We believe that Synergy Pharmaceuticals' (SGYP) stock is poised for a large move in the coming month due to three major company events: initiation of a second Phase III clinical trial of their lead drug, plecanatide; top-line results from their current Phase IIb/III trial of plecanatide; and the completion of the merger of Synergy with Callisto Pharmaceuticals (CLSP). Based on the valuations of other biotech companies with drugs in the same therapeutic class as plecanatide, we believe that SGYP stock is significantly undervalued ahead of these major events as outlined below. The first of these events, the initiation of the company's second Phase III trial, will be announced very soon.
About the Drug
Synergy's lead drug, plecanatide, is an analog of Uroguanylin (UroG), a natural human hormone that regulates the secretion of fluid into the intestine. Both the natural hormone and the drug activate Guanylate Cyclase-C (GC-C) receptors in the intestinal lining and induce the cells to discharge water into the intestine promoting stool motility which is critical for normal digestion. According to information on the company's website, plecanatide is more potent than natural UroG because it has an 8-fold higher binding to human GC-C receptors. Plecanatide is being developed to treat Chronic Idiopathic Constipation (CIC) and Constipation Predominant Irritable Bowel Syndrome (IBS-C). In September, Ironwood Pharmaceuticals (IRWD) received FDA approval for Linzess (linaclotide) which was the first GC-C type drug ever approved for treatment of CIC and IBS-C. Linzess and plecanatide are structurally similar and both drugs act in the gut without being absorbed by the body as verified in clinical trials. According to company estimates, the CIC and IBS-C markets represent a $2 billion annual opportunity.
About the Stock
According to their latest quarterly report, Synergy has 66.1 million shares outstanding. (Note, the balance sheet in the 10-Q states 65.806 million shares outstanding, but the notes to the financial statements mention another 299,911 shares issued subsequent to the close of the quarter.) As of September 30th, the company had some $38.7 million in cash and cash-like instruments and prepaid expenses and approximately $5 million in current liabilities resulting in net working capital of some $33 million. SGYP has no long-term debt. The company has 8.46 million shares issuable due to stock options with a weighted average exercise price of $2.40 per share. Of these options, 2.11 million are currently vested and exercisable. Synergy has 5.65 million shares issuable due to issued warrants.
In the nine months ended September 30th 2012, Synergy reported a net loss of some $27 million. While this figure includes about $4 million in non-cash charges, assuming that the company needs $3- $3.5 million per month to operate going forward is a reasonable estimate since one Phase III clinical trial is ending and another one is beginning. Thus the company has 10 months of cash on hand and, as stated in their 10-Q they will need to raise cash to complete development of plecanatide.
On June 21, 2012, the company entered a controlled equity sales agreement to sell up to $30 million of Synergy common stock with Cantor Fitzgerald acting as placement agent. These sales are covered by the company's $250 million mixed-securities shelf offering filed on the same day. Not surprisingly, Cantor Fitzgerald "initiated" coverage of SGYP on September 25th with a "buy" rating. The 299,911 shares sold in October were sold via the placement agent.
Upcoming Major Events
Synergy has 3 major upcoming events that may drive up the share price. First, the company plans to initiate a Phase III trial of plecanatide in patients with IBS-C. The current trial is studying patients with CIC. At the Piper Jaffray Healthcare conference on November 27th, CEO Gary Jacob stated that the IBS-C trial should be launching "any day now". We expect that the announcement of the initiation of this trial will come within the coming week to 10 days, possibly as early as today.
The second major upcoming event for Synergy is their annual meeting of shareholders on January 3rd, 2013. SGYP shareholders will be voting on whether or not to approve the merger with Callisto Pharmaceuticals. Callisto is the largest shareholder of SGYP stock, owning some 34% of the outstanding shares. This concentration of ownership by another entity has been an overhang for SGYP that may be preventing greater institutional accumulation of the stock. On January 3rd, that overhang could be lifted. Note, the merger was first annouced in July of 2012, and the companies have been working behind the scenes to line up enough votes for the merger to be approved. Having recently set a firm date for the vote, management appears to be confident that the merger will be approved on January 3rd. Callisto's 22.3 million shares of SGYP stock will be canceled, and instead, CLSP shareholders will collectively be issued 28.6 million shares of SGYP stock, representing 39.9% of the company. The additional 5.9% of ownership being given to CLSP holders represents dilution to existing SGYP holders, and is being given to compensate the former CLSP shareholders for the 2-year lock-up period that their shares will experience. We spoke with Synergy's CFO, Bernard Denoyer recently and he explained that "the merger with Callisto is an internal house-keeping item that has been pending for a while." SGYP currently carries a $2.47 million dollar accrued expense on its balance sheet which represents several years' worth of expenses related to paying for audits etc. to maintain CLSP's public company status. By merging, these expenses will be eliminated in the future. We believe the merger makes Synergy's capital structure more attractive to institutional investors (and possibly to potential acquirers).
