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By Jake King

At the end of June, biotech giant Celgene (NASDAQ:CELG) made a $15M investment in a small and obscure biotech for the right-of-first-negotiation to one of its lead development candidates. At the same time, long-time investors in the small regenerative medicine company put up another $18.6M in convertible debt, bringing the aggregate capital raised in this round of financing to $33.6M. The deal caught our eye for good reason. Some "smart money" was involved in the financing, and Tengion (OTCQB:TNGN), a developer of regenerative medicines, appears remarkably cheap at a glance. The company develops regenerative products comprised of a patient's own cells that can be implanted into the body to repair or replace damaged tissue or organs. It's next-generation technology, but what makes Tengion a compelling story to the casual investor is the company's apparent valuation -- a $3.75M market capitalization and a negative enterprise value following the latest financing.

But a closer look tells a much different story, and Tengion may in fact be one of the biggest value traps in the biotech space. A poorly managed balance sheet and developmental delays over the last three years have resulted in a 1-for-10 reverse split, a NASDAQ de-listing, repeated dilutive financings, and a plethora of convertible debt and warrants. Tengion's outstanding share count -- just 3.4 million -- fails to capture the company's extensive convertible debt and existing warrants. Fully diluted, Tengion's market capitalization is closer to $250M.

The "smart money" that caught our attention is certainly that; these institutional buyers hold stakes in Tengion at marked discounts to market, bought with immense deal-sweeteners, and had the wherewithal to build highly advantageous re-pricing arrangements into Tengion's previous offerings. The news that Celgene was making a contribution alongside the June 28th financing has prompted a parabolic rally in the three weeks following, and TNGN has doubled in price since July 1. We believe that retail investors have jumped in with fervor, misinterpreting Tengion's low market capitalization and Celgene's investment as a cheap opportunity and validation of the technology. While Tengion might be making incremental headway in a complex space, investors who buy on the open market are in for a rude awakening -- TNGN is a value trap of epic proportions, and shareholders won't want to be stuck holding the bag as conversions materialize, diluting their existing shares by more than 6600%.

Tengion's Regenerative Medicine

Tengion's roots begin with the research of Anthony Atala, TED-talker and Director of the Wake Forest Institute for Regenerative Medicine. Atala's and Wake Forest's claim to fame stem from their development of "lab-grown" bladders. A bladder biopsy is performed with the intent of isolating and extracting specialized bladder and muscle cells called urothelial cells. These cells are then cultured in the lab. After sufficient growth, they are placed on a specially designed bio-scaffold made from PGA/PLGA and left to continue growing. The final product is then attached to the patient's own bladder, where over time the PGA/PLGA scaffold is processed and excreted by the body.

Tengion has adopted the same underlying technique for its Neo-Urinary Conduit (NYSE:NUC) and Neo-Kidney Augment (NYSE:NKA) products. Here's a description provided by Tengion: "The NUC under investigation is a regenerative medicine product comprised of the patient's own smooth muscle cells, procured from a fat biopsy. Tengion has developed appropriate culture conditions to reproducibly generate the necessary quantities of SMC in vitro from autologous adipose tissue biopsies. The NUC is produced at Tengion's Good Manufacturing Practices (GMP) qualified clinical production facility. In this process, smooth muscle cells (SMC) obtained from an adipose tissue biopsy are propagated ex-vivo for approximately 3 - 4 weeks. At the end of this process, the SMCs are seeded onto the surface of a biodegradable PGA/PLGA mesh scaffold to form the NUC. The NUC is shipped to the investigative site for surgical implantation. Over time, the NUC should facilitate the regeneration of urinary tract tissue." The Neo-Urinary Conduit is being developed for the treatment of patients who require bladder removal in connection with bladder, abdominal or pelvic cancer. Tengion's NUC, made from a patient's own cells, diverts urine from the ureters to an ostomy bag outside the body. The current treatment for patients undergoing cystectomy involves the creation of a conduit or bladder replacement with the use of bowel tissue, which carry a host of safety issues. Tengion proposes that the use of a patient's own cells in the creation of a urinary conduit will eliminate the risks associated with current practices. Tengion estimates that more than 28,000 urinary diversion procedures are conducted yearly in the U.S. and E.U.

