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