A highly unusual small company

The small company investment mantra: ‘Tell investors we’re going to change the world and hope for the best’.

Of course, I am being facetious but there is a real point there – changing the world and generating sustainable cash flow are apples and oranges. The dream obviously is for both to engage in a positive feedback loop that makes laissez-faire capitalists weak at the knees. As we know all too well though, often all management presents to investors is a blank chequebook and a sleazy smile.

This is a particular problem because of the nature of many small firms.

There is often a single innovator behind them. He or she serves as CEO in addition to leading scientific or technical efforts. This centralisation of control can be fantastic for company direction but often fails given that innovators, in my (albeit limited) experience, tend to not be as adept at capital allocation as a veteran executive.

This brings me on to my main point: talking about one of my latest investments – DeepVerge (LON: DVRG) – and how excited I am about the business model.

What DeepVerge and its transformative CEO Gerard Brandon have done is take historically mismanaged businesses – with huge data and intellectual property moats – and bring them together under one roof. This has all happened within the last few years. As such, the market in my view values DVRG like a startup even though its subsidiaries have been in operation for more than 10 years.

On to those subsidiaries then, and there are a few. We’ll start with Labskin, which has produced ‘the only commercially available lab-grown, full thickness human skin model with entirely human collagen production for cruelty free skin testing.’ This overcomes three key obstacles:

  1. Eliminating often unethical testing of products on animals, but also humans.
  2. Overcoming logistical and time issues regarding procurement of clinical trial subjects.
  3. Reducing human error in clinical skin trials.

As one can imagine, this is very much in the nouveau ESG mould. What’s more is that Labskin are augmenting their offering through offering personalised skincare packages – available to consumers this year. Essentially a swab is taken of one’s skin and sent to DeepVerge. They then get back with a personalised skincare plan based on that individual’s genetic makeup. The below slide from DeepVerge’s December 2020 investor presentation sums it up well.

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You may be wondering: how does Labskin do all this? Couldn’t a larger competitor usurp them? It’s certainly a very valid concern and one I’ve written about before. Fortunately, their aforementioned moat is so vast that that concern is greatly diminished. According to DeepVerge, Labskin have 13 years of data and have written 30+ research articles. Naturally, this is not something that a company can usurp without large sums of money and – even more elusive – time. This is precisely why according to the December 2020 investor presentation Labskin are testing products for 18 (!) of the top 20 largest global cosmetics companies.

So Labskin may be about to enter a market worth $189.3bn in 2025 with a personalised, unique skincare offering, in addition to revolutionising how the industry thinks about clinical skin trials. What (in my opinion) tops even this?

Modern Water Group (MWG), which DeepVerge in fact secured 100% ownership of today.

MWG are attempting to modernise the water monitoring industry. At present, the convention is to take a sample, send it to a lab and then wait typically a few days for the outcome. MWG, using artificial intelligence from the Rinocloud subsidiary and predictive analytics, now aim to a) identify and b) predict virus clusters in wastewater in real time. The technology thus enables proactive pandemic/epidemic management based on likely outbreak centers. It is only too easy to imagine how this could have helped ameliorate the effects of the Covid-19 pandemic in the UK. The November 2020 wastewater monitoring summary for SAGE says as much.

Why are MWG the team to change the way we monitor wastewater? Well, they’ve got a bit of a reputation. Over 100 patents, 30 years of brand recognition for the ‘Microtox’ product, and 700+ scientific research articles are a few of the highlights. Oh – and they have more than 3000 units installed in more than 60 countries. Huge amounts of data, cutting edge algorithms and a fantastic patent portfolio; now that is what you call a moat! It is a matter now of retrofitting existing units with AI capabilities for live water monitoring and prediction of pathogen clusters. That is before we even get on to installing new units in (for example) China and India, the former of which has set aside over $270bn to combat water pollution according to DeepVerge. They have contacts and knowhow in these places that is unachievable without years spent selling a premium offering.

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A slide from the DeepVerge December 2020 investor presentation, on their water monitoring services

Finally, a brief snippet on their potential cruise ship offering. The below DVRG slide again does a good job of articulating the potential market size for this offering. It involves a patented breathalyser licensed from PulmoBioMed for the Microtox BT breath test and a Microtox PD, AI-driven wastewater pathogen detection system. In short, this would be instrumental in protecting cruises not only from coronavirus outbreaks, but also any other outbreaks (remember the norovirus panic anyone)?

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Of course you would be right in thinking that Microtox BT has other applications. The passage below from this article explains its potential in opening large venues here:

‘The Company believes Microtox BT has the potential to enable instant real-time testing of people within the community. This could be capable of  providing daily triaging of everyone who may or may not demonstrate levels of infection.  To “open the economy”, Integumen (now DeepVerge) has incorporated a 24-hour Digital Health Pass that indicates if the person tests positive or negative for infection. Matched with blockchain secure date and time stamp of the test, the company believes Microtox BT and the Digital Health Pass using “one second” QR Code scanners could potentially contribute to enabling the economy to re-open with personalised go/no go entry into venues such as work, events, social locations, public transport and airports.’

The combination of all these businesses, tied together under the DeepVerge moniker, has the potential to yield some truly explosive growth. In fact, it already is. Revenues were up more than 300% in 2020 to £4.4m, and guidance is for 2021 to be another year of revenue more than doubling at £10m. DVRG, based on even capturing a small sliver of the addressable markets above, could generate hundreds of millions of pounds in revenues – at high net profit margins – by the end of the decade. Any more specific guidance is bound to be wrong with how fast the company is growing.

