Editor's Note: SA author Jason Napodano has written a rebuttal of this article. You can access it here.
Organovo (ONVO) is about as hot as any concept stock could ever be right now. It sits right at the crossroads of 3D printing and regenerative biotechnology. In addition, Organovo just uplisted from the OTCBB to the NYSE, further fueling the strong enthusiasm.
Following the uplist, Organovo soared from $3.90 to $8.50, a gain of over 100%. But since then it has been dropping almost daily. By Monday it had fallen 26% to $6.29. However, yesterday the latest issue of Popular Science hit the newsstands with a cover story featuring futuristic "bio-printing". Organovo was mentioned and the stock soared as much as 15% due to the article alone.
The article was clearly good for a predictable trade. It was also welcome relief for investors who were getting tired of seeing their stock give up gains each day. But those who are still left holding are likely walking in front of a moving train.
Popular Science has been a long time source of very interesting and thought provoking topics including flying cars and life on Mars. But in stoking the imagination, it tends to ignore many of the practicalities that these futuristic ideas entail.
With Organovo, we are now seeing a "rush for the exits" from different classes of sellers who are trying to beat each other to hit the sell button. With over $300 million in stock coming for sale, this will easily take the stock back to $4-$5 very quickly.
Overall, those who choose to hold shares of Organovo are likely fighting a losing battle which really just comes down to a huge supply of available shares coming for sale which can overwhelm current demand.
No one has a perfect crystal ball to predict where Organovo will be in 10 years' time. The stock could be at $30 or it could be at zero.
While the concept is extremely cool, the company is extremely speculative.
Almost all revenues (only a few hundred thousand dollars per quarter) at present are the result of government grants and research collaborations. Revenues from actual product sales are still years away at best. The stock currently boasts a market cap of over $400 million (over $500 million fully diluted), despite having almost no revenues or near-term revenue prospects. Against this $500 million valuation, the company has just $15 million in cash. Aside from this, the company has only $1.5 million in total assets. This is truly a "blue sky", concept stock.
Fortunately, we all have the tools to predict the share price performance in the near term.
A sharp rise upon the uplisting was certainly easy to predict. The company had implemented all of the perfunctory corporate governance and structural measures necessary for an uplisting. Management had also been hinting at it for some time. Anyone who sold before the uplisting was either not paying attention or was just too impatient to wait for this predictable move up. However, the 100% gain was certainly larger than anyone could have predicted.
Now that the uplisting is behind us, a near-term drop of at least 20-30% is easy to predict due to the following four very visible sell catalysts:
First, Organovo overshot on its uplisting, doubling from $3.90 to nearly $8.00 on that event alone. Many stocks will see a bump up of around 10-30% upon uplisting due to the improved liquidity that a senior exchange provides. But given that an uplisting involves no fundamental change in the business, any increases of more than 30% are typically very short lived. The 100% gain experienced by Organovo was highly unusual and has already begun to reverse itself.
Second, there is a substantial overhang of 32 million shares (around $200 million) from the sellers who were named in the April prospectus from the Reg D offerings. These investors would certainly not have sold before the uplisting. For anyone who had already been waiting for over a year to sell their stock, waiting an extra few months for the uplisting would be just plain common sense. The stock began its run up after the announcement on July 9th, but has only been on the NYSE for a few days. As a result, there simply has not been enough time for these sellers to complete their selling.
An article in May entitled "Get Rich or Die Tryin'" highlighted this overhang and caused a brief dip in the share price. But the volume that resulted from that article was nowhere near what would have been necessary to clear this number of shares and the price drop was not nearly as steep. So again, it is only sensible to conclude that the majority of holders were waiting for the uplist catalyst in order to sell their shares. The liquidity event that they have been waiting for is happening right now.
It should also be noted that many of the 16 million warrants that are listed in the prospectus would have already been exercised, either voluntarily or due to forced conversion by the company. When the warrants are exercised, the holder is then left with shares which must be sold. So the simple act of exercising the warrant does not remove the overhang. Only selling the underlying shares removes the overhang.
Third, Organovo just filed an S3 registration statement for the sale of $100 million in new shares. The S3 was just filed on July 17th, meaning that it was ready and waiting for the uplisting. By filing immediately after the uplisting, Organovo has signaled its intent to proceed with the offering as quickly as possible, taking full advantage of the strong share price. But with an offering size of around 25% of market cap, this deal will require a discount of around 20%. Relative to the current price, that would price the offering at around $5.50 plus warrants. However, the offering is now competing with the existing Reg D sellers. Any additional selling from the Reg D sellers will mean that Organovo must price its $100 million offering at an even lower level.
