On July 24, 2013, Seeking-Alpha author Richard Pearson published an article: Organovo: Red Hot But Set To Drop. For those unfamiliar with the story, Organovo (ONVO) is a biotechnology company engaged in applying 3-D printing to solving healthcare problems ranging from preclinical toxicity testing to the preparation of complex tissues (and potentially artificial organs) for the treatment of human disease. They are one of the few companies out there marrying two potential breakthrough technologies in 3-D printing and regenerative medicine.
According to his profile, Mr. Pearson is an activist investor and former investment banker focused on Equity Capital Markets. While I commend Mr. Pearson for his efforts in sharing a contrary perspective with Seeking-Alpha readers, the purpose of this article is to address what I believe to be a number of important misunderstandings and misconceptions in his article. Specifically, I found the article to be inaccurate with respect to analysis of the financial statements and believe he has misinterpreted some recent SEC filings. Below I try to outline some of the instances where I believe Mr. Pearson has erred. Let's start off by analyzing a few of the statements from Mr. Pearson's article:
Issue # 1: Early in his article Mr. Pearson cites a feature on Organovo in the magazine Popular Science for creating an artificial pop of 15% in the shares on July 23, 2013. The author notes the magazine hitting the newsstands that day. I'll be honest here - I don't know why Organovo's stock jumped 15% on July 23, 2013. It's not important. Facts are important. The Popular Science magazine hit the newsstands on July 13th.
Here's someone named "Rocketstocks" on the InvestorHub message board talking about the magazine on July 13th (LINK). And below is a snap-shot from the always reliable Yahoo-Message Board (sic) talking about the article on July 13th.
No need to butcher Mr. Pearson for this mistake, but I don't see the Popular Science featured article as any reason for concern or excitement. From an investment standpoint, it's a non-event.
Issue #2: Throughout this article, Mr. Pearson constantly points to 32 million shares ready to be sold overhanging the stock. He notes the recent uplisting to the NYSE-MKT that took place on July 12th as a major catalyst, even stating that his was a "predictable trade". Where we disagree with the author is when he states, "These investors would certainly not have sold before the uplisting," and gives "common sense" as his justification for that belief.
We believe his flaw is citing a Form 424B3 Prospectus filed with the SEC on April 4, 2013 as the opening of the window for these investors to begin selling. He states:
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.
I simply do not think this statement makes sense. First-off, these 32 million shares were not unlocked in April 2013 through the Form 424B3 noted above. They were unlocked back on June 13, 2012 through the filing of a Form S-1 Registration Statement. Keep in mind, as found in the company's most recent Form 10-K/T, on May 1, 2013 the number of outstanding shares totaled 64.7 million. Subtracting the 32.0 million the author thinks became unlocked in April, and another 23.7 million we know were unlocked in February 2013 (under Rule 144) following the one-year anniversary of the reverse merger, that leaves only 9.0 million shares available for trading in 2012. All this information can be found in the Form 8-K outlining the reverse merger back in February 2012.
From July 2012 to February 2013, Organovo traded some 95 million shares. It's ridiculous to think that 9.0 million shares and warrants, many in the hands of insiders, created 95 million shares of trading volume over those eight months. To me, it is obvious that the 32 million shares Mr. Pearson is concerned will be dumped on the market over the next few weeks has already been traded, over-and-over, dating back to the June 13, 2012 Form S-1 filing. There is no 32 million share overhang waiting to be sold in my opinion.
One final note, between July 8th and July 24th, Organovo traded 62.4 million shares. That's almost the entire outstanding share count in 13 trading days. Liquidity is not a concern here.
Issue #3: Mr. Pearson believes that Organovo is running dangerously low on cash given the massive operating burn and low cash balance.
Simple financial statement proves Mr. Pearson wrong here. The author states that Organovo has an operational need for cash soon because, "Losses have ranged anywhere from $10 million to almost $40 million - per quarter!" And that Organovo reported only $15 million in cash as of March 31, 2013. These are both factual statements. However, losses per quarter are accounting losses, not cash losses. I've tried to explain this to people dozens of times (see this article).
When you have outstanding warrant liabilities, with call provisions, and your stock price goes up, the warrant liability also goes up. The liability is calculated by Monte Carlo simulation modeling, and includes the time remaining in the exercise period, the strike price, the current stock price, the volatility of the stock, and the rate of free return. What investors need to understand though is that as the warrant liability increases on the balance sheet it is recorded as losses on the income statement. These losses are NON-CASH accounting charges. Organovo is not burning $10 million to almost $40 million per quarter, this I assure you.
The truth is, for the three months ending March 31, 2013, Organovo burned $2.7 million in cash from operating activities. For all of 2012, the company burned $9.7 million in cash from operating activities. Since inception, which dates back to April 19, 2007, Organovo burned $15.8 million in cash from operating activities. This is not a company that is in desperate need of cash. It is burning around $2.5 million per quarter. The $15 million in cash they reported as of March 31, 2013 is enough to take them well into 2014.
I tend to focus my time on analyzing the Statement of Cash Flows in the quarterly filings, they are far more telling than the Income Statement. Thus, I believe Mr. Pearson's statement that, "The company clearly needs to raise at least $30-40 million in the near term," is just plain wrong.
Issue #4: Mr. Pearson saw the Form S-3 filing on July 17, 2013 and panicked. Above the author notes that the company is running desperately low on cash and that a significant financing is on the horizon. Seeing, and misinterpreting the shelf registration statement, leads Mr. Pearson to another faulty conclusion. Let me help clear up some misconceptions based on the recent SEC filings.
Form S-3 are not offerings. They are registration statements. This Form S-3 authorizes the potential for Organovo to raise $100 million through the issuance of common stock, preferred stock, debt, warrants, or other units. Form S-3 registration statements are good for three years. They allow a quicker, cheaper, and easier way for qualifying and compliant publicly traded companies to raise money than an initiation Form S-1 public offering. I repeat, they are not offerings or dilution as the author believes, and states:
"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." And, "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."
I strongly disagree with the above statement. A Form S-3 is not an offering, and calling it an offering and trying to spook investors into believing that the company will raise $100 million at steep discounts to the current stock price is just a scare tactic to get current stockholders to sell. It's a tool of the Short-sellers. For Mr. Pearson's take, I can't honestly tell you if his misleading around the Form S-3 is deliberate misinformation or a simple misunderstanding, but I hope this helps clear the air. My guess is that Organovo is just creating financial flexibility for itself, and that you may see a financing later in 2013; but certainly not all $100 million at once.
Issue #5: Mr. Pearson states that Organovo has, "Almost no revenue or near-term revenue prospects." Again, I disagree. I think the revenue potential is near. My article summarizing the company's Breakthrough In Hepatotoxicity Testing outlines the opportunity for the company. Organovo is already working to expand beyond liver cell models into kidney, cardiovascular, lung, and oncology cell models. I think you will see the first kits on the market in less than 18 months.
Just yesterday the company announced an agreement with Methuselah Foundation where Methuselah will fund research at major research institutions using Organovo's proprietary NovoGen Bioprinting technology. The program will feature grants of research funding from the non-profit Methuselah Foundation to major academic research centers engaged in cutting edge biomedical research. We expect this to begin to contribute revenues to Organovo through greater access to the company's technology.
I hope this article has helped clear things up for Mr. Pearson and those interested in the Organovo story.