Biotech startups by their very nature blow through a ton of cash until they can get to the commercialization process and become cash flow positive. Before that time, they have an important decision to make - whether to finance their drug themselves through to the commercialization process or to find a partner with cash and expertise to help them. Choosing the wrong method and being faced with a cash crunch during the wrong time on the market can result in significant dilution or the liquidation of the company.
A stock that has made a lot of noise lately has been Sarepta Therapeutics, Inc. (SRPT) thanks to the extremely successful results of their lead drug eteplirsen in its battle against Duchenne muscular dystrophy. It's been a favorite option play of mine, as I have gone with calls and puts in the lower end and higher end of their trading range over the past 6 months. I find SRPT's stock price in the low 30s to be a fair price at the moment, given the recent news and market conditions; I don't hold any long or short positions at this time. Therefore I believe I'm as an objective observer as one can get when analyzing this company. Despite the good that the company can do from a medical standpoint, from a stock market perspective, it has been very polarizing, and a lot of what I read about the stock has blatant long or short bias.
In terms of a partner versus finance decision, it is clear that the correct path for SRPT is to commercialize eteplirsen themselves. It has nearly $180 million in cash net of debt as of the end of 2012 and has shown an ability and willingness to finance rather large sums of money over the past year.
The important decision for them is: how much more should they finance? My suggestion would be that whatever amount Sarepta believes it will need to get to commercialization under the slowest FDA approval scenario, it should add about 50% of that and go see if it can finance that in cash right now. If SRPT can get that amount for $30 or even $25 a share, the company should not hesitate for a second to get it.
Some people may not like this idea, as it could dilute the stock by as much as 50%, but we have to consider a stock like Dendreon (DNDN). When it was trading at $50+ in 2010, there were a ton of people screaming buy with absurd targets like $500, just like many are doing with SRPT right now. Now DNDN trades at under $5.
We have to consider the market. SRPT has done very well for itself over the past year in a market, which many people believe, is in a bubble thanks to low interest rates and a wavering economy. Similar biotech stocks like DNDN and other medium sized companies that don't earn much revenue and are cash flow negative have not had it as good as SRPT in terms of recent stock price performance.
Having an absurdly high amount of cash to ensure funding through the commercialization process, even if there are setbacks, will guarantee that SRPT does not become the next DNDN. If another 2008-like market crash were to happen, the company would have the financial flexibility to do what it needs to do without worrying about the cash crunch like other companies would. Shareholders might have their upside potential cut in half, but even more importantly, their downside risk is significantly cut, as even in the biggest market bear scenario, there would be a floor on the price somewhere around the cash per share of the stock.
Despite having nearly $180 million in net cash, SRPT's burn rate is quite high, so it may need to finance again in 2014. Waiting until then is a little like playing Russian Roulette in terms of where the market could be. If prices aren't so favorable to equities at that time or if the FDA decides to take their sweet time to come to a decision on eteplirsen, the company might end up diluting at much lower prices than today. There really is no downside to financing today other than giving up some future upside potential in the stock price. There is no such thing as having too much cash if they overdo it. Eteplirsen is a miracle drug and they should be able to get the money today at very good prices if they pursued that avenue.
While financing is the best approach for Sarepta, some biotechs can do well with a partnership. One example is a Canadian company called Med BioGene (OTC:MBGNF). It trades on the TSX Venture under the symbol MBI. Anyone familiar with the TSX Venture knows what a running joke it is. The entire index is down 35% in one year and is down over 60% from its peak in early 2011. That's while almost every other market in the world has gained in price during that time. MBI is one of the few stocks on the Exchange that have provided investors with good returns over the past couple of years.
Two years ago, the company was on the brink of bankruptcy and traded at 3 cents. It decided to partner up with Precision Therapeutics to commercialize LungExpress Dx (now called GeneFX® Lung). It got the necessary cash infusion from Precision to pay off its debt, and now the company sits and waits as Precision commercializes GeneFX® Lung over the summer. Upon commercialization, MBI receives another cash infusion from Precision and won't need to finance until the third quarter of 2015 at the earliest and may never need to finance again if sales sufficiently pick up by that time.
MBI collects a royalty from sales of GeneFX® Lung in the high single digits (7% to 9%) while Precision pays for 100% of the costs. Other than general and admin costs of less than $400K per year and a royalty owed to the University Health Network (UHN) that will be paid out as a percentage of the royalties received from Precision in the high teens, Med BioGene will occur no other expenses while their revenue base grows.
Once GeneFX® Lung hits $10 million a year in sales, MBI will be cash flow positive even under the most conservative of royalty scenarios. If GeneFX® Lung were to hit $100 million a year in sales, MBI would receive gross revenue between $7 to $9M with net income in excess of $5M per year. Not bad for a TSX Venture penny stock with a market capitalization of less than $8 million. Here is an article outlining the potential market and growth for GeneFX® Lung for Precision and Med BioGene.
Financing and going to market as an independent company would work best for SRPT, as the company can keep 100% share of eteplirsen, which more than makes up for the fact that they'll have to dilute their stock further to do so. On the opposite end of the spectrum, Med BioGene partnered up with Precision Therapeutics and had to give up 92% of the share of its pipeline. But keeping 8% while having Precision Therapeutics mass market GeneFX® Lung and paying for none of the associated costs is better than keeping 100% of the share of a product they would not have the cash resources to market themselves, or the dilution needed would be far too disruptive to the stock price.
Both companies are good examples of effectively managing a development-stage biotech corporation to maximize shareholder return. There are numerous examples out there of companies that were unable to do so, despite good science behind their pipeline. What can be learned from this is when you choose your biotech stocks, you can't just choose the ones with the best science or even the best market. To give yourself a shot at positive returns over the long haul, you have to choose the companies that are able to make the correct go-to-market decisions within the restraint of their financial resources. Having great science doesn't help you much if that science is eventually commercialized under the equity of the former bondholders post-bankruptcy or under a vulture fund that picked up your company at a fraction of the stock price you paid for it.