Last year, while browsing on Aim for a target company to reverse-merge his business into, Dubliner Gerry Brandon spotted something interesting.

The potential target company was called Integumen. It was a disaster of a business, with the distinction of being the worst-performing Aim flotation in 2017. By mid-2018 it was as good as dead, with a market cap of £1.2 million.

Integumen listed as a loose collection of skincare products and lab science. The idea was that some of the skin products were ready for the market, others were still at R&D stage, and that somehow the thing would hang together. It did not.

Brandon’s own company was called Cellulac. The reverse takeover manoeuvre was a way to get Cellulac listed on Aim without the expense and effort of an IPO.

Normally in a reverse takeover, the old listed business gets wound down and discarded. But when Brandon was sizing up Integumen, he spotted something interesting among its grab bag of products and IP. 

Integumen owned a product called Labskin. Labskin is an artificial skin product, developed over many years at York University. The artificial skin — which is literally cloned from human skin cells, and looks just like your own skin — is used for testing purposes.

Brandon saw potential in Labskin. Years before, he’d started a wound care company called Alltracel, which he’d been able to sell for €31 million in 2008. So he had experience in testing and marketing skin products.

Excited by Labskin, Brandon bought Integumen outright. He fixed up its balance sheet by disposing of its non-performing products, clearing £2 million of debt and a litigation liability — it’s now down to £500k of debt, or 3.1% of market cap. He brought in his long-time business partner — and fellow Dub — Camillus Glover, and set about implementing a new strategy. 

Today the company has a market cap of £16.9 million — up 1252 per cent from the low in October. It’s valued at an eye-watering 16 times sales (by comparison a mature business might be valued at two times revenues; a very-exciting startup might be valued at eight times). 

Same product, different customer

The big idea was to sell Labskin to a different type of customer. 

Previously Labskin been sold to R&D labs for around £1,500 a pop. Instead, Brandon wanted to position it as a marketing service for a much higher — and recurring —price of about £50,000.

The reasoning went like this: skincare companies want to make big claims about the scientific properties of their products. That’s because, when a customer sees a proven scientific claim on the side of a moisturiser, they’re much more likely to buy.

But as Brandon knew from his Alltracel days, getting the evidence you need in order to make a claim on the side of a moisturiser is not easy. It requires trials, test subjects and lab equipment. A test of this kind might cost £200,000. 

The bottom line is that Labskin lets companies run their tests on skincare products much more cheaply than £200k. The results stand up scientifically. Which means the marketing department can make its claim and sell more moisturiser. And no animals need be harmed in the process. 

Thus a £1,500 testing kit for R&D labs was turned into a £50,000 marketing service.

Bugs and data

So how does Labskin work? It has two special properties. The first is that Labskin is the only lab-grown skin product on which you can grow bacteria, viruses and fungi. That’s important because your skin is alive with trillions of these things (they’re part of what’s called the microbiome). They’re critical to your health. And many products target the microbiome directly.

The other special property of Labskin is to do with data. 

As we’ve seen, Labskin was spun out of research at York University. It was developed there over many years, where it was used in over 38,000 experiments, and in more than 30 published scientific papers. 

Each of those 38,000 experiments generated data. Labskin owns all that data. And the data is what makes Labskin valuable.

The data is valuable because a customer can take, say, 100 samples of physical Labskin. They can use the samples to run a study on their moisturiser. And when the results are in, they can remotely plug into Labskin’s system, and compare their Labskin test results to the database of 38,000 previous Labskin test results. This means less trial and error, which gets the results more quickly, and ultimately gets the moisturiser on the shelves faster.

Labskin uses machine learning to help customers run the experiments. This sounds fancy, but all it means is that Labskin uses computer algorithms to look for useful patterns and anomalies in the data. All in service of running tests more quickly.

From a physical to a digital product

So the value in Integumen is Labskin, and the value in Labskin is in its database of 38,000 previous test results. 

The challenge for Integumen was scaling up — finding a way to serve lots of customers without massively raising costs.

That’s why in April it acquired a Cambridge University spinoff called Rinocloud. Rinocloud was founded by a Corkman named Eoin Murray. (His father Fionán Murray had been managing director of Rinocloud. An experienced salesman, he’s now Group Sales Director at Integumen.) 

Rinocloud provided the key piece of technology that allows Labskin to be offered remotely as a digital service, rather than in-person as a physical service. This lets it be potentially scaled up to thousands of customers.

What Rinocloud does is take data from any piece of lab equipment capable of digital output and turn it into a uniform, user friendly visualisation. It’s a software layer that brings the outputs from different lab equipment together in a uniform way. Before Rinocloud, there hadn’t been a way to do this.

