Friday, September 15, 2023

Graphite Bio: Broken Biotech, New CEO, Operating Lease Questions

Graphite Bio (GRPH) (~$130MM market cap) is a clinical-stage gene editing biotech that paused development in January for their lead asset, nulabeglogene (a treatment for sickle cell disease), following a serious adverse event in the first patient dosed.  About a month later, Graphite Bio made the determination to explore strategic alternatives and did a large reduction in workforce.  In the months since, the company sold their IP in a couple transactions for nominal amounts, the CEO resigned to pursue other opportunities and they did a further layoff.

In August, the company brought in Kim Drapkin as the CEO (plus just about every other relevant executive function) to lead the strategic alternatives process.  Drapkin was previously the CFO of Jounce Therapeutics (JNCE), a similarly situated broken biotech, which accepted a cash bid plus a CVR from Kevin Tang's Concentra Biosciences (Tang does own ~4% of GRPH).  Interestingly, as part of Drapkin's compensation package, she receives an additional $200k in severance if a definitive agreement is reached within 3 months of her 8/21/23 start date:

The Company entered into a letter agreement, dated August 21, 2023 (the “Start Date”), with Ms. Drapkin (the “Offer Letter”). Pursuant to the terms of the Offer Letter, Ms. Drapkin will be entitled to a base salary of $550,000 per year. In addition, Ms. Drapkin will be entitled to cash severance payments in the amount of (i) $400,000 in the event of a termination of her employment other than for cause or death upon or within 12 months after the closing of a strategic transaction, plus an additional $200,000 if the definitive agreement for such strategic transaction is executed within three (3) months after the Start Date or (ii) $350,000 in the event of a termination of her employment other than for cause or death upon or within 12 months after the Board’s approval of a plan of dissolution of the Company under Delaware law, in each case subject to Ms. Drapkin’s execution and non-revocation of a separation agreement and release, as further provided in the Offer Letter.

While that's not enough to ensure a deal is reached in that timeframe, it certainly points to the expectation of a quick deal when she was brought on board.  Another attractive quality to GRPH, their net cash position (after deducting current liabilities) is well over $200MM, that's a meaningful amount of money to many potential bidders which should increase the quality of any deal counterparty compared to some of these true micro/nano cap broken biotechs.

The one large red flag here is their operating lease liability; near the top of the recent craziness, GRPH entered into a 120 month lease for some office and laboratory space in San Francisco (which only started after they raised the white flag).

On December 16, 2021, the Company entered into a lease agreement with Bayside Area Development, LLC (“Bayside”) for 85,165 square feet of office and laboratory space in South San Francisco, CA. The lease for the office and laboratory space commenced in April 2023. The term of the lease is 120 months with the option to extend the term up to an additional ten years. This option to extend the lease term was not determined to be reasonably certain and therefore has not been included in the Company’s calculation of the associated operating lease liability under ASC 842. During the three and six months ended June 30, 2023, the Company took possession of the Bayside lease and recognized a $32.0 million right-of-use asset and corresponding lease liability upon the lease commencement date. In addition, the Company recognized $27.2 million in leasehold improvements. Bayside provided a tenant improvement allowance of up to $14.9 million, of which $14.7 million was utilized and recorded in lease liability. 

In connection with the Restructuring Plan, the Company has determined that it will not utilize this facility for purposes of its own operations, and as a result, intends to sublease the vacant space to recover a portion of the total cost upon recognition of the lease.

They've yet to sublease the space or negotiate a termination payment with their landlord.  Given the state of Bay Area office space, it might be advisable to assume the entire long term operating lease liability against the NAV.

I'm going to assume only two quarters of G&A versus my normal four, to account for the time it has already taken since the original announcement plus the three month incentive fee, it doesn't appear this one should take too long once the operating lease is neutralized in one way or another.  Although the default expectation with these should be a reverse-merger, the odds of a simpler cash deal should be higher given Drapkin's experience at JNCE.

Disclosure: I own shares of GRPH

Homology Medicines: Strategic Alternatives, Potentially Valuable JV

Homology Medicines (FIXX) (~$70MM market cap) is a clinical stage genetics biotech whose lead program (HMI-103) is meant to treat phenylketonuria ("PKU"), a rare disease that inflicts approximately 50,000 people worldwide.  In July, despite some early positive data, the company determined to pursue strategic alternatives as FIXX wouldn't be able to raise enough capital in the current environment necessary to continue with clinical trials.  Alongside the strategic alternatives announcement, the company paused development and reduced its workforce by 87% which resulted in $6.8MM in one-time severance charges.

Outside of approximately $108MM in cash (netting out current liabilities), FIXX has a potentially valuable 20% ownership stake in Oxford Biomedia Solutions (an adeno-associated virus vector manufacturing company), a joint venture that was formed in March 2022 with Oxford Biomedia Plc (OXB in London).  As part of the joint venture, FIXX can put their stake in the JV to OXB anytime following the three-year anniversary (~March 2025):

Pursuant to the Amended and Restated Limited Liability Company Agreement of OXB Solutions (the "OXB Solutions Operating Agreement") which was executed in connection with the Closing, at any time following the three-year anniversary of the Closing, (i) OXB will have an option to cause Homology to sell and transfer to OXB, and (ii) Homology will have an option to cause OXB to purchase from Homology, in each case all of Homology's equity ownership interest in OXB Solutions at a price equal to 5.5 times the revenue for the immediately preceding 12-month period (together, the "Options"), subject to a maximum amount of $74.1 million.

 Poking around OXB's annual report, they have the below disclosure:

Using the current exchange rate, that's approximately $47MM in value to FIXX.  Now OXB isn't a large cap phrama with an unlimited balance sheet, so there is some counterparty risk that OXB will ultimately be able to make good on this put.  In my back of the envelope NAV, I'm going to mark this at a 50% discount to be conservative.

Unlike GRPH, the operating lease liability at FIXX is mostly an accounting entry as the company's office space is being subleased to Oxford Biomedia Solutions, but doesn't qualify for deconsolidation on FIXX's balance sheet.  I'm going to remove that liability, feel free to make your own assumption there.  Additionally, even though HMI-103 is very early stage, it wasn't discontinued due to a clinical failure and might have some value despite me marking at zero since I can't judge the science.

It is hard to handicap the path forward, maybe OXB buys them out, they could do a pseudo capital raise with FIXX's cash balance while eliminating the JV put option liability.  Or FIXX could pursue the usual paths of a reverse-merger, buyout or liquidation.

Disclosure: I own shares of FIXX

Friday, September 8, 2023

Manchester United: Glazers Under Pressure to Sell, Dual Share Class Concerns

Similar to the Albertsons post, not a lot of original thoughts here other than the spread to the rumored takeout/private market value is too wide and could close shortly if all goes right.  If not, the current valuation isn't too demanding.

Manchester United (MANU) ($3.25B market cap, $4.15B EV) is one of the most popular soccer/football franchises in the world.  Since 2005, the English Premier League mainstay has been owned by the Glazer family (originally Malcolm Glazer, he died in 2014 and distributed his stake evenly to his six children) who purchased the team via a controversial (at the time) LBO that saddled the team with debt.  In the eyes of Manchester United supporters, due to debt incurred, the team was forced to divert cash flow from improving the team/facilities to debt service.  It took a few years, but the team's performance has suffered as a result, the team last won the Premier League in 2012-2013, a long drought for the storied club.  With the influx of foreign money, especially from the Middle East into the Premier League, Manchester United is no longer the club with the most resources and faces stiff competition for talent, including from their cross town rival, Manchester City, which is owned by members of the UAE royal family.  Again, in the eyes of supporters, the Glazers either don't have or won't spend the resources necessary to compete at the highest levels in Europe and ManU's millions of fans want them out.  Pressure has built to a significant level, protests and criticism from the notoriously difficult British press, partially led the Glazers (who also own the NFL's Tampa Bay Buccaneers) to announce they were open to sale nearly a year ago.