Fourth, the uplisting has also made Organovo a much easier stock to short. Shorting a stock which just spiked due to its uplisting is often an easy money trade. But when such a stock has as much as $300 million in imminent selling due to two registration statements, it becomes almost too easy for short sellers to pass up. There is ample ammunition to make the stock fall, but there is virtually nothing that could make the stock rise substantially for more than a day or so.
As with the Reg D sellers, short sellers will likely drive the share price lower. This will potentially cause Organovo to price its equity offering below $5.00 if the price dips even slightly.
We can already see that the shorts have been flocking to Organovo as soon as the uplist was complete. The stock was quickly placed on the short sale restriction list due to heavy shorting. Borrowable shares have been snapped up almost as quickly as they become available due to very high demand.
Trading the uplisting
Anyone who follows uplistings should certainly have predicted that this one was coming. An uplisting is actually not a difficult process to undertake. In fact it is entirely mechanical and perfunctory.
Obtaining the original shell on the OTCBB is as easy as completing a reverse merger with a once-defunct company. Organovo completed its reverse merger in a series of transactions in 2011 and 2012.
From there, getting to the NYSE was easy. All that Organovo had to do was implement a board which was comprised mainly of independent directors and then establish three board committees (audit, nominations, compensation). The biggest impediment keeping most issuers from the NYSE or NASDAQ is the market cap and share price restriction. However, the sharp rise in Organovo's stock this year made the uplisting almost a sure thing.
Organovo's uplisting was entirely predictable and had been hinted at by the CEO for months. Despite this, the stock quickly doubled.
Investors need to keep in mind that there has been no fundamental change to the actual company which would change its valuation. It is the same company which now simply trades on a more liquid exchange.
In addition, many investors continue to be mistaken in assuming that the uplist implies some type of positive opinion being expressed by the exchange with respect to the company. This is absolutely not the case. Instead, the company simply fulfilled a simple check list of criteria and was then automatically accepted. In the past we have seen hundreds of companies undergo the identical process. A few years ago, it was the case that hundreds of fraudulent Chinese companies became listed on the NYSE and the NASDAQ. When they were ultimately delisted again due to fraud, the NASDAQ and the NYSE were very quick to point out that uplisting does not involve any qualitative assessment on a company's investment merits.
The key point is that holding Organovo prior to the uplisting was an obvious and easy trade. The uplisting was almost certain to provide a quick boost of 10-30%. But once the share price spiked by 100% with no fundamental developments, selling it is now an even more obvious trade.
The impact of a 32 million share overhang
Back in April, Organovo filed a prospectus which allowed for the sale of 32 million shares of stock by selling stockholders. These shareholders got in at a price of just $1-2 per share around 18 months ago and are now sitting on 3-4 baggers in that time.
Expecting these shareholders to continue to hold such a quick home run forever is just plain unrealistic. In addition, the timing of the uplist coming just 9 weeks after the prospectus suggests that this was very much a planned liquidity event for these shareholders.
Some may be tempted to think that these shares were already sold following the "Get Rich or Die Tryin'" article in May. This is clearly not the case. That article caused a brief dip in the share price. But the volume only exceeded 1 million shares for two days. Within days of the article, the volume was back down to 200,000-300,000 shares per day - not nearly enough to clear such a huge overhang.
The ability for these holders to eventually sell was entirely made possible by the uplist to the NYSE. Just prior to the uplisting, the stock was trading only around 100,000 shares per day. A full liquidation of 32 million shares would easily have taken months and would have put extreme pressure on the share price.
Now the stock has far greater liquidity and the share price is 100% higher than where it was before the uplist.
Although this is highly beneficial for those who are selling, it will still mean heavy pressure on the share price for those who continue to hold. At current prices, the 32 million shares equates to around $200 million, or roughly 50% of Organovo's market cap!
Even at prices of around $4.00, this means that many of these holders will still be sitting on 4 baggers. If selling at around $6.00, these holders are locking in quick 6 baggers. The point is that these sellers will likely not be very sensitive to price when locking in their tremendous gains. They have more to lose by waiting than they have to gain.
There has simply not been enough volume to allow for sales of 100% of these shares since the uplisting, which means that we will likely see continued pressure on the share price. We have already seen it dip from a high of $8.50 on Thursday to a low of $6.29 on Tuesday - a very quick retreat of 26%.
Evaluating the $100 million S3 offering
Organovo filed its $100 million S3 shelf registration statement just 1 week after it became listed on the NYSE. The timing of this filing was clearly not a coincidence.
Documents such as this will take the company and its legal counsel weeks to complete. But completing it before the uplisting would have been a waste of time and money because there would be many stock specific sections that would need to be redrafted following the move to a new exchange.
Instead the company clearly had a fully drafted S3 which applied to an uplisted stock even before the uplisting had occurred. They simply waited for the uplisting to take place and then filed the document almost immediately.