The Neo-Urinary Conduit is currently in a small Phase 1 study in the U.S., while the Neo-Kidney Augment Program should enter an early proof-of-concept study in the second half of the year. Tengion announced earlier this year that it had successfully implanted the seventh patient in the ongoing Phase 1 NUC trial. The company plans to recruit three additional patients as more trial sites come on-line, and the company has indicated interest in initiating a Phase 2/3 trial in the near future. Tengion's Phase I NUC study won't be completed until 2017.

Simultaneously, Tengion has ramped up development of its Neo-Kidney Augment Program. In April, Tengion announced that the Medical Products Agency in Sweden had accepted its Clinical Trial Application (CTA) to begin a first human study. The CTA will allow Tengion to initiate a Phase I study evaluating the safety and efficacy of the Neo-Kidney Augment. In addition, Tengion plans to file an IND with the FDA in the second half of the year, with initiation of the trial in the fourth quarter if the IND is accepted. Tengion expects to have proof-of concept data in-hand in 2014. As far as Tengion has come, commercialization is still a ways off. After burning through ~$200 million in its 10 years of operation, Tengion has one human study currently active. Getting these products to market is going to take considerably more capital, and that means further dilution for existing shareholders.

A Dilutive History

Tengion was founded in 2003 with an undisclosed amount of capital from HealthCap, Oak Investments Partners and J&J Development Corporation [Johnson and Johnson's (NYSE:JNJ) investment arm]. Originally intended as a funding vehicle for the research of Anthony Atala, an early proponent of regenerative medicine, repeated rounds of financing have resulted in a veritable hijacking by large institutional investors. With the intention of creating artificial functional bladders, Tengion has blown through over over $150 million in cash over the past ten years, money raised at terms that have been increasingly detrimental to the uninitiated investor.

Despite Tengion's unassuming $3.75 million market capitalization, the players involved are surprisingly high profile. Financiers include Oak Investment Partners, J&J, HealthCap, L. Capital Partners, Bain Capital (of Romney fame), Quaker Bioventures, Brookside Capital, Deerfield Capital Management, Horizon Technology Finance Management LLC, Oxford Finance Corporation, and Celgene.

Tengion's first round of funding (Series A and A-1) took place over the course of 2004 and 2005, with Oak, J&J, HealthCap, and L Capital Partners participating. Investors purchased 24,190,672 preferred shares at $1.62 per share, generating net proceeds of $35.3 million for Tengion. Just a year later in 2006, Tengion sold another 27,637,363 preferred shares at $1.82 per share for net proceeds of approximately $50 million. All Series A players participated in this second round of financing, with the addition of Bain Capital, Quaker Bioventures, and Brookside Capital.

By the end of 2006, there were roughly 51.8 million preferred shares outstanding. Tengion secured another $54.6 million (net) in Series C funding over the next two years (2007 and 2008), selling 30,126,092 preferred shares at $1.82/ share. When the company filed its pre-IPO registration statement in December of 2009, its preferred share count stood at 81.95 million.

Tengion IPO'd in April 2010. Initially, the company expected to raise $35 to $44 million in gross proceeds by selling 4.44 million shares at $8-10 apiece. But Tengion's underwriters cut the offering price to $5.00 per share and increased the share count to 6 million, presumably due to low demand for the stock. The company raised $26M in net proceeds and the common stock began trading on the NASDAQ on April 9, 2010 at $5.00. In addition, Tengion executed a reverse split/conversion, rolling the 81.95 million preferred shares into just 5,651,955 common shares through a 1-for-14.5 reverse. On the day of its IPO, Tengion had 12,353,536 shares of common stock outstanding, no preferred shares issued, and $45.3M in cash & equivalents.

TNGN performed poorly through 2010, and things only got worse early in 2011 as the company revealed in February that should it fail to find a buyer for the company or secure capital within two months, it may need to wind down operations -- in other words, bankruptcy. On March 1, a few intrepid investors put up $31.4M in aggregate to keep the company on its feet. Tengion issued 11,079,250 in common stock and an additional 10,460,857 warrants exercisable at $2.88 -- the stock closed the day at $2.49. Still, the company required a significant restructuring in November of 2011 to reduce its cash needs, slashing its workforce by more than 50% and downsizing operations. By the end of 2011, less than two years after its IPO, shares of TNGN had plummeted from $5.00 to $0.35 per share.The split-adjusted chart below shows TNGN's performance since the beginning of 2010.