My primary concern with publicly traded sports teams is that they're almost always controlled companies with dual share class structures, probably rightly so as it would be potentially chaotic for the leagues if not.  There has been plenty of ink spilled on how great of an investment sports franchises have been, the number of billionaires continues to go up while the number of marquee sports franchises (the ultimate status symbol) has remained relatively flat, pushing the value up each time one comes on the market.  However, since the appeal to sports team ownership is mostly as a status symbol, the value in being the owner is being the controlling owner and face of the franchise.  Team owners aren't investing in the team for the cash flow (there generally isn't much, otherwise that would anger fans, thus reducing the asset value of the franchise), in order to be the recognized as the team owner, a would be buyer only needs to acquire enough shares to be the majority shareholder.

Manchester United has a dual share class structure where the Glazers own 100% of the Class B shares and 4-5% of the Class A shares.  Class B shares carry 10 votes, while Class A shares get 1 vote, giving the Glazers 95+% of the vote.

What happens if a buyer only buys the Class B shares from the Glazers?

In the original offering document from the 2012 IPO, the Class B shares automatically convert to Class A shares if they're no longer owned by an affiliate of the Glazer family:


Each Class B ordinary share is convertible into one Class A ordinary share at any time at the option of the holder of such Class B ordinary share. Each Class B ordinary share shall be automatically and immediately converted into one Class A ordinary share upon any transfer thereof to a person or entity that is not an affiliate of the holder of such Class B ordinary share. Further, our Class B ordinary shares will automatically convert into shares of our Class A ordinary shares upon the date when holders of all Class B ordinary shares cease to hold Class B ordinary shares representing, in the aggregate, at least 10% of the total number of Class A and Class B ordinary shares outstanding.

But given the above Excel snip, even if the Class B shares were fully converted to Class A shares, a buyer of the Class B would still have a majority of the economic ownership and the vote.  This is the primary risk one has to get comfortable with in this sale situation, that MANU shareholders might not see the same economic benefit as the Glazers (the Glazers could also get a premium for the Class B over the Class A).  This is not a situation where a buyer would be potentially acquiring a majority voting stake for less than a majority economic stake that could be challenged in court.

However, the good news is the leader bidder, Sheikh Jassim bin Hamad bin Khalifa Al Thani ("Sheikh Jassim") of the Qatari royal family (brother of the Emir of Qatar), wants to buy the entire club outright for a reported £6B or ~$7.5B.  Subtracting out the $900MM in debt, that's roughly ~$40/share, about double where shares trade today, around ~$20/share for the Class A.

Why does it trade at such a wide spread to the rumor deal price?

  1. The Glazers appear reluctant to sell (the process has almost dragged on a year, there's some deal fatigue here) and have been reported to be looking for a £7-10B price tag.  If they don't get it, they're willing to wait a couple years (could be a negotiating tactic) until new media rights packages have been signed, the FIFA Club World Cup expansion is closer and other bidders emerge.
  2. The other bidder, British billionaire Sir Jim Ratcliffe (a big ManU supporter) has bid between £5-5.5B for just more than 50% of the shares (the initial risk outlined) that would also potentially keep the Glazers involved in the club.
Despite these risks, I'm comfortable owning MANU shares at ~$20 given the 50% discount to the report Qatari bid.  The Glazers are going to face increasing pressure from a notoriously rabid fanbase that is dying to return to top form, the Glazers have limited ability to monetize or dividend out their incredible capital gain in the franchise, and the Qatar royal family have a near unlimited budget (plus a clear desire to sportswash - see the 2022 World Cup).  Manchester United's stadium needs renovation, the team needs to reinvest in their players, only a new owner with an unlimited pocket book (and potentially a cultural/political rival with crosstown Manchester City) will placate fans.  Whether it happens this fall at £6B or in 2025 at £7-10B, current prices seem attractive for a trophy asset that's clearly in play.  Other recent sports franchises, Chelsea for $5.25B and the Washington Commanders for $6.1B, have been sold for prices far exceeding the stock market price of MANU, despite being less popular teams.

Disclosure: I own shares of MANU

Albertsons: Merger w/Kroger, Divestiture News

Apologies, this post is mostly for my benefit (I try to post on all new positions), there likey aren't any new thoughts below on combination of the country's two largest traditional grocery chains, Albertsons (ACI) and Kroger (KR), but I just wanted to acknowledge that I bought into the merger arb earlier this week.  Partially after hearing Andrew Walker and Daniel Biolsi discuss it in a recent Yet Another Value Podcast episode.

Nearly a year ago, the two announced that Kroger (~2700 stores) was buying Albertsons (~2300 stores) for $34.10/share in cash (the merger consideration has been adjusted down to $27.25 for a $6.85 special cash dividend ACI paid in early 2023), shares closed on Friday for $23.63, offering 15% upside to the adjusted closing price for a deal that is expected to close in early 2024.  Potentially a juicy IRR.

On its face, the merger appeares to have a significant anti-trust hurdles, but when you examine the industry, traditional grocers like KR and ACI are facing competitive pressure from big box stores like Walmart, Target and Costco, plus competition on the high end from specialty grocers like Sprouts and Whole Foods.  They've been share losers to both sides.  Although others don't always see it that way, regulators took a narrow view of the office supply industry and rejected the attempted Staples and Office Depot 2014 tie up, despite many alternative channels (notably Amazon) to buy office supplies.  Both companies have struggled since, hopefully regulators take a more holistic view here and realize that traditional grocery chains need a strong competitor to the big box concepts (Walmart, Target) that use grocery as an enticement to get shoppers into their stores to buy higher margin non-grocery goods.

From a Chicagoan's point of view (they have overlap significantly here), I was a bit surprised by the relative lack of overlap in the two chain's store map nationally.  Kroger has significant concentration in the midwest and southeast where Albertsons is generally absent, and Albertsons is more focused on the west coast and northeast where Kroger has less of a presence (other than Denver, Seattle, Southern CA):

To address the areas where they do have overlap, when the deal was initially struck, the two set the stage for a divestiture SpinCo that would house between 100 to 375 grocery stores.  In addition to the adjustment for the special dividend (since paid), the cash consideration was to be dropped by 3x the four-wall (store level, pre corporate overhead) EBITDA of the stores assigned to the SpinCo.  Traditional merger arbitrage investors don't like uncertainty in the total consideration, the ACI SpinCo (in the initial docs, it appeared that SpinCo would be ACI stores only) would have likely traded poorly or at had some uncertainty as to its public market valuation.  This uncertainty (in my view) has partially led to the wide merger arbitrage spread, along with concerns around regulatory approval.

Today's news that Kroger and Albertsons had reached a deal to sell 413 stores for $1.9B to C&S Wholesale Grocers ("C &S") should help in a couple ways:

  • Divesting the overlap stores in an arm's length transaction should help calm fears that a SpinCo would be filled with the worst stores and be destined to fail.  A spin would not have been arms length and could have been the ultimate garbage barge, but now the divested stores will be plugged into an established operator who has done their due diligence and should be ready to compete against the combined KR/ACI following the closing of the deal.  That couldn't be said for a spin structure.
  • If required by regulators, KR/ACI has also setup an option for C&S to buy an additional 237 stores if needed.  In the initial merger proxy, the two parties speculated that up to 600 stores would need to be divested in total, this option would firm that up and fully eliminate the need for a spinoff of uncertain value.
  • The original spin appeared to only for ACI shareholders, this divestiture package includes both ACI and KR stores, again highlighting that a third party fully evaluated the competitive position in each market, versus a dump into a SpinCo that might have failed.
  • Similar to above, but grocery stores are heavily unionized, by selling in an arm's length transaction versus a spin, this structure likely helps dispel fears that a SpinCo would fail or that stores would be closed.  C&W has committed to keeping stores open as-is which should help political perceptions around this combination.