Given the price and liquidity before the uplist, launching such an offering at that time would not have been possible.
Offerings such as this can be differentiated between operational offerings and opportunistic offerings. Operational offerings are sized according to specific operational needs which are defined in the "use of proceeds" section. Opportunistic offerings are typically done simply to take advantage of an unusually high share price.
The offering by Organovo is really a combination of the two offering types. It is clear that the company does have an operational need. Losses have ranged anywhere from $10 million to almost $40 million - per quarter! Last year the company burned $10 million in cash, while in the most recent quarter the company burned $3 million in cash. Yet the company currently has only $15.6 million in cash. The company clearly needs to raise at least $30-40 million in the near term.
But the offering size of $100 million clearly reflects a view by the company that the current share price makes NOW the time to raise as much as possible.
This is further confirmed by the defined use of proceeds, which is totally open ended and non-committal:
Except as described in any prospectus supplement and any free writing prospectus in connection with a specific offering, we currently intend to use the net proceeds from the sale of the securities offered under this prospectus for general corporate purposes, including research and development, the development and commercialization of our products, general administrative expenses, license or technology acquisitions, and working capital and capital expenditures.
We may also use the net proceeds to repay any debts and/or invest in or acquire complementary businesses, products or technologies, although we have no current commitments or agreements with respect to any such investments or acquisitions as of the date of this prospectus.
We have not determined the amount of net proceeds to be used specifically for the foregoing purposes.
As a result, our management will have broad discretion in the allocation of the net proceeds and investors will be relying on the judgment of our management regarding the application of the proceeds of any sale of the securities.
Pending use of the net proceeds, we intend to invest the proceeds in short-term, investment-grade, interest-bearing instruments.
This is a very boiler plate use of proceeds definition for companies who wish to complete an opportunistic offering. It basically says "We know that we will need the money sooner or later, so just trust us." It is also a very clear way of management saying that "at the current share price, we wish to sell every share possible."
The problem for current investors is that the offering size is extremely large. At nearly 25% of market cap, the $100 million offering will likely require a 15-20% discount from the current share price. The offering is made more difficult given that the stock is almost entirely held by retail investors. A $100 million offering will clearly require the participation of institutions into a stock which has never had institutional interest. This will likely mean the further issuance of a large number of warrants as we have seen in the past.
All in all, if the offering were priced today, it would likely be priced at around $5.50 or below and would include warrant coverage. This would almost certainly send the share price back to around $4.50 in short order.
The problem is that now the company is competing with the Reg D sellers for who gets to sell first. If the stock falls below $6.00 due to Reg D selling, then the company may end up selling at below $4.50 under the S3 and having to include even more warrants.
For those who wish to remain longer-term holders of Organovo, there is no reason to hold at a time when the share price is likely to exhibit a predictable decline of 20-30%. It is just as easy to sell now and buy back in at prices below $5.00 again.
Here come the shorts
One of the biggest positives of an uplisting is the fact that liquidity is greatly improved on a senior exchange. This will typically provide a boost to the share price. But it is often overlooked that the uplisting is typically the beginning of meaningful short interest. Once the share price rises, the new wave of shorts can often push it back down significantly.
Shorting OTCBB stocks is often a losing game due to the poor liquidity. As a result, funds who wish to short an OTCBB stock will simply keep it on their watch list and wait until it uplists. This strategy has an added benefit in that it usually becomes possible to short the stock at a noticeably higher level due to the predictable pop upon uplisting. This is exactly what we have seen with Organovo.
This short selling should be expected to create additional downward pressure on the stock at just the time the company is looking to issue stock.
Now there are 3 major competitors all selling stock at the same time: Reg D sellers, short sellers and the company itself with its $100 million S3.
Prior to the uplist, only about 1% of shares were sold short. This is virtually nil. When short interest is already high, any changes in the short will not have a noticeable effect on the share price. But when short interest is going from nothing up to something high, the effect on share price can be pronounced. As a high flying stock with minimal revenues, Organovo could expect to see as much as 25% of shares sold short - around 15 million shares. At a minimum, this will serve to cap further upside in the share price. At a maximum, it could end up driving the share price much lower when combined with the Reg D selling.
Valuation considerations for Organovo
At the present time, there is no defensible way to place a fundamental valuation on shares of Organovo. The best we can do is try to predict how certain events will move the stock in one direction or another. The uplisting saw a move up while the flood of shareholder and company selling will knock the stock back down substantially.
Organovo now sports a fully diluted market cap of around half a billion dollars. This market cap will grow considerably larger once the $100 million S3 offering is completed.
