By
Smith On Stocks
:
Investment Opinion
Trius (
TSRX
) completed an equity offering on Friday, January 19 in which it
sold 6.3 million shares at $4.465. I assume that the Green Shoe of
945,000 shares will be exercised and, if so, net proceeds to Trius
will be $31.9 million. I calculate that the number of shares
outstanding at the end of 1Q, 2013 will be about 46.2 million and
that the cash position at the end of 1Q, 2013 will be $84 million,
which equates to roughly two years of cash burn. At the closing
price of $4.90 on Friday, the market capitalization is $226
million.
I think that management made a good decision. With the cash
position firmed up, investors won't be worrying about an equity
offering after the release of phase III data on its second phase
III trial on which topline data is expected in 1Q, 2013. If the
data is positive like the first trial as I expect, there is no
overhang from an equity offering and there is a clear path forward
to submission of the NDA with probable approval in mid-2014. The
$226 million market capitalization seems modest when viewed against
these fundamentals.
There will likely be a partnering deal if the data is positive.
A further benefit of the offering is that the strong balance sheet
gives an enhanced bargaining position for Trius. They aren't
desperate to get cash from a deal. They will be bargaining from
strength and the terms are likely to be better. I think that a
partnering deal for commercial rights in Europe and possibly some
rights in the US might bring in an upfront payment of $50 million
or possibly much more bringing year end cash to $96 million plus.
In addition, a partner would likely pick up a big part of the costs
of developing tedizolid in pneumonia, bacteremia and other
indications thus reducing the $12 million quarterly burn rate.
The stock closed at $5.23 on Thursday, January 28th, and after
the announcement that the deal was done at $4.465, the stock
subsequently closed at $4.90 on Friday, which was encouraging. This
equity offering has done a lot of de-risking of Trius for the
remainder of 2013. The one major worry is that the second phase III
trial will fail. However, if the data is positive as I expect, it
seems like there will be clear sailing for the rest of the year.
Investors can look forward to no more capital raises, a partnering
deal and submission of the NDA. There will be a strong wind at the
company's back for the balance of the year. I see the stock trading
up into the $7+ area in 2013 with the terms of the partnering deal
being the major determining factor. Investors will then begin to
focus on the potential for tedizolid after approval, which I expect
in mid-2014.
Why Now?
I think that this offering surprised Wall Street as most
investors expected the company to issue shares after the
announcement of topline data from its second phase III trial that
is expected sometime in 1Q, 2013. This was based on the assumption
that the data would be positive and the stock would react
positively.
So why did the company choose to do the deal prior to the
announcement of topline data? Some message board chatter suggested
that the company somehow had lost confidence or knew that the data
in the second trial would be disappointing and the stock would
plunge. I reject this idea because the trial is blinded and
management cannot know the results. Moreover, if management did
somehow know that the results were negative, this would be a
material event that would require the issuance of an 8-K.
Why move before the announcement of data? The major challenge to
an emerging company like Trius is demonstrating in well controlled
trials that its product is safe and effective and to also create
the clinical and economic reason for hospital formularies to pay
for it. Nearly as important as the clinical data is the maintenance
of a strong cash position. Small biotechnology companies live in a
hostile environment for raising equity through traditional share
offerings. There is a feeling among some investors that issuing
equity and creating more shares dilutes current shareholders and is
bad. I find many managements afraid to issue shares because they
fear that investors will see the offering as dilutive and sell
their shares and some hedge funds routinely short into announced
deals.
Managements usually wait for some catalyst that they anticipate
will drive the stock higher and finance at that time. There are
risks with this strategy beyond the obvious one that the event
(usually clinical trial results) is disappointing. The first is
that investors expect companies to do this and the stock often
trades down even in the face of positive data. The second risk is
that the company may allow its cash balances to decline to the
point that investors know that it has to finance, and this can
result in buyers in the deal exacting harsh terms.
Trius has a relatively high current quarterly cash burn rate
that averaged $12 million in the first three quarters of 2012.
Trius has been aggressive in keeping its cash balance strong, but
this is a big enough burn rate that if the company is not careful,
it could find itself in the position of having to finance at a time
of weakness. The company has kept its cash position substantially
above the one year of cash burn at which investors usually perceive
weakness.
The company raised about $52 million in 1Q, 2012 bringing its
cash balance at the end of the quarter to $97 million. In August
2012, it signed up for a committed equity financing facility from
Terrapin Opportunity Fund for a total commitment of $25 million. It
executed a drawdown on this facility of $3.4 million in September
and another of $5.0 million in December. If well executed, an
equity line facility is an efficient and unobtrusive way of raising
capital and I think that management felt this might be the best way
to raise capital and could possibly avoid the disruption and
significant discounts that come with a public offering. However,
these drawdowns were not well executed and resulted in noticeable
pressure on the stock that caught the attention of investors who
then began to fear that subsequent drawdowns would also result in
stock pressure. The equity line facility became a cloud over the
stock.