That's pretty much my thesis, the divestiture firms up the merger consideration (shouldn't need the SpinCo any longer) and should appease regulators that a strong third party (versus a helpless SpinCo) has done their due diligence and purchased the divested stores in an arm's length transaction, thus ensuring proper competition.  Assuming this deal closes in mid-February, even after this week's run up, it is offering a 15% absolute return and a ~38% IRR.

If the merger is blocked or otherwise doesn't occur, Albertsons is valued at 8x earnings (roughly inline with peers) and is a semi-controlled company by Cerberus and other PE investors with capital allocation expertise.  The downside doesn't appear too significant.

Disclosure: I own shares of ACI

Thursday, August 24, 2023

Banc of California: PacWest Merger, Get in Cheaper than Warburg & Centerbridge

Banc of California (BANC) and PacWest's (PACW) merger is a bit old news at this point, but initial excitement has worn off and shares are now priced below $12.30/share, where PE firms Warburg Pincus and Centerbridge are making their PIPE investment (originally at a 20% discount, it will close with the merger).  This is less of a short-term special situation trade and more a medium-to-long term investment as we wait for the skies to clear in the regional bank industry and bet on the merged bank extracting a massive amount of synergies.  The merger is a complicated transaction, the basic terms are below, all of this is designed to clean up the larger distressed PacWest:

PacWest was one of the rumored next dominos to fall in this past spring's banking crisis.  Their strategy was to use low cost California deposits (including a venture capital deposit clientele) and then lend those deposits out across the country to CRE and commercial borrowers.  When their depositors fled, PacWest was forced to load up on expensive wholesale funding to plug the hole.  Part of the problem was their customers (both depositors and borrowers) didn't see them as their primary bank, borrowers weren't depositors and depositors weren't borrowers.  Banc of California contrastly operates more like a large community bank, they gather deposits and lend in the same geographic area, southern California.

The accounting here will be a bit quirky, in an acquisition or a merger, a bank needs to mark-to-market the assets of the acquired bank on their balance sheet.  As everyone is well aware, where current rates are, banks have large unrealized losses that aren't included on their balance sheet in both the loans held for investment and securities held-to-maturity portfolios.  Since Banc of California is in relatively better shape, PacWest will be the acquirer here so that BANC's assets are marked-to-market rather than PACW's.  There's a lot of moving pieces here (BANC is selling their residential mortgage and multi-family portfolios among other asset sales to plug the wholesale funding problem), but in the interest of brevity, Warburg Pincus and Centerbridge's investment was designed to plug the capital ratio hole created by this mark-to-market merger accounting, keeping the merged bank's capital ratios in the healthy 10+% CET1 range.

My high level core thesis here is mainly two fold:

  • Pre-regional bank crisis, bank mergers were highly scrutinized.  Back in the summer of 2021, President Biden released an executive order that "encourages DOJ and the agencies responsible for banking (the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency) to update guidelines on banking mergers to provide more robust scrutiny of mergers."  What this meant in practice, banks had to convince regulators/politicians to approve a merger by limiting branch closures and job cuts, make grants into the community, etc.  That's not the case here, regulators are rolling out the red carpet to ensure that the contagion doesn't spread.  The two parties are guiding to only a six month merger timeline as they've already previewed this deal with regulators.  While they'll be careful not to explicitly say it, but the two banks have a ton of geographical overlap that will get rationalized in the coming year or two post closing, likely blowing past their projected synergies.
  • Banc of California previously had a reputation as a bit of a renegade fast growing bank under Steven Sugarman (brother of SAFE's Jay Sugarman), they entered a lot of risky lines of business and even plastered their name on a new soccer stadium in LA for $15MM/year, quite the marketing expense for a small regional bank.  However, four plus years ago Sugarman was pushed aside, in came Jared Wolff to lead the bank, he grew up at PacWest (with a stop in between at City National, another LA bank) and knows it and its management team very well.  Wolff shed many of the risky lines of business, ditched the stadium licensing deal, instead focused on being a community commercial bank.  BANC has performed reasonably well since, trading between 1.1-1.4x book value.  This is a bit of a jockey bet that he can draw on both his experience turning around BANC and being the former president of PACW to merge these two organizations optimally.
In terms of valuation, BANC put out the below estimate for next year's EPS.  This is a full year view and not a run rate, one can assume the exiting run rate is likely above this range going into 2025.
Using an admittedly fairly simple analysis, but I think it works, using the $12.30/share price number where the PE firms are coming in and the EPS guidance mid-point of $1.72/share, BANC is trading for approximately 7.2x next year's earnings and even cheaper on a year end 2024 run rate basis.  The bank also gave a $15.13/share proforma tangible book value, or it is currently trading at 81% of book, compared to historically around 1.1-1.4x.  Book value doesn't include the mark-to-market losses on PacWest's loan portfolio or held-to-maturity portfolio, but with a bank run largely off the table, those losses will eventually burn off.  At 10x $1.80/share in EPS, BANC could be a ~$18/share stock by the end of next year.

Other thoughts:
  • This deal doesn't solve two issues the market has been worried about, geographic concentration and deposit concentration risk, the combined bank will still be commercial focused (lacking significant retail deposits) and in California.  But maybe neither should be a concern going forward?  Market could be fighting the last war, but something I've been thinking about and don't have a strong rebuttal.
  • One of BANC's pitches is there is a void to fill because many of the largest California headquartered banks have either failed or been merged away in recent years.  I don't entirely buy that as the money center banks have a large presence in California, banking is a relative commodity, while relationship community banking can be a good profitable niche, I struggle thinking there's massive growth opportunity here.  This is a merger execution story, not a growth one.
  • Proforma, 80% of deposits will be insured, like to see that a bit higher, but this is a commercial focused bank.  They'll still be a pretty small bank with only 3% deposit share in southern California.
  • Outside of the current bank environment risks, this situation does carry a fair amount of execution risk.  I've been apart of a few acquisitions before, things always take longer and are hairier than it appears to outsiders, need to have some patience.

Disclosure: I own shares of BANC and PACW

CKX Lands: Micro-Cap Land Owner, Strategic Alternatives

CKX Lands (CKX) (~$27MM market cap) is a sleepy micro-cap that goes back to 1930 when it was spun from a bank.  CKX owns 13,699 net acres (about half is wholly owned, the other half is through a 16.67% interest in a JV) in southwest Louisiana which it earns royalties from oil and gas producers, timber sales and other surface rents it collects.  Revenue skews towards oil and gas revenues, but the value of the land is likely more in its use as timberland (they don't give oil and gas reserve numbers). 

On Monday, CKX put out the below press release:

CKX Lands, Inc. Announces Review of Strategic Alternatives


LAKE CHARLES, LA (August 21, 2023)—CKX Lands, Inc. (NYSE American: CKX) (“CKX”) today announced that its Board of Directors has determined to initiate a formal process to evaluate strategic alternatives for the company to enhance value for stockholders. The Board of Directors and the management team is considering a broad range of potential options, including continuing to operate CKX as a public, independent company or a sale of all or part of the company, among other potential alternatives.


The company has engaged TAP Securities LLC as financial advisor in connection with the review process. Fishman Haygood, L.L.P. is serving as legal advisor to the company.


There is no deadline or definitive timetable set for the completion of the review of strategic alternatives and there can be no assurance that this process will result in CKX pursuing a transaction or any other strategic outcome. CKX does not intend to make further public comment regarding the review of strategic alternatives until it has been completed or the company determines that a disclosure is required by law or otherwise deemed appropriate.


CKX Lands, Inc. is a land management company that earns revenue from royalty interests and mineral leases related to oil and gas production on its land, timber sales, and surface rents. Its shares trade on the NYSE American market under the symbol CKX.


TAP Securities is an affiliate of TAP Advisors, an investment bank providing financial advisory, mergers and acquisitions and capital-raising services. TAP Securities is located in New York City, phone number (212) 909-9034.