Against this, the company has only generated lifetime revenues of a few million dollars. These revenues have primarily been the result of government grants and research collaborations. There have been virtually no meaningful revenues from actual sales of a product. Any material revenues are still years away at best.
As a result, investing in Organovo is largely about investing in a story, not about investing in financials. This is the primary benefit of using a reverse merger to list on the OTCBB.
If Organovo were a private company attempting to tap private equity investors, there is simply no way that these investors would award a half billion dollar valuation to a company which only generates a few hundred thousand dollars per quarter in total revenue.
But the reverse merger-OTCBB-uplist process is both cheap and easy. This allows the company to tap into retail investors who are willing to invest based on a sexy story and based on current market hype for both biotech and 3D printing.
Investors cannot say that they were not warned about the speculative nature of Organovo's stock. The list of risk factors runs longer than most companies at 13 pages. The company has made it clear that they are working with an unproven emerging technology which may never amount to anything. They have also clearly stated that they will continue raising money and incurring losses for the foreseeable future. This is all part of the norm for this category of speculative "concept stock". There is simply no foundation upon which to build a traditional valuation framework.
For those who choose to invest in Organovo, it is essential to keep abreast of any new corporate developments. But of even greater importance is the continuous monitoring of the market for signs of increased or decreased hype surrounding the space. With no real revenues or assets, this stock is affected far more dramatically by sentiment towards the space than it is by actual developments at the company.
Organovo - longer term investment thesis
Organovo is hoping to one day commercialize technology that generates human tissues. The company hopes that its technology could one day generate tissues for use in drug discovery and development, biological research, and therapeutic implants. The previous technologies in the field have relied on monolayer (2D) cell cultures. Organovo hopes to create constructs in 3D that could potentially replicate human biology.
According to the 10-K, Organovo's technology is derived from the research of Dr. Gabor Forgacs, a professor at the University of Missouri. The company currently holds licenses to patents from the University of Missouri-Columbia, Clemson University, and Becton Dickinson. The Company has outright ownership of six other patents.
Organovo's path to its current point in the development process has been long but the company still has far to go.
In 2004 Dr. Forgacs began working on organ printing at the University of Missouri-Columbia when his team was awarded the $5 million National Science Foundation Frontiers in Integrative Biological Research (FIBR) grant. This same team subsequently filed the first patent application for the NovoGen™ bioprinting platform. Following the technological developments under Dr. Forgacs direction, a founding team formed and Organovo incorporated in 2007. In July 2008 the company raised $3 million in angel funding, and Organovo opened laboratories in San Diego in January 2009. As Organovo continues down the path towards commercialization, the company has entered into collaborative research agreements with pharmaceutical corporations and federal grants as well. The company first began to form corporate partnerships in the drug discovery area with pharmaceutical and biotech companies in March 2011. In February 2012 the company went public in a $15.2 million financing round. Clearly, the company has grown enormously since its $3 million angel investment in 2008 and $15.2 million financing round in 2012, one-and-a-half years ago. However, Organovo's technology remains extraordinarily speculative and conceptual. It is likely 10 years away from being any sort of reality.
The key to the company's technology is the NovoGen MMX Bioprinter™ which the company proudly states it developed within two-and-a-half years of commencing operations. Organovo's technologies enable various types of tissues to be created using combinations of three types of building blocks that themselves include combinations of "bio-ink" comprised of only cells and "hydrogel" comprised of biocompatible gel. The company believes that at least part of the tissues its technology creates could be constructed solely of cells, a key differentiator from older technologies. This feature enables Organovo to generate architecturally and compositionally defined functional human tissues for in vitro use in drug discovery and development. This can potentially allow more efficient drug development by eliminating the need for actual human subjects in some cases. To illustrate the enormous utility of this, imagine how much more efficient it would be to test drugs on human tissue that can be constructed in a lab than it would be to test drugs on actual people who must be recruited and for whom safety must be assured. Moreover, tissues created using Organovo's technology may be more effective than animal testing. Organovo's fully cellular constructs may also offer advantages in regenerative medicine such as augmenting or replacing damaged tissues. In addition to products for use in drug discovery/development and regenerative medicine, Organovo plans to sell 3D bioprinters for use in medical research and a portfolio of consumables for use with the bioprinters. The role of consumables is conceptually similar to the role of ink in the business model of traditional printer manufacturers.
While the products Organovo is developing may, in the long term, represent significant advances over today's technology, the company is innovating in a rapidly changing field, and by the time the company's products reach the market, the landscape may be very different. While Organovo works on their 3D printing technology, pharmaceutical, biotech and diagnostic companies, as well as research institutions and government agencies are pursuing related technologies that have the potential to make Organovo's technology obsolete. In fact, the scariest thing is that it is very possible that this obsolescence could occur before the company is even able to realize any material revenues from its technology.