The market capitalisation at today’s close is £55.45m. To put that into context, at a 15x PE ratio it is pricing in the equivalent of c. £3.7m in annual net profit, in perpetuity. Based on the above I for one think that DVRG has scope to outperform significantly on this in the coming years. Even if their £3m funding facility does not prove enough for their financing needs, assuming even 100% dilution the company is significantly undervalued in my view. There are multiple ‘shots on goal’ from subsidiaries with huge moats. If they manage to capture a significant portion of any of their addressable markets, the share price quite clearly can see a re-rate.

Thankfully, the directors agree with me, with a combined 15.03% shareholding in the company. This includes over 5% held by Gerard Brandon himself. As of the end of last year, Helium Rising Stars Fund also held 6.55%.

In summary, DeepVerge to me is an investment worth making on multiple accounts:

  • Multiple innovative products
  • Huge addressable markets
  • Significant moats with data and patent advantages
  • Respected brand – rare for a small-cap

Of course, every investment has risks, not least a small cap but the risk/reward is asymmetric in my view – and it is why I have confidence in DeepVerge to deliver. An early adopter of the AI-as-a-service business model and a highly unusual small company, DVRG is one of those that really can do good for the world and potentially help out some of its shareholders a great deal.

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Shinzo Abe’s “Abenomics” has failed. But why?

Who would have thought that it would be in the Land of the Rising Sun that three arrows could miss their target so wildly?

Of course, I’m talking about the Prime Minister of Japan, Shinzo Abe’s, three arrows of fiscal stimulus, monetary easing and structural reform that were intended to claw Japan out of a dangerous cycle of recession and deflation. At the time, it seemed like the perfect policy, with fiscal stimulus intended to increase demand for goods and services and monetary easing by the Bank of Japan intended to generate the 2% inflation that Japan has so longed for, increasing aggregate demand and therefore triggering a virtuous cycle of economic growth. In addition to this, the structural reform intended to increase the competitiveness of Japanese industry with regards to the world as a whole should have ideally bolstered and healed Japanese companies’ future prospects, after years of sluggishness. Yet as so often turns out, while Abe’s plans seemed to be worth their weight in gold on paper, they have failed to revitalise Japan and return it to the supreme economic status which it once had. Amongst a whole host of other indicators, Japan’s inflation rate fell to -0.4% in July 2016, lowering the proverbial coffin into the ground of another seemingly great set of economic policies. But why has it failed when it looked so good on paper? How has Abe fallen flat yet again? Could external factors be preventing the three arrows from working their magic?

Well, when you take into account Japan’s rapidly changing demographic, the answer to the latter question would be resoundingly in the affirmative. Since 2010, Japan’s population growth has been negative and birth rates have steadily declined while life expectancy continues to rise. On the health side of things, this is a massive breakthrough for the country, but economically, what it means is that Japan now is faced with the problem of a gradually dwindling labour force. Hence, although Abe is injecting billions upon billions of fiscal stimulus into the economy, the decline in labour force has resulted in a decrease in consumer demand in spite of his policies, due to less people having the money in their pockets to actually spend in the first place. In this regard, what Abe could further focus on is spearhead a further push for immigration to bolster aggregate demand and consumer spending, in turn boosting growth before the arduous and potentially unfruitful wait for Japanese societal norms regarding children to change (he has made great strides towards this with his Abenomics 2.0 programme). Perhaps in the case of Japan, this policy would be far more beneficial to her than any fiscal package that Abe could come up with; it would certainly at least be worth a try.

One side effect of recent Japanese economic policy (in particular the monetary policy of setting negative interest rates) has also been a devaluation of the Japanese yen, allowing Japanese firms to become complacent in the face of high profits. Due to the weak yen increasing Japanese firms’ revenues from abroad, the result is a lack of incentives for these firms to innovate and increase productivity. Due to this, the economy’s productive capacity has stagnated, hindering its potential for long run economic growth. Recent reports indicate that distinguished figures such as former chairman of the Federal Reserve, Ben Bernanke, declaring that “monetary policy is reaching its limits” in many developed countries. Due to this, it is feasible that the cut in interest rates to negative levels, while effective on paper, has not worked so well in reality because it disincentives innovation within Japan, and without innovation, it is extremely difficult for a capitalist framework to thrive and prosper. Therefore, perhaps an appreciation of the yen against the dollar would not be as disastrous as many pundits claim, and instead, may indeed provide a route by which Japanese firms can finally move forward.

Social attitudes in Japan currently are also not exactly conducive to economic progress. Due to many of the current Japanese young generation having known nothing but economic stagnation, deflation (or very low inflation), and failed government policy, these young people, traditionally some of the big spenders in a modern economy, have failed to provide the Japanese machine with a much needed boost. It has gotten so bad that one individual said to the Financial Times that she feels as if she is “more conservative than [her] grandmother.”, such is the backwards direction which Japan has gone in with regards to spending. The solution to this is much less science than it is alchemy, and the only way which Japan can really try and fix this problem is a bottom-up approach to incentivise spending amongst young people. In my opinion, this could be achieved by portraying spending on goods and services as some sort of natural duty, invoking patriotic sentiment and therefore triggering spending to lurch from its slumber. However, Japan’s problems are both deep and wide ranging, and will take years, or perhaps even decades of consistently successful government policy to solve. While Abenomics is well-intentioned, it simply has and will not work in practice, and perhaps what Abe and his fellow policymakers need to do is to think a little bit outside of the box.