CHIEF INVESTMENT OFFICER’S MARKET UPDATE

By Dr Savvas Neophytou (Chief Investment Officer, Deepbridge Capital)

It is fair to say that 2023 to date has been a slow year across the Venture Capital (VC) sector, representing a period of challenges, but has ultimately also been a period of considerable progress and maturity for the Deepbridge tech and healthcare portfolios.

Whilst all investors crave the big ticket returns and, like us, want to see considerable growth and returns, it is important to understand market context when analysing performance.

In June, Dealroom.co reported that the UK retains its third-place global ranking for attracting VC investment and ranks first in Europe.  Whilst this is great to hear and is testament to the fantastic innovators here in the UK, as well as the impressive ecosystem we have, it is important to temper this excitement with the estimate that this is ~50% down on the same period in 2022.

Like many VCs, including EIS managers, our focus over the past 12 months has been to support our existing portfolio companies and ensure they are well capitalised and ready to take advantage of future market improvements. This has, thus far, worked well and despite high inflation, rising interest rates, tough trading conditions and fewer external funding opportunities, a good portion of our investees have nonetheless made commercial, scientific and international progress.

During 2022 ‘tech’ stocks faced a rationalisation in terms of valuation.  It can easily be argued that ‘big tech’ such as Twitter (whatever it is called these days), Meta, and Tesla witnessed overdue corrections given that their valuations were uncorrelated to profitability, revenue or any other traditional valuation barometer. As discretionary spending has been squeezed, many of these consumer facing stocks faced a challenging time.

The story in 2023 has been somewhat different, with tech stocks rallying to new heights. As illustrated with the NYSE FANG index, an index that provides exposure to a select group of highly-traded growth stocks of next generation technology and tech-enabled companies, showing a +77% total return year-to-date. However, earlier stage portfolios have not yet caught up. When you consider unlisted equities, many of which are in the high-growth part of corporate life cycles, the scarcity of capital availability for over a year has undoubtedly led to a squeeze of valuation multiples across many sub-sectors. Unlisted company valuations tend to lag listed companies for a variety of reasons, but it helps unearth resilience and help refine business models if companies can engage into a period of ‘self-help’. Like any investment, valuations may fluctuate along the stock’s lifetime but ultimately our focus is firmly on providing profitable returns for our investors over the long-term.

Throughout the past 12-months, our team has been working closely with third-party corporate finance advisors, investment banks, private equity and family offices to ensure we leave no stone unturned in support of our investees. Whilst many in the market acknowledge the constrained funding environment and bemoan the lack of merger & acquisition activity, indeed EY reported in July that “2023 IPO [Initial Public Offering] activity on the UK main market and AIM [Alternative Investment Market] saw a 31% drop in deal numbers compared to the first half of 2022,” the forward-looking views suggest that capital will return in due course, with some anecdotally suggesting Q4 of 2023 whilst others are more cautious. 

The theme at present is not missing the ‘early bull cycle’ and a wide range of economists point out that the recent slow-down seems to be economic-cycle related rather than anything more structural, which means the probability of a systemic financial crisis is diminishing. However, we are not out of the woods yet, indeed some point out to the unwanted prospect of a second wave of inflation (much like the 1970s economic cycle) but the bond markets have had 2 years of negative growth and have since shown signs of becoming more stable which can be seen as a positive, although a record 3rd consecutive year of negative returns in the US 10Y bond market is not out of the question yet.

Given these global challenges, our approach of supporting and capitalising our existing portfolio appears to still be a sensible approach.

One appreciates that the macro might all sound like doom and gloom, but I am delighted to report that entrepreneurship and innovation in the UK remains very much alive and kicking.  The volume and quality of early-stage deal flow we see is unabated, with the UK tech and life sciences sectors continuing to create astounding devices, applications, therapeutics and software.

To date we have supported spinouts from 17 UK universities and over the past 24 months almost 90% of our capital has been deployed outside of London.  With HM Treasury reporting in July that 80% of venture capital provides funding within the ‘golden triangle,’ being London, Oxford and Cambridge, we are pleased that we are bucking this trend and helping democratise the distribution of capital across all regions of the UK and supporting spinouts from universities regardless of location.

We are delighted to now be welcoming a number of new companies into our EIS portfolios and there continue to be great long-term investment opportunities for our investors.

Earlier this year we deployed our final tranche of capital from British Business Investment’s Regional Angels Programme, who awarded Deepbridge a £15m mandate to coinvest alongside our EIS capital. This has been extremely useful capital to help our portfolio companies, for which we have been extremely appreciative.  With organisations such as the British Business Bank (of which British Business Investments is a subsidiary) and Innovate UK, as well as Scottish Enterprise, the Development Bank of Wales and Catalyst NI within devolved nations, providing invaluable support to business owners and entrepreneurs, the UK remains a fantastic place to start and scale a business.

In summary, the past twelve months have been a challenging period, but I am delighted with the work undertaken by our investment teams to support our portfolio companies.  This is, of course, not all about us and my closing remark is to recognise the outstanding founders and management teams who make our investee companies appealing, and scalable, investment opportunities.  Running a business is stressful at the best of times, but in a world where funding is in short supply and unpredictable, this is particularly true.  Therefore, the funding our private investors provide has never been more gratefully received to empower great innovation.

Thank you for your ongoing support.

Sources:
The UK has raised double the investment of any other European country in 2023: https://dealroom.co/reports/uk-tech-update-london-tech-week-2023
EY – stock market activity challenges: https://www.ey.com/en_uk/news/2023/07/subdued-london-stock-market-as-ipo-activity-face-challenges