Stock版 - Biotech financing (ZT) |
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发帖数: 335 | 1 Financing Options for Small Biotechnology Companies
If you are an investor in biotechnology companies, periodic financings are a
fact of life and necessary for the company to survive and be successful.
Nevertheless, there is a belief among some investors that anytime a Company
raises money through issuing shares, it dilutes and harms existing
shareholders. However, issuing new shares is not always a bad thing for
existing shareholders. The willingness of new investors to put money into a
company to allow it the financial strength to continue to develop its
products and can enhance value for existing shareholders
Management faces an ongoing challenge of keeping a Company well-funded.
Other than through partnering, the issuance of straight debt or receiving
grants, the Company has to issue shares that increase share count. The key
for investors is to assess that the Company is using the appropriate mix of
financing instruments and is timing share offerings and partnering at
optimal times and from a position of strength. Analysis of this is only
slightly less important than understanding products under development. The
goal for management and shareholder is to finance the Company through
issuing the least number of shares possible and to maintain as much rights
to its products as possible.
I can't list all of the financing options that are available for emerging
biotechnology companies, but let me go through the ones that are most
frequently used and that I am most familiar with. These are traditional
underwritten equity offerings in which stock is sold through investment
bankers; shelf registrations; partnering; grants; at the market equity lines
(ATM) or other forms of equity lines; convertible debt; and straight debt.
Let me discuss these.
Traditional Underwritten Equity offerings
This is the most frequently used form of financing, but it is also the one
that can be quite onerous for small companies. There is an interval required
for marketing the deal from when it is announced to when it is closed which
can be a problem. The deal announcement can lead to shorting by hedge funds
who know from experience that natural buying dries up in anticipation of
the stock offering. They also know that the market capitalizations of small
biotechnology companies often are not large enough to interest large
institutions. This means that there are a small number of potential buyers
and the aforementioned hedge funds may be the major players in closing the
deal.
Buyers often have the leverage to demand a significant discount to the
recent price, which is probably already down from the time when the offering
was announced. To top it all off, the underwriters usually take a 6% or
more commission on the offering price. When all is said and done, the price
received by a company can be 15% to 25% below the price at which the deal
was announced or even more. In the more difficult to sell deals, buyers
often demand warrants that may amount to around 50% of shares issued. The
deck is really stacked against emerging biotechnology companies.
The earlier a company is in the stages that begin in the pre-clinical
setting through phase I to phase II to phase III to regulatory approval to
market launch, the more likely it is that it will have to do an underwritten
equity offering and at terms like those described in the previous paragraph
. Also, missing on a clinical milestone or having a regulatory setback can
also force a company into this type of stressful offering. Traditional
underwritten equity offerings can work well for later stage companies that
are meeting milestones, who have established proof of concept and whose
product is viewed to have promising commercial prospects. For smaller
companies or those who have suffered a clinical setback, this can be a
punishing exercise.
Shelf Registrations
Shelf registrations are a type of public offering that allows a company to
sell multiple offerings to the public based on just one prospectus filing.
As an example, a company might elect to file to sell 20 million shares, $50
million of convertible notes, $50 million of bonds and 20 million warrants.
Off of just one registration statement, the company is allowed to sell any
combination of these financing instruments over a period of years.
One important advantage of a shelf is the ability to negotiate in private
with one or a small number of buyers. A stock or other form of financing can
be executed without announcing the proposed transaction until buyers have
committed and this avoids the short selling during the marketing period that
often causes a meaningful price decline. This can often be a better
alternative for companies than underwritten equity offerings, but not all
companies are eligible.
At the Market (ATM) and other Equity Lines
These can be a very favorable form of equity financing for small
biotechnology companies and are my favorite method of selling equity. Let's
look at how an ATM works. The ATM provider will agree with the company to
sell a set amount of shares over a period of time. The company can determine
when and at what price the shares are sold; the company can decide to sell
on any given day without announcing it to the public. For example if the
stock is trading at $3.00 bid and $3.05 asked, the Company might tell the
ATM provider to sell a certain number of shares at $3.03 or higher; no
shares can be sold below that price.
