Two interesting but very different stories from the closed-end fund universe here in London this week.

The first concerns aircraft leasing. There’s currently a bevy of specialist funds on the London market involved with leasing out mostly large (A380s) planes to long haul airlines. It’s an interesting income-based diversifier but many of the funds have been hit by concerns about the future resale value of the A380s in the fleets.

Now we can add another concern – lease renegotiations. Some of the airlines – not Emirates, the biggie – have their issues at the moment, namely that they are losing money. This is particularly a concern with Thai and Norwegian. DPA – one of the funds with a more diversified set of assets – has both these airlines as customers. And in both cases, it seems as the original leases struck with the airlines were very attractive.

Or at least that’s the view of Matt Hose of Jefferies, who’s been keeping a close eye on this specialized space. One of his reports earlier this week started to put some numbers on these leases. According to Matt…

“For 787-8s we understand this currently ranges from $8m to $12m p.a., depending on the age of the airframe. By comparison, DPA receives $14.9m p.a. for each of its two 787-8s leased to Norwegian Air, and $13.7m p.a. for each of its two 787-8s leased to Thai Airways. The two sets of aircraft were delivered in 2013 and 2014 respectively and so are among the older 787s in operation. Our base case is, therefore, to take the mid-point of the current lease rate range at $10m p.a. but test lease rates as low as $8m p.a. Crucially, we also assume only a single airline’s leases are renegotiated”

The two tables below sum up the impact of a renegotiation of leases with one (or both) customers.

Exhibit 1 – DPA scenario test of Norwegian Air renegotiated leases

Exhibit 2 – DPA scenario test of Thai Airways renegotiated leases

The good news is that the financial structure of both funds seems to be secure at the NAV level after gearing. According to Matt, the leases would have to go below $8m per aircraft before we’d have problems with leverage. The bad news is that the dividends might be badly hit. If we see new leases taken out at $8m per aircraft the net dividend yield falls to between 3.7% and 5.2%.

Private Biotech

A new biotech fund came to the market last week – its called the RTW Venture fund and it is focused on investing in earlier stage, largely private biotech and medical equipment businesses. This is, I think, a very interesting space but I’m not sure anyone else shares my curiosity. According to Numis, this new fundraised just $14.97m through the issue of 14.4m shares at $1.0397. Numis reckons the fund had intended to raise up to $350m – the fund will have a 14.4% free float on admission.

The good news is that the fund had already raised funds from other investors and so at launch with will have net assets to c.$168m at launch, including cash and seed assets rolled over from existing shareholders. The shares will start trading on the Specialist Fund Segment of the LSE on 30 October under the ticker “RTW”.

According to the prospectus, the fund will invest one-third of its capital in early-stage businesses and two-thirds of its capital in later-stage ventures, with an 80/20 split between biopharmaceuticals and medical technology. “Each investment is expected to be between 5-10% of gross assets at the time of the investment, with a maximum portfolio company exposure of 15% of gross assets, except for 30% in the case of Rocket Pharmaceuticals”.

Positives for the fund include:

  • The fact that key personnel have invested a load of their own money (over $26m)
  • A decent track record. “ RTW Investments has invested in 28 private companies to date, leading six of the 12 transactions in 2018 and four of the nine transactions closed in 2019. Of the 11 companies that have had monetization events, the average investment duration was 1.4 years, the average gross extended IRR was 322% and the average gross multiple of capital contributed was 4.7x. The Investment Manager has produced public-private annualized returns of 29% from 1 March 2009 to 31 August 2019”
  • The fees charged also aren’t that terrible given the highly specialist nature of the fund. Management fees are 1.25% pa of net assets. There is a performance fee of 20% of NAV growth, triggered if returns are in excess of an 8% pa hurdle. 50% of the performance fee is payable in shares, which are subject to a six-month lockup.

The obvious downside is the investment cycle. To say that we are quite possibly late in the growth company cycle is an understatement of the century. There’s also the small matter that a certain Mr. Woodford has also been investing in earlier stage biotech businesses and not exactly covered himself in glory – although to be fair the team behind this fund are clearly sector specialists. I can’t quite see why anyone would invest in this fund at the moment. Over the longer term, there are profoundly good reasons to focus on earlier stage biotech businesses…just not now. My hunch is that this will be seen as subscale and the shares will drift to a discount in the next growth company/biotech sell-off – which is inevitable in the next 12 months. At that point this fund could be a great contrarian bet.

Seed Assets and Pipeline Assets