(click to enlarge)

In 2012 the downward spiral continued. Tengion failed to meet the NASDAQ's minimum bid requirement, prompting a move to the NASDAQ Capital Markets, then a 1-for-10 reverse stock split in June of 2012 to maintain that listing. Finally, despite consummation of the reverse, the company received notice from the NASDAQ and began trading on the OTCQB on September 6, 2012. Shares closed their last day on the NASDAQ at $1.65, $0.165 had it not been for the June reverse.

In-part a result of its poorly performing share price, Tengion turned to debt financing, and the bad turned to worse. On October 2, 2012, Tengion entered into a private placement for $15 million in Senior Secured Convertible Notes with warrants to sweeten the deal. In addition to allowing the Noteholders to convert at $1.00 for 1.33 shares, investors were issued 51.1 million warrants exercisable at $0.75/share (these have since gotten more plentiful and cheaper due to interest and repricing provisions, and are now exercisable at $0.69/share, 57,438,408 warrants). At August 10, 2012, Tengion had a fully diluted share count of 3.8 million shares. Four months later at December 31, 2012, with the addition of just $15M in new capital, TNGN's fully diluted share count stood at ~103.6M shares. Retail investors who bought on the open market, unable to keep up with large institutional deals, saw their stakes diluted to ~4% of their previous value in the second half of 2012.

Although the recent June 28 financing appears to be a call for celebration, a closer examination further demonstrates the strangulation of the retail investor. In the June 28 financing, Tengion sold $18,576,000 in Senior Secured Convertible Notes (convertible at $0.69) to a number of large investors. To sweeten the deal, the same investors received 5-year warrants to purchase up to 26.9M shares, and 10-year warrants for 53.8M shares, (issuable at $0.69/share) for a total of ~81 million shares issuable through warrants. In addition, Celgene put up $15M in cash for the right to first negotiation on the company's Neo-Kidney Augment program. But the deal also granted Celgene 5-year warrants for 7.4M shares and 10-year warrants for 14.9M shares of common stock at an exercise price of $1.01/share. Again, another ~22 million shares issuable through the exercise of warrants. The above 2013 Notes, converted at $0.69, are good for another 26.9M shares. The June 2013 financing effectively doubled the company's fully diluted share count, already a mess following the October 2012 financing.

Open-Market Buying: Like Bringing a Knife to a Gunfight

For those not keeping track at home, Tengion now carries a fully diluted share count of over 230 million shares. In contrast, the company's SEC filings and major financial websites display an outstanding share count of 3.4M, for a market capitalization of just $3.74M. Fully diluted, TNGN is valued at over $250 million, rich in our view considering that the company's lead candidates are still in proof of concept studies. Regenerative medicine is a frontier littered with failed candidates.

It's this disparity that suggests Tengion is a value trap for the casual investor. While TNGN's share price has climbed meteorically over the last three weeks, in large part-due to Celgene's financial involvement, a cursory look glosses over a detrimental situation for investors buying shares on the open market. The 3.4M shares outstanding represent just 1.5% of the fully diluted share count.

While Celgene has made a noteworthy investment, its recent $15M injection means little for a company with $3.5 billion in accessible capital, particularly considering the 22M in warrants acquired in the deal. Tengion, with approximately $30M in cash and an average quarterly burn of $5M, has a year-and-a-half of operations on its balance sheet. We suspect the company will need to return to the equity markets in 2014, much sooner if the company begins two new clinical trials, as planned, in the next six months. If history is any indication, investors can only expect more of the same dilution that has plagued TNGN. In the past three years alone, Tengion's fully diluted share count has climbed by more than 60-fold. Current shareholders would do well to avoid holding what amounts to a rapidly shrinking bag.

Source: Tengion: A Value Trap Of Epic Proportions

Additional disclosure: PropThink is a team of editors, analysts, and writers. This article was written by Jake King. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article. Use of PropThink’s research is at your own risk. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. You should assume that as of the publication date of any report or letter, PropThink, LLC and persons or entities with whom it has relationships (collectively referred to as "PropThink") has a position in all stocks (and/or options of the stock) covered herein that is consistent with the position set forth in our research report. Following publication of any report or letter, PropThink intends to continue transacting in the securities covered herein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. To the best of our knowledge and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable, and not from company insiders or persons who have a relationship with company insiders. Our full disclaimer is available at www.propthink.com/disclaimer.