And — as a sidebar — that’s interesting because it has allowed Rinocloud build a sort of Airbnb for lab equipment. Lab equipment at the Integumen lab, University College London, Newcastle University, DCU, and others are all plugged into the Rinocloud system. If a customer wants to run a test, they can just fire up the Rinocloud network and run the test remotely on a lab in Newcastle, UCL or wherever. Integumen acts as the middleman. Like Airbnb, it takes a cut from bringing the customer together with the supplier. 

But in any case, the main strategic rationale for buying Rinocloud was to do with Labskin. Rinocloud allowed lots of customers to plug into the Labskin data sets and run their experiments cheaply.

Three tailwinds

Repositioning Labskin as a high-price, low volume service was an important part of Integumen’s comeback. But Integumen has also benefited from a couple of tailwinds. 

The first is rule 2017/745: 21. Passed by the EU in 2017, it says “tests are now required for substances intended to be introduced into the human body via a body orifice or applied to the skin and that are absorbed by or locally dispersed in the body”. In other words, every product that interacts with the surface of the body sold in the EU — be it a shampoo, tampon, skin cream, nasal spray or cue tip — needs to be tested for safety. Companies have until 2020 to comply. This has created a boom in skincare testing.

The second is EU rule 1223/2009 — the ban on animal testing for cosmetics products. This one came into force in 2013, and it has helped build the market for Labskin and other artificial skincare products.

The third tailwind is something called CBD, or cannabidiol. Cannabidiol is a chemical produced by the cannabis plant. It has a number of notable properties. One, it doesn’t get you high. Two, it’s a natural anti inflammatory with a wide range of potential health applications. Three, for the last two years there’s a stock market mania for anything to do with it. 

Companies are looking to infuse everything and anything with CBD. It’s in smoothies, cocktails, beer, skin creams. Some of these companies are coming to Integumen for testing. Just last month it announced it had tested Daye, the world’s first CBD-infused tampon. 

Integumen is a picks-and-shovels play on the CBD craze — ie, it’s complementary to it. The company happy to benefit from CBD, but it’s not the main focus. And looking at Integumen’s share price over the last six months, it’s very possible that it’s been pumped up by the crazy boom in cannabis stocks. 

What’s it worth?

Integumen then: interesting technology, smart strategy, at a good time to be in the testing business.

But as we’ve seen, the company has a market cap of £16.9 million, up 1,252 per cent in nine months. Where has this valuation come from?

Well, it’s certainly nothing to do with profits. It looks like Integumen is at least two years from turning an EBITDA profit, and at least two years from turning cash flow positive. 

The £16.9 million market cap figure is derived entirely from Integumen’s revenue growth in the last 12 months. I’ll go into the revenue numbers in a bit of detail here, because they’re really the only way we have to value the company.

In the first half of 2018, before the takeover, Integumen did £70,000 in revenue. Things started to change in the second half of 2018, when it did £210,000. A big improvement, albeit from a tiny base. Then in the first half of 2019, it did £524,000. That number is made up of £346,000 like for like sales, as well as an extra £178,000 chipped in by the new Rinocloud acquisition.

So Integumen grew revenues 200 per cent in the second half of last year, and a further 149 per cent in the first half of this year. That’s the trajectory. And that’s basically all stock market investors have to work with. Three sets of revenue numbers and an interesting story about Labskin.

You can project those revenues forward and come to a 2020 revenue forecast of anywhere from £1 million to £7 million, depending on how optimistic you are about Labskin sales.

If the company were to make £7 million in revenue in 2020, its current £16 million market cap (which, by the way, is about the same as its enterprise value) would mean it’s valued at 2.7 times 2020 revenue. Which would make it steal at today’s price. If the company were to get to £7 million revenue in 2020 it would have grown astonishingly quickly, and would be deserving of a multiple of anywhere from 7-12 times sales. Which gets you a highly speculative market cap of £49-84 million.

On the other hand, were Integumen to make £1.5 million in revenue in 2020, it would be currently valued at 12.7 times market cap. That would not be good. The share price would take a serious hit. And were the company to have a slower second half of the year, or god forbid stop growing, the share would be wiped out. To merely to justify the current share price — ie for it not to rise or fall in value — I estimate Integumen will need to make somewhere between £2 million and £2.5 million in revenue in 2020. 

I know, this is all very imprecise. But that comes with the territory. I’m guessing not just Integumen’s sales in 2020, but also about its future profitability and business model.

