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The opportunity

Rockwell (NASDAQ:RMTI) shares have been hammered down to $3.00 from $8.00 in the past month because of a financing overhang that has been going on for five months. Last November, the company surprised the market with a much faster burn rate than expected leaving cash levels at only a few quarters of burn. During its Q3 call the company said it would raise capital from either of (1.) licensing its lead drug candidate SFP outside the US (2.) potential partnerships (3.) other alternatives. RMTI took too long to raise cash from the first two options. Accordingly the stock has crashed to this absurd sub $100 mn value as the "wolves of Wall Street" smelled blood. Rockwell is not unique. It is common for biotech stocks to get hammered due to a financing overhang. For example, Supernus Pharmaceutical, (NASDAQ:SUPN) saw a huge increase in its short interest shortly before announcing a funding gap last week. Its shares dropped rapidly to $5.00 from $8.00 in one week. Short attacks happen to biotech share prices regardless of the quality of their science. It is up to management of the biotech to manage their cash balances so their equity does not become vulnerable.

In early February RMTI released results from its Prime study (marketing study) and despite SFP showing great results of an ESA reduction of 37%, the stock got slammed. The "wolves of Wall Street" knew the Prime data was not "pivotal" for value creation and that the big issue facing RMTI was that its resources were running dangerously low. Thus the stock was vulnerable to weakness until the financing issue was resolved. The stock was hit with aggressive short selling (short interest increase to 3.2 mn shares from 1.7 mn shares) and the shares went straight down since the positive Prime data.

Now fully funded to pivotal phase III data due in July

On the Q4 investor call held on March 18th management stated the pivotal phase III SFP results (Cruise I) will be released in July, in line with sell side expectations.

With the subsequent $12 mn cash raise (4.3 mn shares @ $3.00 on 03/20/13), the financing overhang is removed. Rockwell has sufficient cash to fund its phase III program so that it can release pivotal data in July. There was growing risk that the progress of the phase III program would be delayed the longer RMTI ran without sufficient funds. That is no longer the case. The cash raised from the recent offering ensures that the SFP pivotal phase III data will be released in July.

RMTI will need to raise another $20 mn to $30 mn to fully fund the rest of the phase III program and to fund the submission of an NDA to the FDA targeted for the end of 2013. Capital may come from the potential licensing and/or partnerships RMTI identified or alternatively it will be easy for RMTI to raise capital at much higher valuations if the phase III results are positive.

$23.00+ share value on positive phase III data

Positive phase III SFP results will be transformative for RMTI justifying a market value of $600+ mn without giving value to the existing dialysis business and future vitamin D business.

SFP has an excellent safety profile and unlike IV iron there is no significant increase in ferritin iron stores in the body which can be toxic to the liver. The science behind SFP is different and better than the current IV irons which supports the case for SFP to take the entire IV iron market. The US iron market is estimated at $600 mn and RMTI's customer base comprises 25% of the market. So unlike a typical biotech, RMTI has established sales and distribution ready to sell SFP which should lead to rapid sales growth.

The sell side average price target for RMTI is $16.00. These targets will be raised on positive phase III results as is typical.

Keryx Biopharmaceutical (NASDAQ:KERX) serves as a good proxy for how RMTI should respond to positive phase III results. KERX achieved a peak market value of $900 mn in just three days in response to its positive phase III results for Zerenex (phosphate binder for ckd) and it has settled in the $600 mn market value range. Sell side consensus estimates for outer year profitability for KERX is nearly identical to RMTI. Both companies are expected to earn approximately $70 mn net income in 2015 and $85 mn net income in 2016. Another comparable, AMAG Pharmaceuticals (NASDAQ:AMAG) reached a market value of $700 mn in response to reaching the endpoint of its phase III program for its IV iron Feraheme in 2006.

With 26 mn shares outstanding RMTI will trade at $23.00 to reach a $600 mn valuation.

How high can RMTI trade ahead of the release of data?

RMTI should trade $8.00+ in anticipation of SFP phase III results in July. KERX traded at a $250 mn value before the release of its phase III data and AMAG traded at $350 mn value ahead of its phase III data. At $8.00 RMTI market value is $208 mn.

Probability of positive phase III results is high

On the Q4 investor call management stated that the data from the Prime study implies the change in hemoglobin was 1.0 to 1.5 grams for patients without SFP. This is significantly greater than the 0.5 gram end point required for the phase III Cruise study. The Prime study enrolled 100 patients so the sample size is relatively close to the size of the 300 patient arm of Cruse I. This gives confidence that as the number of patients "n" increases that there is no change in the efficacy outcome. In addition, the efficacy endpoint was met in the phase IIb trial. So we have consistency of data points from two trials that show the efficacy endpoint for the phase III trial will be reached.

Trading opportunity

With the financing overhang removed the stock should trade higher as the discount between $3.00 and a $20.00+ potential value in a few months is too great.

In addition to an outright long in the common shares, the August $5.00 calls are cheap at $0.25 and offer considerable upside of $18.00 or 90x return to $23.00. There have been a large number of August $5.00 and $7.50 calls sold over the past month (2.2 mn and 1.1 mn) likely purchased by short sellers as a hedge. The majority of these calls are likely "naked" and will contribute to a short squeeze on positive phase III results in July.

RMTI management has missed deadlines previously so that brings to question if they can deliver SFP data in July. In support of management credibility they did release Prime results in February as guided. Moreover, the July guidance for SFP pivotal results appears easily achievable. The last patient enrolled in the Cruise I trial was on May 31, 2012. Patients are enrolled up to 12 months. Assuming the last patient stays enrolled for the full 12 months then the last data to be collected will be May 31, 2013. Normally it takes about four weeks to compile, analyze and report data. If we add a two week buffer then we arrive at a mid July release date. The August calls expire on August 17, so there is a comfortable four week buffer from the mid July date for a total six week buffer for time delays. Thus the August calls are highly attractive.

Source: Rockwell May Rise On Positive Phase III Results In July