I think management came to view this equity line as not being
right for them and they decided against drawing down the remaining
$16+ million from the facility. They appeared to lose confidence in
the ability of Terrapin to execute drawdowns without pressuring the
stock. Management still needed to bolster cash positions and its
only viable option was a public offering, but the next question was
when to do it. Why do an equity offering now rather than wait for
the second phase III trial results?
I think there were two reasons for moving quickly. The first is
that the company did follow the usual strategy of doing an equity
financing after the successful completion of the first phase III
trial. However, investors had anticipated an equity deal, and
despite the positive trial results, the financing issue was
dominant and the stock traded down. Management feared a repeat
after the release of the second phase III trial results.
The other concern for management is the chaotic political
situation in Washington in which raising the debt ceiling is in
question. While the odds seem very high that the debt ceiling will
be raised, we have to admit that politicians from parties are
extremely dysfunctional and that some turn of events could lead to
no increase in the debt ceiling. This could create utter chaos in
the capital markets and might lead to a position in which the
company would have about $52 million of cash on its balance sheet
at the end of 1Q, 2013, which is barely a year of cash burn. The
company might still be perceived as financially weak and a
financing might not be doable only so at very onerous prices.
Management did not want to run this risk.
My View on Equity Offerings in General
There is more often than not a kneejerk reaction to equity
offerings that essentially can be summarized as believing that any
issuance of shares dilutes existing shareholders and is
unequivocally bad. This creates a problem for emerging
biotechnology companies that must spend great amounts of money
researching and developing their products for years before they are
approved and come to market thus incurring large negative cash
flows for several years. They have no choice but to raise money on
a periodic basis. If everyone were to accept the argument that
equity offerings are dilutive and therefore bad, the ultimate
outcome would be that a biotech company would either partner its
product or simply operate until it runs out of money and then shut
its doors. The latter is obviously absurd.
To be a little more precise, biotech companies might also have
the option of seeking someone to acquire them, but this is a
relatively rare event. They could also try to fund themselves
through grants. For the purist non-diluters out there, this is
really the only true form on non-dilutive financing, but grants are
usually not available to a company and almost never can be more
than a supplemental source of funding.
Partnering is looked at as good because it is assumed that not
issuing shares is non-dilutive. However, I think that partnering
can be a highly dilutive form of financing as the licensor may lose
much, usually more than half, of future profits to its partner and
runs the risk of losing control of the development of its drug to a
less committed partner. I have seen a lot of biotechnology
companies suffer severe economic damage as a partner lost interest
when clinical development difficulties arose as they so often do
during development.
Let me suggest that investors take a balanced view on financing
a biotechnology company. The first thing to understand is that
options other than grants result in other investors now having a
call on the company's future profits either because new shares are
issued or future profits must now be shared with a partner.
However, existing shareholders can benefit because without these
new stakeholders the company would fail and the value of all shares
is zero. The new money invested can provide great benefit for
existing shareholders as it allows the completion of programs that
can pay high rewards. Think back to Amgen (
AMGN
) and Epogen. If Amgen had not partnered Epogen with Johnson &
Johnson (
JNJ
) and raised money through timely secondary offerings, there would
undoubtedly be no Amgen today.
Going into almost any emerging biotechnology investment, the
investor has to understand the reason why management is bringing
new stakeholders into the company. There are situations where
partnering or electing not to raise money through public offerings
can be bad. Conversely, share offerings and partnering can
sometimes be good. It is all about the use of the proceeds and the
timing. An equity offering is good if ultimately the return on
investment to existing shareholders is increased (even though there
are more shares) through allowing clinical development to continue
or finish and to commercialize a new product. The goal of any
company is to issue the fewest number of shares possible and retain
as much control of future profits as possible.
Failing to issue shares to allow for the development of a
promising product can be catastrophic. Investors have to consider
equity offerings in the context of timing and reason. Based on this
line of reasoning, I see the Trius offering of January 19th as a
positive for existing shareholders. In my mind, managements must be
first judged on their choice of products to develop and their
clinical development plans. This is the science part. However, how
management elects to finance its operations is almost as important.
Some managements are very good and some are not so good. I think
Trius management is very good financially.
Disclosure:
I am long [[TSRX]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
See also
Coming Soon: More Losses At Clean Energy Fuels
on seekingalpha.com