Friday, April 21, 2017

Innocoll Holdings: PE Buyout, Big CVR Attached

Innocoll Holdings (INNL) recently agreed to be acquired by Gurnet Point LP, a healthcare investment fund headed by Sanofi's former CEO Christopher Viehbacker and backed by billionaire Ernesto Bertarelli's family office, for $1.75 per share plus up to $4.90 per share in contingent value right ("CVR") payments.  The CVR has several milestones based on the approval and commercial success of Innocoll's drug/device Xaracoll which is a biodegradable implant that delivers bupivacaine to provide non-opioid acute pain relief for several days post surgery.  During surgery, Xaracoll is implanted near the incision to provide an initial burst of bupivacaine followed by a slower sustained release that delivers pain relief over 72 hours, and since its biodegradable, it doesn't need to be removed and instead dissolves in the body.

Prior to the buyout offer, Innocoll was troubled and near insolvent.  In 2016, the company pulled the plug on their previously touted Cogenzia (for treatment of diabetic foot infections) after studies failed to show it was effective.  Then late in the year Innocoll experienced another set back when Innocoll received a Refusal-to-File letter from the FDA for Xaracoll causing the stock price to drop roughly 60% in a day.  According to the company, the Refusal-to-File was mostly clerical as the FDA considers Xaracoll a drug/device, not just a drug, thus requires additional information/studies to be performed before the FDA could take it under full consideration for approval.  However, Innocoll didn't have the cash to fund additional studies and was forced to either raise capital or find a buyer, Innocoll found a buyer.

The specifics of the CVR Payment Events:
  • First CVR Payment Event: Gurnet Bidco will pay $0.70 in cash per CVR if on or before December 31, 2018, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following open abdominal Hernia repair
The first payment event seems like a low hurdle, they ran a successful phase 3 trial for postsurgical pain following open abdominal Hernia repair, it seems reasonable that once the paperwork is in order, the FDA will approve it.  Innocoll's only other potential pipeline product is CollaGuard which prevents post-operative adhesions, CollaGuard's potential commercialization is farther out and the addressable market appears smaller than Xaracoll (there are over 1MM Hernia repair surgeries annually in the US).  Often the drug or asset contemplated in the CVR is a secondary asset that the seller believes in more than the buyer, but here the CVR is referencing the primary remaining asset of Innocoll and the deal structure appears to be more of a risk mitigating scheme for Gurnet Point than a typical CVR.  If Xaracoll fails completely, the remaining assets are likely worth less than the $1.75 per share cash offer making Gurnet Point incentivized to at least meet this first initial milestone.
  • Second CVR Payment Event: Gurnet Bidco will pay an additional $1.33 in cash per CVR if, on or before December 31, 2018, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Soft Tissue repair (and not limited to hernia repair).
  • Third CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.00 in cash per CVR if, on or before December 31, 2019, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repairs; or, if not $0.60 in cash per CVR if, after December 31, 2019 but on or before June 30, 2020, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repair.
The second and third CVR payment events require new clinical trials that Gurnet Point will need to fund.  The phase 3 trial for Hernia repair ran for 8 months, so the timelines given for these events seem reasonable.  However, since Gurnet Point will need to fund these trials, there's a risk that they'll time the trials *just so* to miss the CVR payment date.  That's the primary risk with CVRs, the seller is essentially putting the final purchase price in the hands of the buyer, the incentives are misaligned.
  • Fourth CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.87 in cash per CVR if global net sales of Xaracoll exceed $60 million in any four consecutive Calendar Quarters ending on or prior to December 31, 2019; or, if not, $1.00 in cash per CVR if global net sales of Xaracoll exceed $60 million in any four consecutive Calendar Quarters ending on or prior to March 31, 2020.
I don't feel comfortable handicapping the potential sales of Xaracoll so its hard to have an opinion on the fourth CVR.  There is a competitor in Exparel that combines bupivacaine with a foam in a similar manner and has annual sales above $200MM.  However, opioid painkillers are cheap and they're great at treating acute short term pain, the real opioid epidemic problem revolves around their use for treating long term pain, so its hard to determine if the benefits of Xaracoll would be worth the additional cost?  Maybe for addicts or those at risk to be?

Most likely for today's $2.05 stock price, you get $1.75 cash in the next few months and $0.70 for 1st CVR milestone in ~12 months, plus the optionality of the long dated payment events.  Seems like a reasonable speculation to me, I bought a small amount.

Disclosure: I own shares of INNL

10 comments:

  1. Thanks for the post. Any substantial risk the deal breaks? I imagine INNL would have a ways to fall in that case.

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    1. I think the risk of the deal breaking is relatively low. Almost half the shares have already committed to the deal, there's really no more bad news that can come out between now and the close date, and Gurnet Point is already funding the company. But if it did break, you're right, look out below.

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  2. This is an interesting one.

    How do you think about position sizing on this one? I bought like a 1% position which is low for me.

    I originally bought at $1.95 but then the price ran up quite a bit. It's hard to take not take the profit on that knowing you can lose not just the $.2/share I originally thought but more like $.4/share after the move.

    I coincidentally have a limit order in for $2.05.

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    1. Yes, position sizing is tough with these, but I think that logic also creates some of the discount? The first milestone is pretty unlikely to get paid in 2017, if you buy at $2.05, depending on how you account for it in your year end performance, you could "lose" $0.30 and impact your compensation if you're a professional manager. If you think the first milestone is probably good, then you're selling a $2.45 stock in a year for $2.05 today? I guess it depends on your risk tolerance, but yes, size this one small, it's speculative.

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  3. From the PREM14A looks like there is some tax ambiguity. It's possible they assign a value to CVR and it's taxable upon closing, also possible any CVR is taxed as interest income, but they also say they don't really know. Any experience with this?

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    1. I'll just take an ignorant guess/stab at it, but yes I would assume any distributions would be taxed as ordinary income (same as interest income) versus being a return of capital or long term gain treatment, just seems to make sense from a tax perspective. They could assign a value to the CVR at closing, if they do, you'll be able to take a loss on whatever value they assign at a later date, not ideal and wouldn't be a perfect wash due to timing, but for me I don't view as much of a concern. Thanks.

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  4. Any news on these? FDA approval should be known by now, no?

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    1. I can't find anything either, was supposed to be a few days ago and now we're running out of time on the first two CVR payments.

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  5. Seems like there hasn't been even the FDA approval as of today, or am I misreading the FDA site? 4th CVR payment event therefore seems very unlikely to be reached I suppose, so best case either of the 3rd events materialize and we get $0.6 or $1 back? Hardly a great outcome but obviously better than full loss. Any thoughts MDC?

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    1. Strange that we didn't hear anything at all? Sorry - I don't have any insight, but seems like the CVR is a zero, the 3rd seems like a long shot at this point. Best to keep these small and apply the basket approach?

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