Woodford: implications for Patient Capital
Dealing has been suspended on LF Woodford Equity Income, the £3.7bn open-ended flagship fund managed by Neil Woodford. It seems likely that a substantial proportion of that fund will be redeemed and it may be closed.
Woodfod Patient Capital holds many investments in common with the open ended fund. If the open-ended fund is seen as a forced seller of these holdings, it seems likely that the value of these investments will be written down.
Woodford Patient Capital was trading at 76.5p last night, a 12% discount to the last published NAV. At the time of writing, the share price has touched a low of 60.6p this morning (4 June). It should go without saying that investors should exercise extreme caution in this situation.
[QD comment: There is a school of thought that open-ended funds should not have any exposure to illiquid assets but the regulator allows them to hold up to 10% in unquoted equities. (Curiously there is a 10% limit on private equity but no limit on direct property exposure in property unit trusts).
LF Woodford Equity Income is an open-ended fund that has been shrinking as investors head for the exit. Consequently, its exposure to unquoteds has risen beyond that 10% limit. Last year, the fund brought its unquoted exposure down by selling its holding in AJ Bell, unfortunately just before that company published its intention to float. It also swapped some stakes in unquoted companies for shares in Woodford Patient Capital. Controversially, it arranged for four of its holdings to be ‘listed’ on the International Stock Exchange (formerly the Channel Islands Stock Exchange) as a way of getting around the 10% limit.
Woodford had a long-term plan for the UCITS fund to switch all of its unquoted exposure into WPCT. (Doing that now would have required a vote by WPCT shareholders, but they had no say on the asset swap deal because it was structured to be smaller than the 10% limit on share issuance that shareholders granted the board at the June 2018 AGM.)
WPCT shareholders would have also had to get comfortable with (and approve) the UCITS fund being by far the largest shareholder, which would raise a whole range of conflict of interest issues. Furthermore, if the open-ended fund continued to shrink, its stake could overhang the market and further entrench WPCT’s discount.
One of WPCT’s best performing investments has been Industrial Heat (7.0% at the end of January 2019). This company is working on commercialising cold fusion. As WPCT’s website says “scepticism has historically surrounded this branch of science” – most people would tell you it is impossible as it breaks the laws of nature.
Benevolent AI (9.2% of WPCT and its largest holding) is, on paper, a $2bn company. It is using artificial intelligence to analyse data from clinical trials and academic papers to identify therapies that ordinary human researchers may have missed. It has a Phase 2 trial ongoing, BEN-2001 in Parkinson Disease patients with excessive daytime sleepiness. This started in November 2017 and was supposed to complete in August 2018 but nothing has been published yet. Even if this fails, it would be too early to dismiss Benevolent AI’s approach but we are a long way from the company having a revenue generating product.
There is a debate about the merits of writing up the value of companies that are not generating any revenue on the back of fundraises alone. Any question mark about WPCT’s NAV should raise questions about its 17% gearing (which is unusual for a private equity fund). Investors might be concerned about this given we have already seen it lose substantial sums on the likes of Prothena, Circassia, Vernalis and 4d Pharma; all companies with supposedly wonderful ideas that failed to come to fruition.]