss in H1 on revenue of $21m; but given the sequential month-on-month improvement expected, we maintain revenue and EBITDA estimates for FY24E. In addition, we view recent customer wins for ZOOstudio as a major endorsement, with significant revenue potential as orders ramp up. We reintroduce FY25 estimates, albeit at a reduced level, with upside potential if the recovery proves faster than expected, given ZOO’s operational gearing. In this note, we also focus on the opportunity for Artificial Intelligence (AI), which we believe could enhance ZOO’s position in the marketplace rather than representing a threat.

H1 24 – positive news, short and long term

Tern has announced an update on its portfolio activity. Individual companies are gaining commercial traction, with configuration work turning to repeat licencing as businesses move to SaaS models. As flagged, valuations across the global technology landscape have been challenged due to risk appetite and long-term value expectations. However, third-party investments remain critical proof-points that Tern’s model is delivering. Tern is positioned at the confluence of IoT, data and thereby Artificial Intelligence (AI), where we see multiple opportunities in the existing portfolio; we discuss this in more detail overleaf. We note Tern’s decision not to invest further in Konektio, which we see as strategically correct and perhaps a signal that the new structure is working well. We continue to look for significant value creation from Tern’s hybrid VC model, with management seeking well-timed exits that maximise value ‘when the market conditions are right’.

Portfolio update highlights transition period

Thruvision has delivered 28% revenue growth for the H1 trading period (to 30 September 2023). Its diversified business model, with a broad customer base in a number of international markets, is helping to offset the lack of a US Customs and Border Protection (CBP) order in this US Government fiscal year, which we view as a timing issue. International government activity has increased, including initial orders from two new customs agencies, and a renewed focus on entrance security has generated a marked pick-up in revenue. Despite the difficult retail trading backdrop, Retail Distribution has delivered a resilient performance, continuing to add clients. We welcome the recent report by Retail Economics highlighting the scale of theft in the UK retail market (see our note). We see this as a significant driver of demand for the Thruvision product, which is gaining traction with a growing number of leading retailers and global 3PLs.

Resilient H1 24 with many opportunities ahead

Thruvision recently commissioned Retail Economics, a leading independent consultancy, to produce an in-depth report on the scale of theft in the UK retail market. The report estimates that in calendar year 2023 the value of retail theft will reach £7.9bn, with 40% of this theft from retail workers themselves, concentrated in warehouses and distribution centres. Losses from dishonest employees are, on average, four times higher than from shoplifters, adding to retailers’ operating costs and squeezing profitability. We see this as a significant driver of demand for the Thruvision product, which is already gaining traction with a growing number of leading retailers and global logistics providers.

Market forecasts highlight scale of opportunity

SDI Group has announced the acquisition of Peak Sensors, a UK manufacturer of temperature sensors, for an estimated £2.4m (£2.3m less cash). The initial cash consideration is £1.58m, with a further c.£0.82m payment due shortly after completion. The deal will be funded from SDI’s revolving credit facility. As at 30 September, SDI had c.£1.78m cash, £15.1m bank debt and £9.9m undrawn bank facility excluding the accordion, providing considerable financial flexibility for the group. The acquisition is expected to be earnings enhancing in the first full year of acquisition. Our FY24 estimates remain broadly unchanged, with the slightly higher EBIT offset by a higher interest charge. We see this acquisition as an encouraging development for SDI, confirming that management is committed to its buy and build strategy, bolting on quality businesses at reasonable multiples that can grow from a small base under the SDI structure.