The company's disclosures lack much detail, it is challenging to value this asset from the outside.  Management here has a significant informational edge over public market investors, but with this, they are signaling that CKX is likely worth considerably more than the current trading price.  Having read a few of these announcements over time, if I had to guess, the highlighted part sounds like management wants to take it private.

Additionally, management doesn't take any cash salary and instead the board granted them a generous stock incentive package that vests over time as CKX hits certain share price targets.

Presumably these are reasonable targets, the $12 threshold was previously met, but the shares currently trade at approximately $12/share.  To see if that's reasonable, on a quick back of the envelope, I have the shares trading for approximately $1350/acre.
To be worth $15/share, the acreage (mostly timberland) must be worth closer to $1900/acre.  By poking around Land Watch, for the below parishes, it does appear that $1900/acre is within reason.

I don't really have a good sense of how much CKX is worth, other than I like the setup, I'd be interested in hearing more complete thoughts from others that have done more work on CKX, please feel free to comment below.

Disclosure: I own shares of CKX

Wednesday, August 2, 2023

HomeStreet: Stressed West Coast Small-Regional Bank, Pursuing a Sale

HomeStreet (HMST) ($180MM market cap) is a small regional lender based in Seattle that flew a bit too close to the sun in 2021-2022 and is now facing increased borrowing costs as they rely heavily on wholesale funding (loan-to-deposit ratio above 110%).  Their net-interest margin has been squeezed, as a result, they're a barely profitable enterprise despite minimal credit issues (ROE currently ~3%, versus 11.5% in 2022).  I first came across HomeStreet after it was briefly mentioned on the Value After Hours podcast by the team at Seawolf Capital.  Last night it moved up my watchlist because Bloomberg reported that HomeStreet is pursuing a sale, but also open to an asset sale or capital raise.  The speed of these troubled bank tie-ups seems to be increasing and regulators appear more open to mergers (BANC/PACW is guiding to a quick 6-month close).  I would expect this process will have an expedited timeline.  The simple/quick thesis that would make HomeStreet attractive to a buyer capable of fixing their funding problem:

  1. HMST trades for 1/3rd book value (~$9/share versus tangible book value at $27.50/share), despite having virtually no held-to-maturity portfolio and thus far, minimal issues in their loan book.  The tangible book number does include -$5.37/share of unrealized losses in the available-for-sale portfolio that will eventually burn off too.
  2. HMST has an attractive footprint across Seattle, southern California, Portland and a few branches in Hawaii where the deposit market is dominated by local players.  A larger regional bank could come in and realize significant synergies, especially in the current environment where regulators/politicians are once again more worried about shoring up the financial system than saving jobs or blocking branch closings.
  3. HMST is one of ~20 banks that has a license to originate and service multi-family loans under Fannie Mae's Delegated Underwriting and Servicing ("DUS") program.  This is an attractive franchise as Fannie Mae bears 2/3rds of the credit risk on a pro-rata basis while the lender maintains the relationship and associated servicing fees.

Other thoughts/risks:

  • 36% of their loan portfolio is multi-family lending in California.  Multi-family has held up reasonably well, we're starting to see some cracks in transitional bridge loans that mREITs fund, but too early to tell if troubles will work their way up to the MF CRE bank debt.  Typically, a transitional bridge loan is taken out with long-term financing by a bank when a property is stabilized.
  • Uninsured deposits were down to 7% of total deposits on 6/30, from 14% on 3/31, making a bank run here less worrisome (no venture or start up deposits), this is more a zombie bank that can't turn a profit or originate new loans.  HomeStreet is currently limiting lending to more niche floating rate products like construction loan and HELOCs.
  • Capital allocation has been exceptionally poor, HomeStreet has been a big buyer of their own shares in recent years, typically at prices well above book value. In 2022 alone, HomeStreet bought back 7.3% of their shares at an average price of $50.97/share.
  • HMST was recently kicked out of the S&P 600 small cap index which could have caused some forced selling pressure on the shares.  They also slashed the dividend significantly in April.

When a stock trades this cheap on a tangible book basis, the buyer can swoop it up for a huge discount, let's say 50% of book and still would be a 50% gain for the HMST equity.  I'm guessing this will be a stock-for-stock deal, so the realized premium might not be that big.  I bought some shares this morning.  Any other banks that need to make a deal?

Disclosure: I own shares of HMST 

Tuesday, August 1, 2023

Esperion Therapeutics: Litigation Special Situation, Potential Blockbuster Drug

This one is speculative, outside of the broken-biotech basket, but I still think it could be interesting in a small position size or LEAPs.

Esperion Therapeutics (ESPR) ($182MM market cap, ~$700MM EV assuming cash is fully burned) is a pharmaceutical company focused on developing non-statin medications for high cholesterol.  Statins (e.g., Lipitor, Crestor) are cheap and effective, but many people are statin intolerant, muscle pain is the number one complaint and as a result, patients either don't take the necessary dosage amount or falloff altogether (WSJ article discussing ESPR and other statin alternatives).  Esperion has FDA approved treatments utilizing bempedoic acid under the brand names Nexletol and Nexlizet that are currently only labeled for a narrow use case.  Following the success of their completed study ("CLEAR Outcome"), Esperion is set to significantly broaden their addressable market by 8-10x with a new label for cardiovascular risk reduction.  Nexletol/Nexlizet could be a "blockbuster drug" with the new label, meaning annual sales above $1B.  In Q2, the company officially submitted their expanded label applications in the U.S. and Europe, Esperion expects to receive approval in ~April 2024 (approval likelihood appears high, but open to pushback there).

Like many other biotech firms, Esperion has burned through a lot of money to get this point.  To raise cash they've partnered with larger pharmaceutical companies that will market and distribute their drugs outside the United States.  As part of these arrangements, Esperion received upfront fees and negotiated milestone payments, while also retaining a royalty on sales.  Daiichi Sankyo, the second-largest pharmaceutical company in Japan, is the largest of these partners, with agreements to distribute throughout Europe and Asia ex-Japan.  Following the release of the CLEAR Outcome study results, the two are in dispute over a $200-$300MM milestone payment tied to the range of relative cardiovascular risk reduction.  Obviously, it's not a great situation to be in a dispute with your largest commercial partner (reminds me a tiny bit of RIDE/Foxconn) when you're a cash burning enterprise.

Below is the contract language at the heart of the dispute:

I'm not a lawyer, but I do stare at a fair amount of legal agreements in my day job, this is certainly poorly written and vague language.  Relative risk reduction is not a defined term, a $200-$300MM payment left up to interpretation looks poorly on Esperion management and their legal counsel.  If they meant any endpoint would trigger the payment, they should have included that clarification.

Anyway, the results of the CLEAR Outcome study are viewed positively by the scientific community, Esperion's drug reduces:

  • 27% reduction in non-fatal heart attacks
  • 23% reduction in the composite of nonfatal and fatal heart attacks
  • 19% reduction in coronary revascularization (sever blockage of the arteries)
  • 15% reduction in fatal and nonfatal strokes
  • 15% reduction in MACE-3 (a composite of cardiovascular death, nonfatal heart attacks, or nonfatal stroke)
  • 13% reduction in MACE-4 (a composite of cardiovascular death, nonfatal heart attacks, nonfatal stroke, or coronary revascularization)

Esperion argues that their drug reduces "cardiovascular risk" because of the first two results, Daiichi Sankyo is pointing to the last one, MACE-4 which is the broadest goal post and misses the 15% minimum level for a milestone payment altogether.  Esperion is in a precarious financial position, they currently have $138.5MM in cash and securities, projected to get them to mid-2024, leaving a tight opening to turn cash flow positive assuming the new label is approved a few months earlier.  This milestone payment is key to Esperion's future, otherwise they may need to do dilutive financing or auction themselves off in a firesale.