The third and most important upcoming event for Synergy is the release of top-line data from their Phase IIb/III trial of plecanatide in CIC. Note, SGYP's previous Phase IIa trial of plecanatide was a dose ranging and safety trial. Efficacy was NOT a primary endpoint of that trial. Given that plecanatide is an analog of Uro-G (only one amino acid is different), we believe that the upcoming trial results should be positive. According to the company, during the Phase IIa trial, more than 50% of the patients on the drug had their first bowel movement within 7 hours of taking the drug vs. 16 hours for placebo. This suggests that the increased binding affinity of plecanatide at the GC-C receptors may be allowing the drug to induce more fluid into the intestines thereby creating it's therapeutic effect.
Why We See Value
One could make a heap of assumptions regarding approval dates and possible sales rollout and expenses 5 to 10 years out to come up with a discounted future cash flow model; however, a basic valuation for SGYP can be arrived at much more simply using comparables.
IRWD's drug Linzess received FDA approval in September of this year. IRWD currently has 50% of the US rights to the drug with Forest Laboratories (FRX) owning the other half. IRWD currently has a market capitalization of $1.2 billion, and Linzess is their only approved drug. IRWD has several drug candidates in much earlier stages of development, so the primary driver of IRWD's value is their approved drug. IRWD has close to 200 million in cash; therefore, net of cash, the market is attributing approximately $1B to IRWD's assets and pipeline.
Assuming that 80% of IRWD's noncash value comes from their approved drug, the market is attributing a $1.6 billon valuation to Linzess (recall IRWD only owns 50% of the rights to the drug, so we must double the 800M market cap to value the drug properly). This suggests that, should plecanatide be approved after completing clinical trials, the drug should be worth close to $1.6 billion. Since Synergy will have to raise close to $60 million in cash to finish development and get to approval, we expect the share count at approval to be between 85 and 100 million shares, suggesting a valuation of $16 - $19 per share by 2015. The present value of the shares should lie between $11.50 and $14 based on these estimates and a reasonable assumption of discount rates (15%). Based on these (very rough) estimates, SGYP is undervalued by up to 180% if the clinical trials are strongly positive. This undervaluation reflects the significant uncertainty in predicting trial results.
We note that consensus estimates by sell side analysts have a buy rating on the stock with price targets ranging from $7 to $25 with a median target of $10.25 and a mean of $12.17. At Red Acre, we rely on our own analysis and do not place undue emphasis on the sell-side community agreeing with our view. On the other hand, seeing that other successful investors are on the same side of the trade is often helpful. In the case of SGYP, we note that Baker Brothers Advisors own some 2.4% of Synergy's outstanding shares. Baker Brothers Advisors are also large holders of Acadia Pharmaceuticals (ACAD), another small company that recently announced stellar top-line results and delivered gains of over 300% for investors who bought based on our initial recommendation and sold right after the trial results were announced as we suggested.
Another reason we see value in SGYP is that the company's chairman, Gabrielle Cerrone, has significant experience in leading biotech companies thorough successful development and acquisition. This profile outlines his career in some detail. In addition to having several successful biotech acquisitions, Mr. Cerrone recently purchased 87,820 shares of SGYP stock when it was trading below $4.
Synergy pharmaceuticals is substantially undervalued if their upcoming clinical trials turn out positive. Based on the fact that plecanatide is a more potently binding analog to a naturally occurring hormone that increases fluid in the intestines, we believe that the clinical trial results have a very good chance of being positive. The market has largely ignored SGYP due to its small market cap and the overhang from the 34% ownership by Callisto. The upcoming annual meeting of shareholders for SGYP and CLSP on January 3rd should resolve the ownership issue and clear the way to increased institutional interest in the name. During his presentation at the Piper Jaffray Healthcare conference (see link above), Synergy's CEO Gary Jacob stated that the Phase 3 top-line results should be out in the first week of January. The start of their next Phase III trial, which may be announced any day this week, could be a trigger for an upward move in the stock price.
Holding long through a binary event is always a risky proposition because of the risk of a negative outcome. If the top-line results from their current Phase IIb/III trial fail to meet the efficacy endpoint, SGYP could trade down as low as cash value (about 60 cents per share). On the other hand, unequivocally positive results combined with the clearing of the ownership issues set up the stock to increase in price, potentially by more than 100%. If one were to weigh these two outcomes as equally likely, SGYP would be fairly valued at $6.05. At Red Acre Investments, we believe that the trial results have a 75% chance of being positive. Using the low end of our valuation estimate, we calculate fair value ahead of the trial results to be (75%X$11.50 + 25%X$.60) = $8.77. SGYP is undervalued ahead of the clinical trial results if one assumes that the trial has at least a 50% chance of meeting its efficacy endpoints.
SGYP's stock recently traded as low as $2.98 per share. Momentum traders who have been playing the run-up in price but who do not intend to hold through the binary event have recently begun exiting the stock as seen by the dip in price in the past few trading sessions. There may be some additional selling pressure in the last week of December since the trial results are due in the first week of January, and investors should keep these dynamics in mind if they are on the sidelines and considering establishing a position. Also investors should keep in mind that SGYP's options are thinly traded and should plan options strategies accordingly.