The discount is usually on the order of 2% to 3% as opposed to 6% or more
for underwritten deals. Because there is no pre-announcement to the public,
there is no pressure on the stock in anticipation of shares being sold and
since the shares are being sold in the open market, there is no further
discount to induce institutions to participate. And of course, there are no
warrants. If you consider the discount for a traditional equity offering to
be the difference in the price from the announcement of the deal to the
pricing, the discount can be on the order of 10% to 25% versus 2% to 3% for
an ATM.
The one drawback of an ATM is that the company must have good trading
liquidity and it takes time to raise significant amounts of money. Usually,
an ATM can sell about 15% of the shares that trade daily without affecting
the stock price. Let's think of a $5.00 stock that trades 500,000 shares per
day. They could raise about $400,000 dollars per day (this is $5.00 x 500,
000 x 15% of daily trading volume). Over the course of a quarter in which
there are roughly 66 trading days, this Company could raise $9 million by
executing the ATM on one of every three trading days. To see how this might
work for a company you might be interested in; you can do the math by
plugging in share price and average daily trading volume. ATMs require
companies with liquidity, for less liquid companies other versions of the
equity line may be more suitable. These usually require the provider to hold
some of the purchased stock in inventory unlike ATMs.
ATMs and equity lines work especially well when there is a major catalyst
that drives up the stock price and trading volume. Let's look at an example
of the hypothetical company with a $5.00 stock price that announces
extremely good news that cause the stock to surge to $10.00 and trades 2,000
,000 shares per day; not an infrequent event. Using the ATM, this company
could raise $3 million in a single day ($10.00 x 2,000,000 x 15% of daily
trading volume) with a 2% to 3% discount. This underlines the great
advantage of the ATM that it can be implemented on same day notification
that allows the stock to be sold at a time when the market is receptive to
buying the stock. I think that every emerging biotechnology company should
have an ATM or equity line.
Partnering
I often hear investors say that partnering is a non-dilutive form of
financing because no shares are issued. It is true that partnering avoids
the issuance of shares, but this doesn't mean that it is not dilutive. The
partnering company is giving up a large share of future sales and profits
for the geographic region in which the product is partnered.
As a rule of thumb, the acquiring company gets 50% of more of sales and
profits. Let me make up an example to show how dilutive this can be. Let's
say that a product in partnered in year one for $100 million, that the
company gives up 50% of future sales and earnings. Let's then hypothesize
that the product five years later has sales of $300 million. The market
might value this product at five times revenues so that its value is $1.5
billion. In this case the partnering company receives $100 million
immediately and gives up $750 million of value five years later.
Some investors immediately proclaim that a partnering deal is good for
shareholders, but I think that you can see that it has its own form of
dilution. Moreover, the partnering company may give up control of
development to a larger company that could let the development flounder if
problems develop or it becomes pre-occupied with some other project.
Partnering is the best option if the company does not have the financial
resources or infrastructure to develop a product. It is often the case that
partnering a product in foreign markets is by far the best or only option
for a small company.
Grants
Grants from governments or other institutions are the only truly non-
dilutive source of capital. However, the amount of money received in this
manner is usually relatively small and can only be a supplementary source of
capital.
Convertible Debt
Companies sometimes issue convertible bonds in an effort to reduce share
dilution. Let's take the example of a Company with a $5.00 stock price. Let'
s hypothesize that it is able to sell a $100 million convertible bond issue
with a ten year maturity at a 5% annual interest rate and that the debt is
convertible into common stock at $6.50 per share. If all goes well and the
stock is at or above $6.50 in ten years, the $100 million can convert into
15.4 million shares (at $6.50). This would compare to 20 million shares if
the stock were sold at $5.00 per share to raise $100 million. There is also
the added cost of $5.0 million of annual debt service.