The company expects to grow into a software-as-a-service type model. That makes sense, based on Integumen’s product and strategy. Successful SaaS businesses would typically have 75-80 per cent gross margins, 15-20 per cent R&D spending, and all going well, 20 per cent net margins and decent cash flows. In other words, there’s a ready made, profitable business model there for it to pick up. The question is back to how much revenue it can bring in this year and next.

We have a few clues. The first is that Integumen has, twice this year, had to increase its lab capacity. Lab space is up 100 per cent on last year, and is already close to full capacity. 

Another clue is that four of the world’s top ten biggest skincare brands have signed on as customers this year. This should mean repeat business, since big skincare companies are permanently spending on R&D. And it could mean further big skincare customers on the way.

And the last clue is, simply, that Labskin is forecasting further revenue growth in the second half of 2019. 

Unanswered questions

How might things go wrong? Well, Aim stocks tend to fail in the same way. First they show promise, often based on a unique new product or service. Then they have trouble turning the product into into tangible sales and cash flows. Then they place shares on the market in order to raise money and keep the show on the road. And on and on. 

That’s the very position Integumen was in 12 months ago. Could it happen again?

The under-new-management Integumen has, indeed, already raised money from Aim this year. It raised £2.75 million to  fund its growth back in April. Most of that is already gone — it has just over £1 million in cash at the most recent update — so in a year’s time it might come back to the market for more money. But that’s not necessarily a bad thing. Fast-growing companies often burn through cash on their way to becoming established, mature and profitable. The key questions is whether the company is raising cash to grow or merely to stay alive. And don’t expect a dividend any time soon.

It’s an appealing idea — Integumen knitting together the world’s scientific community, and making a fortune in the process. And the company is happy to talk up this prospect.

Another risk is over intellectual property. What’s to stop a competitor from copying Labskin? After all, it’s not patent protected. I asked Gerry Brandon this, and he stressed that the value in Labskin isn’t in the skin technology itself. Instead he says the value is in the data, the 38,000 experiments. The ability to compare new samples to the existing database is why Labskin is useful to companies. 

Then there’s Rinocloud, and this “Airbnb of lab equipment” idea. Right now, the Rinocloud system is solely being used to run Labskin tests. But in theory, it could be opened up to any kind of test. 

Customers looking to access lab kit on demand could plug into the Rinocloud network, run their tests and extract the standardised data. Universities could get some extra money for the use of their idle equipment. And Integumen could  get paid as the middleman. 

It’s an appealing idea — Integumen knitting together the world’s scientific community, and making a fortune in the process. And the company is happy to talk up this prospect.

But I would caution any investor not to get excited about the Airbnb of X or the Netflix of Y. 

There are many pretenders to the title of Airbnb of X. But getting established as the dominant middleman in a two-sided market, as Airbnb has done, is incredibly hard. It takes a huge marketing / customer acquisition push. And a single minded focus. 

Integumen doesn’t have a single minded focus on becoming the Airbnb-of-labs. First and foremost, it’s the Labskin company. For Integumen, the lab equipment on demand business is a sideshow. That’s why I’m skeptical it’ll ever be a big business for them.

Long-odds

So in the end, where do I come down on Integumen?

First thing’s first — they’re not the chancers you often uncover at the bottom of Aim. Gerry Brandon and his team have a strong track record of delivering for shareholders (Alltracel was ultimately acquired at a 51 per cent premium to the share price). Their strategy makes sense. And they’re beginning to execute on it.

Cash burn is, if anything, likely to increase this year as Integumen invests in new production. I’d expect an equity raise next year to plug the gap.

As for the product, I understand Labskin well enough to understand why a company might pay to use it, but frankly I don’t know whether it’s going to be a cash cow years from now. It’s too complicated to be certain. Maybe Integumen are right, and their database of results gives them an enduring strategic advantage over the competition. Or maybe Labskin will be obsolete by 2022. 

For now, the proof I need is the sales growth, particularly sales to big skincare companies. And on that front, I’m cautiously optimistic about Integumen. I know from other software as a service business that once you get established as a customer of a big enterprise, the cashflows keep on coming in. Revenues from new customers accumulate on top of revenues from existing ones. And because Labskin is scaleable (thanks to Rinocloud), additional revenues should drop to the bottom line.

Integumen will be needing more capital. It has £1.08 million in cash, and it burned £1.26 million in operations last year. Cash burn is, if anything, likely to increase this year as Integumen invests in new production. I’d expect an equity raise next year to plug the gap.

I’m — speculatively — forecasting £3.5 million in sales for 2020. Times a growth multiple of 10x sales gets a market cap of £35 million. That’s more than double today’s £16.9m. I don’t need to remind you it’s risky. But I have a feeling there’s something there.