SMALL CAP SHARE IDEAS: Instem

In a sector where customers are usually valued in the billions, a desire to bulk up is understandable.

To achieve this, AIM-listed Instem is positioning itself as a consolidator of smaller, diverse companies in the fast-growing sector of pharmaceutical services.

The business currently is valued at £150million (at 680p) which by AIM standards is meaty enough but in a pharma sector dominated by such as Pfizer, Merck and AstraZeneca, having a bit more clout clearly would be no bad thing.

Two acquisitions this year already under its belt underline the ambition.

Instem is a consolidator of smaller companies in the sector of pharmaceutical services

Both purchases look classic ‘buy and build’ bolt-ons, adding to the company’s product spread and in-house expertise as well as boosting earnings.

Chief executive Phil Reason says the pharma services market is very fragmented and it wants to do more deals like this.

‘Businesses in life sciences have so many suppliers and so many different solutions that it is a huge opportunity.’

Instem’s core business is a technology suite to speed up the drug development process, something that has become even more important with the onset of Covid-19.

Industry estimates suggest taking a drug from an idea to market can cost between $1billion- $2billion so pharma companies have plenty of incentive to accelerate and so reduce development costs.

Instem’s early stage and pre-clinical data collection and processing software is set up to do just this and demand is growing with the business already generating healthy revenues and profits.

In 2020, a year that was disrupted by the impact of the pandemic across the healthcare sector, sales rose by 10 per cent to £28.2million, with underlying profits before one-off costs rising to £4million from £3.2million.

But it is the two buys this year that will be the platform to take the company to a different level, believes Reason.

The Edge, costing an upfront £6million in March, specialises in early-stage discovery work and will complement Instem’s expertise in pre-clinic and R&D.

D-Wise, bought for up to $31million in April, meanwhile, will expand Instem’s late-stage trial expertise and its position in drug regulatory work.

Reason says that had both companies been part of the group in 2020, revenues would have been £48million rather than £28million.

As important, he adds, is that the acquisitions now give it a breadth of coverage right from the start of the drug development process through to product marketing at the end.

It also gives Instem and each of its individual component parts a greater scale, something that matters to large pharma groups operating in huge sectors.

And there is no doubt that Instem is operating in a big market. Estimates from within the industry suggest currently there are 18,500 new drugs in development, which is roughly double the number ten years ago.

Last year, the number of drugs in Phase I trials or pre-clinic rose by 6 per cent even with the impact of the pandemic.

That presents a substantial opportunity but one that Instem’s progress up to this point suggests it can take advantage. Indeed, its development is now being recognised outside of its traditional areas of operation.

The company recently won its first contract in Korea with a CRO, the groups that carry out clinical trials for pharma groups.

As well as a new territory, Reason says CROs are ideal customers for Instem as they provide a shop window for its services to pharma groups.

Asia Pacific generally is a hot spot currently for drug development, he adds, but traditional areas of strength such as the US and Europe are also going well.

Brokers have pencilled in revenues of £46million this year rising to £56million in 2002 as The Edge and D-Wise bed down.

Other deals though are said to be in the pipeline, so in eighteen months the picture is likely to be very different again.

Instem raised £15million last year to kick start its acquisition programme and might need more cash if the right opportunity does present itself, but the shares have done well recently which also makes its equity a valuable commodity for deals.

Investors liked this year’s purchases for the scope they give to leverage the company’s global infrastructure and sales and marketing capabilities.

More deals are likely to amplify that beneficial effect even more and with Instem growing in confidence as well as scale, this is one to watch.