There are investment funds that concentrate on buying convertible notes and
that use a hedging strategy. Let's say that such buyers purchase the entire
$100 million convertible bond offering. Their strategy is to then short the
stock, selling 15.38 million shares (I'll explain the 15.38 million shortly)
at the current price of $5.00. The shorting results in $76.9 million of
cash so that their net exposure is $23.1 million ($100.0 million less $76.9
million.) Throughout this report, I ignore transaction costs, the time value
of money and the probability that the note might be callable in order to
reduce the complexity of the calculations.
In the situation in which the stock goes up and surpasses $6.50, regardless
of how high the stock goes, they can ultimately cover their short position
of 15.38 million shares by converting their $100 million of convertible bond
holdings into the identical 15.38 million shares. They also will receive $5
million of annual interest payments as long as they hold the bonds. The $5
million of interest payments could cover their $23.1 million exposure in 4.7
years. Over ten years, they would receive $50 million of interest payments
versus their investment of $23.1 million.
If the company were to fall on hard times with say the stock dropping to $2.
00 at the end of ten years, the short position established at $5.00 could be
covered in the open market and would be worth $46.1 million. However, the
company would also owe the buyers $100 million to repay the debt and the
bondholders continue to get $5 million of annual interest payments. In this
scenario, over a period of ten years, bondholders could receive a profit of
$196 million; this would be $46.1 million for covering the short position
plus $100 million for the debt repayment plus $50 million in interest
received. This would be a massive win for the convertible bond holder.
From the standpoint of the Company and shareholders, this can be a very
cheap source of capital if the Company executes on its strategy and the
stock rises quickly to above the conversion price of $6.50. In the short
term, it is bad for shareholders because as the bondholders establish their
short positions, it puts pressure on the stock. If the company fails and the
stock remains below $6.50, the convertible debt become the equivalent of
standard debt and is a massive overhang on the company. In this example in
which the stock drops to $2.00, the company might have to issue 50 million
shares at $2.00 to repay the $100 million of debt.
Issuing convertible debt allows no room for setbacks and if they do occur,
there can be disastrous consequences for the company and shareholders. I do
not like the risk profile on this financing instrument. This is the
situation that Dendreon (DNDN) now finds itself in.
Straight Debt
Increasingly, small companies are turning to venture debt for financing.
This avoids the issuance of shares and may or may not have warrants. This
financing is fine if the Company anticipates that the debt can be used to
bridge between milestones. For example, let's say that the stock of the
hypothetical company I have used in previous examples is selling at $5.00,
but that it thinks that a milestone that may occur in a year could double
the stock price. It might elect to postpone an equity offering until the
milestone is reached and use venture debt for interim financing needs.
I think this is a very risky financing strategy and one that I don't like.
If it works as planned, it can reduce the number of shares that need to be
issued. However, a major problem arises if something goes wrong as so often
happens in biotechnology such as a clinical trial setback or a regulatory
issue and the stock declines. This could force the company into issuing
shares (at a lower price) for both operational needs and to retire the debt.
Equity Offerings Can Be Good for Existing Shareholders
This is clearly illustrated by a recent financing of Trius (TSRX). The
Company announced an equity deal on January 18 2013. The closing price on
the day of the offering was $4.90. As investors realized that this deal
meant that the company was now well funded to take its lead product
tedizolid through product approval in mid-2014 and was in a strong position
to bargain with partners, the stock has performed very well. At the latest
closing price of $7.95, the stock is up 62% since the offering. See my
report on the financing.
I think that it is in the interest of shareholders that a company
incorporates all of these financing options in its strategy. The goal is to
always keep the company in a position of financial strength. It is an
unavoidable fact of life that biotechnology companies will have to raise a
great deal of money and issue shares or partner to do this. The goal is to
issue the fewest number of shares possible and to give up minimal product
rights to a partner. | s*******t
发帖数: 335 | |
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