The smoking gun might be Esperion's claim that Daiichi Sankyo ("DSE" in the below) put MACE-4 in a draft of the document but then agreed to take it out:

 11. The Negotiating and Drafting History of the Agreement. Because the language of Section 9.2 is unambiguous, there is no need to go beyond the four corners of the Agreement.  In any event, the extrinsic evidence is fatal to DSE’s reading of the Agreement. During the negotiation and drafting of the Agreement, DSE proposed making Esperion’s regulatory milestone payment contingent on a reduction in the specific MACE-4 endpoint—the contract term DSE now says was agreed to. But Esperion expressly rejected this proposed contractual term and DSE agreed to remove it. In other words, the parties specifically considered adding language to the Agreement to make MACE-4 risk reduction a specific requirement for Esperion to receive the full milestone payment and decided not to add this requirement. DSE’s position that MACE-4 is the contractual north star is a naked attempt to re-trade the parties’ deal and obtain through bad-faith repudiation what it failed to achieve at the negotiating table.

12. DSE’s motive is clear. At the time of DSE’s bad-faith repudiation, Esperion was on the eve of closing an offering to raise capital. DSE knew that given the materiality of the $300 million payment, Esperion, a publicly traded company on NASDAQ, would be required to publicly disclose DSE’s repudiation of its payment obligation to the investing public. On information and belief, DSE timed its repudiation to put maximum financial pressure on Esperion, in a transparent attempt to drive down Esperion’s stock price and pressure it to re-negotiate the financial terms of the parties’ license agreement.

13. DSE’s repudiation inflicted immediate and substantial harm to Esperion. When DSE’s repudiation became public, Esperion’s stock plummeted, dropping 54% in a single day. The harm to Esperion is ongoing and its stock price remains below $2 per share.

Assuming this is all true, which it appears to be as Esperion provides screenshots in their response, it'll come out during the discovery phase of the trial that is set for April 2024, around the same time Esperion expects to receive approval for the expanded label.

I expect them to settle for some discount prior to the trial as it would lift a big cloud from Esperion and allow themselves to sell to a larger pharma company that isn't starting a sales and distribution operation from scratch like Esperion.  Esperion does also have a similar $140MM milestone payment tied to their partner in Japan where the labeling date is a little farther out (1-2 years).

I don't really have a price target for ESPR, but would anticipate a positive outcome could be a multi-bagger from today's prices.  Open to any opinions on this situation, especially from those with more experience in biotech/pharma disputes or the science behind Esperion's drugs.

Disclosure: I own shares of ESPR

Thursday, July 20, 2023

Pieris Pharmaceuticals: Broken Biotech, Quirky Accounting, Possible Value Nuggets

The dumpster diving continues, this one is a bit messier and riskier.

Pieris Pharmaceuticals (PIRS) is a clinical stage biotechnology company targeting treatments for respiratory diseases and cancer indications.  In late June, the company announced that their partner, AstraZeneca (AZN), in their lead product candidate, elarekibep, discontinued its Phase 2a trial and this week we found out that AstraZeneca also terminated their R&D collaboration agreement with Pieris.  Getting a read out on elarekibep's Phase 2a trial was the company's top strategic priority, so much so that they limited investment in their other assets, now without that partnership, the company is left in a difficult position where they are burning cash and can't raise capital in the current environment.

In comes the strategic alternatives announcement where they disclosed a 6/30 cash balance of $54.9MM and a reduction in workforce of 70%.  The CEO's (4.8% owner) comments were rather specific:

"We are pursuing strategic options across three main areas following the recent developments that have impacted our ability to independently advance our respiratory programs," commented President and CEO Stephen Yoder. "One track is accelerating partnering discussions of PRS-220 and PRS-400. A second focal area is diligently selecting the best possible development partner and deal structure to re-initiate clinical development of cinrebafusp alfa, our former lead immuno-oncology asset, which has shown 100% ORR in five patients in a HER2+ gastric cancer trial that was discontinued for strategic reasons. Third, we will explore whether our balance sheet, position as a public company, and other assets are of strategic value to a range of third parties.” Mr. Yoder continued, "While the challenges we recently experienced across our respiratory franchise have forced us to make very difficult personnel decisions, I cannot express enough gratitude to our departing colleagues for their dedication, collaborative spirit and integrity."

I appreciate the honesty of "position as a public company" being of strategic value, that points to a reverse merger being high on the list, which isn't ideal.

Pieris has a lot of partnerships, in addition to AstraZeneca, Pieris has current collaboration deals with Genentech (now part of Roche), Seagen, Boston Pharmaceuticals and Servier.  These are in addition to the assets mentioned in the above quote.  PRS-220 and PRS-400 are wholly owned and controlled, PRS-220 is currently in a Phase 1 trial in Australia and PRS-400 is still pre-clinical.  Plus they have cinrebafusp alfa (don't ask me to pronounce that) which previously had a successful Phase 1 study, they were initiating a Phase 2, but stopped to redirect corporate resources to the failed AstraZeneca program.  In PIRS's own words in the latest 10-Q, before the strategic alternatives announcement:

In July 2022, we received fast track designation from FDA for cinrebafusp alfa. In August 2022, we announced the decision to cease further enrollment in the two-arm, multicenter, open-label phase 2 study of cinrebafusp alfa as part of a strategic pipeline prioritization to focus our resources. Cinrebafusp alfa has demonstrated clinical benefit in phase 1 studies, including single agent activity in a monotherapy setting, and in the phase 2 study in HER2-expressing gastric cancer, giving the Company confidence in its broader 4-1BB franchise. In April 2023, clinical data showing an unconfirmed 100% objective response rate and promising emerging durability profile was presented at the American Association of Cancer research annual meeting. These data provided encouraging evidence of clinical activity for this program and we are considering a range of transaction to facilitate the continuation of cinrebafusp alfa, including an immuno-oncology focused spinout to traditional partnering transactions. 

Between the strategic alternatives press release and the language in the 10-Q, it doesn't appear Pieris is just beginning the process, but rather they've been looking for ways to raise capital all along by selling these three assets (because they needed cash to get to their previous mid-2024 AstraZeneca readout timeline), here there might be quicker asset sale catalyst than others in the broken biotech basket.

But as usual, I have no real thoughts on the science behind any of this, but among the partnerships and the wholly owned programs, there might be some value nuggets above and beyond the cash on the balance sheet.

The partnerships do create some quirky accounting. Pieris has received upfront payments in each of these deals for the licensing rights and some R&D collaboration on future development, they account for the upfront payment by creating a deferred revenue line item for the revenue received but where services haven't been performed (like R&D spend).  While this shows up as a liability, as you read through the lengthy description of each partnership, it appears (feel free to push back on this) like their partners can't claw back funds and its not a true debt or liability.

One could probably figure out the margin on this deferred revenue over time by doing some data mining, but with the 70% reduction in workforce, likely over indexed to the R&D team, it doesn't appear the company is too concerned about not being able to recognize this revenue or having it clawed back.

Running through my back of the envelope math, I come up with the following liquidation estimate (reminder, this is likely not a liquidation):
The shares outstanding number is a bit wonky, the company has preferred stock outstanding to their largest investor, Biotechnology Value Fund, that is convertible at 1,000 shares of common for each pref share.  I believe that's fully converted in the 93.6MM number that was reported in BVF's latest 13D.  But please check my math, I have low confidence in that number, but it's hopefully right within a few million shares.

In order to account for the deferred revenue, I put in 2 quarters of 30% R&D burn for ongoing partnership work.  While this one doesn't look super attractive on my typical math, with all the different irons in the fire, I'm guessing there is some value to their IP (might make an interesting CVR in a reverse merger).  I made this a small position this week.

Disclosure: I own shares of PIRS

Tuesday, July 18, 2023

MEI Pharma: Flawed Deal w/ INFI, Activist Target

MEI Pharma (MEIP) ($50MM market cap) is a fledgling clinical stage biotech that has a pending merger with Infinity Pharmaceuticals (INFI) ($18MM market cap), the merger is facing activist pushback from a shareholder group (14.8% stake) led by Cable Car Capital and Anson Advisors.  

Last November, MEI Pharma's development partner (Kyowa Kirin) on their primary drug candidate (Zandelisib) walked away after the FDA provided feedback on the need for a new clinical trial design that would be costly, the partnership ended and MEI Pharma laid off a good portion of their employees.  The company does have two additional programs, both in Phase 1b trials with expected readouts around year-end.  In February, in an attempt to restock their development pipeline, MEIP entered into a stock-for-stock merger agreement with INFI where INFI shareholders would end up with 42% of the new company (to be renamed Kimbrix Therapeutics - KMBX) despite only bringing $4MM in net cash to closing compared to $80MM from MEIP (using the minimum net cash amounts in the merger agreement).  INFI has one product in their pipeline, Eganelisib (to be used in combination with Keytruda) for patients with a type of skin cancer, that desperately needs capital to fund a phase 2 trial.  As usual, I have no view on the merits of the science, but it is clear why INFI wants to do this deal, without it, INFI will run out of cash quickly and be forced into a quick asset sale or liquidation.  From INFI's Q1 10-Q:

If the Merger is not completed, we will need to raise additional capital in order to successfully execute on our current operating plans to further the development of eganelisib. If the Merger is not completed, we will explore other plans to mitigate the conditions which raise substantial doubt about our ability to continue as a going concern. We consider one of the following courses of action to be the most likely alternatives if the Merger is not completed:
Pursue another strategic transaction. We may resume the process of evaluating a potential strategic transaction, including the sale of the company or its assets. Based on our prior assessment, we do not expect that we would have the necessary time or financial resources to pursue another strategic transaction like the proposed Merger.
Wind down the company. If the Merger does not close and we are unable to enter into another strategic transaction, our board of directors may conclude that it is in the best interest of stockholders to cease normal operations and wind down the company through bankruptcy or dissolution proceedings. In such case, there would be no assurances as to the amount or timing of available cash remaining, if any, to distribute to stockholders after paying our obligations and setting aside funds for reserves.

MEIP's intentions are less clear as the company trades well below cash.  The agreed stock-for-stock exchange ratio is 0.052245 MEIP shares for each share of INFI, at current prices, the spread is approximately 100%; the market has serious doubts this merger will be approved and/or significant concerns about INFI's value on a deal break.  Last week, the company postponed their shareholder meeting to July 23rd, presumably because they don't have enough votes, and this week, the activist group filed a preliminary consent solitication seeking to replace the entire board.  Despite having the support of the proxy advisory firms, this merger seems doomed to fail.  However, MEIP does have two readily apparent alternative options:

1) The activist group did previously submit a proposal to buy the shares they don't already own for "cash consideration of not less than $8.00 per share" plus a CVR for the disposition of MEIPs remaining clinical assets.  Management has rejected this proposal.

2)  As part of MEIP's strategic alternatives process, they did evaluate a liquidation, from the S-4 (6/2/23):

 Liquidation Value

The pro forma DCF analyses imply a significant premium to both MEI’s standalone DCF valuation range and current trading price. Torreya also compared the implied value of MEI as presented in the pro forma DCF analyses to the estimated liquidation value of MEI. To calculate the liquidation value, management provided its best estimate for the cash available to shareholders upon a hypothetical liquidation. Based on discussions with management, a hypothetical liquidation could occur in the second quarter of 2023, and after paying all wind-down obligations, a fully wound-down MEI entity would be left with $82.8 million of available cash. This would imply a liquidation value of $0.62 per share. Given that the pro forma DCF represents a significant premium of up to 134% to the liquidation value, and up to 52% in the scenarios with required equity fundraising, Torreya believes the DCF supports their opinion that the exchange ratio is fair to MEI shareholders.

That analysis was pre-reverse split, post-split the liquidation value per share would be $12.40.  Similar to MGTA, the liquidation analysis assumes an unrealistic scenario where the company could be wrapped up within a few months with minimal expenses.  A more realistic scenario is as follows:

To be a bit conservative, I'm using the minimum net cash amount required if the deal closed in July of $78MM.  This is likely too low, management's projected (versus the minimum to close the deal) net cash level as of 6/30 was $92.8MM, but MEIP is spending money on this merger and fighting off the activists, makes sense to be a little conservative.  And then MEIP would escrow $10MM for any contingencies and still be able to make an initial distribution of $10+, well above where the shares trade today.  I bought shares recently.

The biggest risk I see, even if the deal breaks and the activist group fails to remove the board, MEI Pharma could continue on with their two phase 1 product candidates while burning cash.

Other thoughts:

  • Infinity Pharmaceuticals (INFI) on a break might be interesting in a very speculative way.  The company doesn't have any real debt the liabilities, the related to sale of future royalties line item on the balance sheet is only payable on the receipt of any royalties to assets they've previously sold (and aren't Eganelisib).  Even in a potentially conflicted sale, MEIP did assign significantly more value to INFI's IP than the market.
  • Daniel Gold stepped down as CEO on 6/2 and was replaced by former General Counsel and COO David Urso, probably a non-event as INFI management would take over the reigns, but shows a little lack of confidence in seeing the deal through to completion.
  • Another probably nothing-burger, but MEIP and INFI do share a board member, Sujay Kango who orchestrated the original meeting between the two companies, he then excused himself according the background section in the S-4.

Disclosure: I own shares of MEIP

Wednesday, July 12, 2023

AVROBIO: Another Broken Biotech, Clinical Assets Potentially Worth Something

AVROBIO (AVRO) (~$76MM market cap) is the latest broken biotech that is trading below net cash to announce they are pursuing strategic alternatives.  AVROBIO is a clinical stage gene therapy company that sold one of their assets, AVRO's cystinosis gene therapy program, to Novartis in May for $87.5MM in cash, while retaining their HSC gene therapy for Gaucher program which they had previously announced intentions to initiate a Phase 2/3 trial later this year.  With the strategic alternatives announcement, AVROBIO announced they were pausing development efforts (and laying off 50% of their workforce), but the remaining IP assets likely have some positive value unlike others in the broken biotech basket.  If any readers have expertise in this area or insight into the potential value, please comment below.

Doing my quick back of the envelope math on what a liquidation scenario would like (to be clear, a liquidation wasn't mentioned as one of the options they were considering, but I still find it helpful):

The above is likely overly punitive in this scenario but I wanted to be consistent with other similar ideas.  As part of the asset sale, AVROBIO did sign on to provide support to Novartis for 12 months under a Separation Services Agreement, which might be why they still need to retain 50% of their workforce.  Again, their remaining IP likely still has value, if they can sell it for $10+ million, then we're looking at closer to $2.00 per share.  A reverse merger seems to always be the first option, with the market rallying, maybe those come back in vogue as well.

Disclosure: I own shares of AVRO

Tuesday, July 11, 2023

Vertical Capital Income: NAV Slashed Ahead of Carlyle Closing

Another day with egg on my face.  Today, Vertical Capital Income (VCIP) announced that ahead of their pending closing with Carlyle, the fund had liquidated most of their portfolio of residential mortgage whole loans (which was a condition of closing) for a 17% discount to their last reported NAV on 6/30, a full 11 days ago.  In their own words:

Based upon the expected proceeds from this sale, which resulted in aggregate proceeds lower than the book value of the combined assets due to the significant  sale needed to facilitate the Transaction, the Fund has adjusted its net asset value per share ("NAV") from $9.96 as last reported on June 30, 2023, to $8.27 as of today.

Huh?  Seems like there must be a typo or a word was deleted between significant and sale as there's an extra space in there.

The portfolio assets are residential mortgages, most of them are fixed rate, rates have moved slightly up in recent weeks but not enough to justify that discount.  The old management, Oakline Advisors, is kind of an odd shell that is probably checked out at this point and the board of trustees barely own any stock (0.18% as a group).  The incentives to execute a full competitive auction to get best execution just probably weren't there, someone got a steal.  Carlyle doesn't care either, they just want to be handed a bank account with cash in it, doesn't matter to them how much is in the bank account, they're going to go through with their tender and subsequent investment at the value of the cash account.  Not sure how management or the board of trustees can get away with having a shareholder vote a month ago to approve the transaction based on such a faulty mark.  But that's above my head.

What does it look like from here? 

Based on the press release, looks like the deal will close by the end of the month, this will all happen pretty quickly.  Shortly after the deal closes, Carlyle (from the management company, not the fund) will pay $0.96/share in cash to shareholders and then will tender for $25MM at NAV.  If we assume the market is fully pricing in the $0.96/share payment, everyone tenders in full, my math comes up with a proforma price of $7.26/share or 88% of NAV.  Please check my math.

The other CLO equity funds trade above NAV.  It will take time (6-12 months?) for Carlyle to ramp the portfolio up from zero, add some leverage, etc., to get to the point where it looks like one of other CLO equity funds.  The world could change in the meantime.  But Carlyle should be incentivized to make this trade close to NAV, they're one of the largest CLO managers, they want the captive CLO equity vehicle to grow that business.  In its current size, VCIF is too small to accomplish that, if it trades at or above NAV, Carlyle will be able to issue shares accretively and everyone is happy.

Disclosure: I own shares of VCIF

Friday, June 30, 2023

Mid Year 2023 Portfolio Review

This will be more of a brief check-in rather than a full review.  Unfortunately, my recent spell of underperformance has continued into the first half of 2023, my portfolio is up marginally, 6.75% versus 16.89% for the S&P 500.  I'm still above my long term goal of 20+% IRR; the show goes on.

The main performance detractors were oversized positions in MBIA (MBI) and Transcontinental Realty Investors (TCI), two speculative M&A candidates that have failed to materialize.  Many of my other speculative M&A ideas did announce deals, but well below where I had penciled them out.  As a result, I've leaned more on smaller position sizes in the broken biotech basket and other flavors of special situations for new ideas recently.

The one outsized performer was Green Brick Partners (GRBK), homebuilders have exceeded low expectations as single family home inventory has remained tight despite rising interest rates.  I've begun to sell down my position, it had become too large and doesn't really fit into a value or special situation bucket any longer.

Closed Positions

  • Radius Global Infrastructure (RADI), INDUS Realty Trust (INDT) and Argo Group International (ARGO) all received bids that were a bit disappointing from elevated early 2022 expectations when rumors surfaced that each were for sale.  All were interest rate sensitive businesses where the value declined as rates rose faster than initially expected.
  • In the broken biotech basket: 1) sold Talaris Therapetuics (TALS) after their recent reverse merger with Tourmaline Bio for a nice gain; 2) sold Oramed Pharmaceuticals (ORMP) for minimal gain after a few readers pointed out their promotional (maybe being kind) management and then saw it first hand; 3) Sold Carisma Therapeutics (CARM, fka Sesen Bio) after the reverse merger, was left with a stub position (received the non-tradable Sesen CVR) that I sold fairly indiscriminately for a small loss.
  • The Franchise Group (FRG) story ended rather disappointingly, have a bit of a bitter taste in my mouth, after rumors surfaced early in the year that CEO Brian Kahn was considering taking the company private.  FRG then went on to have a terrible Q1 where they breached a covenant in their credit facility, preventing them from continuing their dividend, that was disclosed at the same time as the company agreed to Kahn's $30/share buyout.  Since the company is kind of a one-of-one based on Brian Kahn's deal making, with a covenant breach, it was unsurprising that no other bidder came forward during the go-shop period.
  • I sold Star Holdings (STHO) shortly after the close of iStar/Safehold transaction after a few readers reached out with some concerns on SAFE.  I'll re-evaluate down the road, this is one I'll likely rebuy again at some point in its liquidation journey.
  • My thesis in Liberty Broadband Corp (LBRDK) was stale, I originally bought General Communications as a merger arb and held through GCI Liberty into Liberty Broadband.  Sold it more because of the opportunity cost, reinvested those proceeds into more current ideas.
  • Digital Media Solutions (DMS) ended up rejecting management's buyout offer and instead took on debt to make an acquisition, now it's trading below a dollar.  I want to believe the existence of all these busted SPACs will eventually turn into more special situation type opportunities, but these are questionable management teams and it might take a little while longer for management and boards to fully come to their senses.
  • Sonida Senior Living (SNDA) disclosed a going concern warning, I mentioned some place else that I oversized this position given the combination of operating leverage and financial leverage, should have treated this more as an option than a core position.  Shares have recovered a bit, but they still face a challenging labor environment and a lack of scale.
Current Portfolio
I do also have an assortment of non-traded securities (CVRs, liquidating trusts and a bond without a market) that I've omitted above.  Thanks for continuing to read and follow along, also thank you to all that have sent me ideas.  Everyone please have a safe holiday.

Disclosure: Table above is my taxable account/blog portfolio, I don't manage outside money and this is only a portion of my overall assets.  As a result, the use of margin debt, options or concentration does not fully represent my risk tolerance.

Cyteir Therapeutics: Liquidation Announced

Cyteir Therapeutics (CYT) ($92MM market cap) is another broken biotech, unlike others, this one is forgoing a reverse merger and announced today they were simply liquidating:

Planned Liquidation and Dissolution


Due to the planned discontinuation of CYT-0851 development, and the previously announced discontinuation of Cyteir’s discovery pipeline, the Company’s Board of Directors intends to approve a Plan of Liquidation and Dissolution (“Plan of Dissolution”) that would, subject to shareholder approval, include the distribution of remaining cash to shareholders following an orderly wind down of the Company’s operations, including the proceeds, if any, from the sale of its assets. Prior to winding down operations, the Company intends to complete regulatory and patient obligations from the ongoing clinical trial. The Company will engage independent advisors, who are experienced in the dissolution and liquidation of companies, to assist in the Company’s dissolution and liquidation. The Company also intends to call a special meeting of its shareholders in the second half of 2023 to seek approval of the Plan of Dissolution and will file proxy materials relating to the special meeting with the Securities and Exchange Commission (the “SEC”). If the Company’s shareholders approve the Plan of Dissolution, the Company would then file a certificate of dissolution, delist its shares of common stock from The Nasdaq Global Select Market, satisfy or resolve its remaining liabilities, obligations and costs associated with the dissolution and liquidation, make reasonable provisions for unknown claims and liabilities, attempt to convert all of its remaining assets into cash or cash equivalents, including through a potential sale of CYT-0851, and return remaining cash to its shareholders. The Company will provide an estimate of any such amount that may be distributed to shareholders in the proxy materials to be filed with the SEC. However, the amount of cash actually distributable to shareholders may vary substantially from any estimate provided by the Company based on a number of factors.

The company isn't going to put out an estimate until they file their proxy, but let's attempt to make a conservative guess on how much they could distribute to shareholders.  Cyteir did layoff approximately 70% of their employees in January and incurred severance payments in Q1, so their expense run rate is probably significantly lower in Q2 and beyond given this announcement.  I have no clue how to value CYT-0851, but it doesn't sound like a total zero, there might be some additional value here.

Here's my quick, likely wrong, swag at a liquidation scenario:
I'm estimating $20MM of cash burn, which might be too high, especially during a period where money market funds are returning 5%, helping to offset some G&A.  I'm assuming a year end initial distribution of 90% of the cash, and then just 30% of the holdback amount in 3 years when the liquidating trust winds down.

Disclosure: I own shares of CYT

Wednesday, June 28, 2023

Astrotech Corp: Strange Microcap Net-Net, Unsolicited Takeover Offer

Astrotech Corp (ASTC) (~$24MM market cap) is an odd little microcap that IPO'd in 1995 as an aerospace company dubbed SPACEHUB, however, when the U.S. wound down the manned space program the company sold most of their operations to Lockheed and pivoted to "mass spectrometry technology" (don't ask me what this means) in the mid-2000s.  Astrotech has struggled to find a use case for their technology, they're currently pursuing testing for explosives in travel settings, cannibas industry applications and viral/COVID testing, all while generating minimal revenue in the past half decade.  The one thing they have sold plenty of is stock, during the mania of 2020-2021, Astrotech sold $79.4MM in equity in a series of capital raises.  As of 3/31, they only have $44.1MM of cash remaining and no debt, making it a net-net, albeit a low quality cash burning one.  If there was any doubt of management's lack of capital allocation skills, Astrotech announced a new ATM equity program earlier this month despite shares trading at an extreme discount to net cash.

Earlier this week, BML Investment Partners (good firm to watch, often involved in a lot of these broken biotechs and other net nets) re-entered the picture by amending their 13D to include an offer to buy the shares they don't own (currently own 13.1%) for $17.25/share.  In the exhibit, they included a brief letter below:

The CEO, Thomas Pickens III, owns 8.3% of the company (management has a whole owns 9.7%), he pays himself handsomely, some $1.2MM in 2022 which included a $450k salary and $375k cash bonus, added together that's just under the $869k in revenue the company did during the same timeframe.  So at first glance, I didn't like BML's chances of convincing the board to take their offer.

But an interesting thing happened yesterday afternoon, a day after receiving BML's offer, the company did indeed cancel their ATM program, which is a stipulation of the deal.  Why do that if they weren't serious about evaluating the offer?  Especially since the shares spiked up, making it more attractive to execute the ATM if that's the path they wanted to take.  That action alone is worth a small position for me.  BML did put a strangely tight timeframe on a response, but hopefully the company has already met that threshold by cancelling the ATM and acknowledging the offer in an 8-K.  From my memory, I don't remember BML buying a company outright, but they are experienced in liquidation scenarios and have likely helped companies execute them behind the scenes.  This doesn't seem like a stretch for them and there's no financing condition.

Shares currently trade for $14 or roughly a 20% discount to the offer price.  

Disclosure: I own shares of ASTC

Thursday, June 22, 2023

Magenta Therapeutics: Likely Liquidation If Reverse Merger Vote Fails

Magenta Therapeutics (MGTA) ($39MM market cap) is a member of my broken biotech basket, I'm bringing it forward again to highlight the opportunity for shareholders to vote down the proposed reverse merger with privately held Dianthus Therapeutics.  In MGTA's S-4, the company strongly hints that if the deal is not approved, a dissolution and liquidation is on the table:

If the merger is not consummated, Magenta’s board of directors may decide to pursue a dissolution and liquidation. In such an event, the amount of cash available for distribution to its stockholders will depend heavily on the timing of such liquidation as well as the amount of cash that will need to be reserved for commitments and contingent liabilities.

There can be no assurance that the merger will be completed. If the merger is not completed, Magenta’s board of directors may decide to pursue a dissolution and liquidation. In such an event, the amount of cash available for distribution to its stockholders will depend heavily on the timing of such decision and, with the passage of time the amount of cash available for distribution will be reduced as Magenta continues to fund its operations. In addition, if Magenta’s board of directors were to approve and recommend, and its stockholders were to approve, a dissolution and liquidation, Magenta would be required under Delaware corporate law to pay its outstanding obligations, as well as to make reasonable provision for contingent and unknown obligations, prior to making any distributions in liquidation to its stockholders. As a result of this requirement, a portion of its assets may need to be reserved pending the resolution of such obligations and the timing of any such resolution is uncertain. In addition, Magenta may be subject to litigation or other claims related to a dissolution and liquidation. If a dissolution and liquidation were pursued, Magenta’s board of directors, in consultation with its advisors, would need to evaluate these matters and make a determination about a reasonable amount to reserve. Accordingly, holders of its common stock could lose all or a significant portion of their investment in the event of liquidation, dissolution or winding up.

Included in the S-4 is also a management prepared liquidation analysis (the distribution estimate here assumes a May or June 2023 distribution, clearly that's not a realistic timeline, additional liquidation costs will be incurred if MGTA does end up down that road):

In light of the foregoing factors and the uncertainties inherent in estimated cash balances, stockholders are cautioned not to place undue reliance, if any, on the Liquidation Analysis.

The below summary of the Liquidation Analysis is subject to the statements above, and it represents Magenta management’s estimates of Magenta’s cash which may be distributed to stockholders as permitted under applicable law pursuant to a plan of dissolution.

Key assumptions underlying the Liquidation Analysis included (i) that the entire distribution of Magenta’s net cash would be made in either May 2023 or June 2023, (ii) that Magenta would have approximately $65.2 million and $63.9 million of net cash as of May 2023 and June 2023, respectively, after deducting costs and expenses, including legal fees, the fees payable to Magenta’s strategic financial advisor, accounting fees, employee retention bonuses, severance and benefits, insurance expenses and other transaction-related costs, with no adjustments for taxes; (iii) that these costs and expenses were forecasted to total approximately $11.8 million assuming the closing of a liquidation in each of May 2023 and June 2023; and (iv) approximately 60.7 million total shares outstanding as of April 27, 2023. The analysis resulted in an estimated cash distribution per share in May 2023 and June 2023 of $1.07 per share and $1.05 per share, respectively.

Today, shares trade for $0.64 per share, well below management's liquidation estimate.  There's a reasonable presumption a liquidation would indeed follow a "no" vote to the merger, per the merger agreement, MGTA would be required to pay a termination fee of $13.3MM (huge in comparison to their cash balances or market cap) if MGTA enters into another merger within 12 months.

Termination Fees Payable by Magenta

Magenta must pay Dianthus a termination fee of $13.3 million if (i) the Merger Agreement is terminated by Magenta or Dianthus pursuant to clause (e) above or by Dianthus pursuant to clause (f) above, (ii) at any time after the date of the Merger Agreement and prior to the Magenta special meeting, an Acquisition Proposal with respect to Magenta will have been publicly announced, disclosed or otherwise communicated to the Magenta board of directors (and will not have been withdrawn), and (iii) in the event the Merger Agreement is terminated pursuant to clause (e) above, within 12 months after the date of such termination, Magenta enters into a definitive agreement with respect to a subsequent transaction or consummates a subsequent transaction.

A liquidation would be their only realistic option, 12 months is a long time to wait it out for a cash burning biotech with no pipeline (they sold all their assets in April).  In order to close the deal, MGTA needs a majority of the votes cast to vote in favor of the merger (edit: they need a majority of the shares outstanding), the support agreement only has 6.9% of the shares, leaving quite a bit of ground to cover.  Tang Capital Management owns just under 10% and presumably is the Investor named in the background section of the S-4 who proposed a cash tender offer:

Between March 1, 2023 and March 28, 2023, a stockholder of Magenta (the “Investor”) made several unsolicited inquiries to Stephen Mahoney, the President, Chief Financial and Operating Office of Magenta, to inquire whether Magenta would have an interest in the Investor proposing a cash tender offer for Magenta at a discount to its current cash position. No specific proposal, terms or valuation were discussed during this conversation, or any subsequent conversation between the Investor and representatives of Magenta.

It is unlikely that Tang would vote in favor of the reverse merger at this point, given the current discount to cash.  I'm guessing it will be challenging for management to get the 50% of the vote necessary, but as we've seen in other microcaps, getting investors to vote at all could be an issue.  A non-vote here doesn't impact the vote one way or another, likely benefitting management.

MGTA's target net cash position at the time of closing (Q3) per the merger agreement is $60MM, if we assume that the vote fails and MGTA pursues a liquidation, let's guess that they holdback $10MM for additional winddown expenses or contingencies.

Above is my potential IRR math, I'm assuming an initial distribution by year end and then a small one ($3MM of the $10MM holdback) in 3 years.  In addition, the company did sell their pre-merger assets in April, $20MM in combined milestone payments are in play too, but I'm assuming those are worthless.  The merger vote hasn't been set yet, but I would expect it in early-mid Q3.  I bought more recently.

Disclosure: I own shares of MGTA