A few months ago I wrote about an excellent arbitrage opportunity in the biotech space. Specifically, Synergy Pharmaceuticals (SGYP.PK) and Ironwood (IRWD). Now, finally, there’s a catalyst that I think will close that arbitrage in the next few weeks.
First a summary of the basic arbitrage:
- Both companies deal with one of the most brutal and prevalent diseases out there: irritable bowel syndrome. Both companies develop a drug for IBS (irritable bowel syndrome). Over 100mm people on the planet suffer from some form of IBS (primarily severe constipation). This is potentially a $20 billion market according to a research report from Merrill Lynch.
- Both Ironwood and Synergy are working on very similar drugs. In fact, the scientists from both companies came out of the same laboratory at Monsanto (MON). The arbitrage is buy Synergy and potentially even short IRWD but I never recommend shorting. So this is primarily why I think Synergy will start to trade up near IRWD levels. First, some basic facts:
A) IRWD had a $1.5 billion market cap. Synergy has a $326 million market cap. Part of the reason for this is that while Synergy is about to enter Phase III trials with the FDA, IRWD has already passed Phase III. However, the drug has very similar compounds and Synergy’s drug should do as well as IRWD’s drug. There are key differences, however. Explained below.
B) IRWD only owns the rights on 38% of the potential revenues of their drug. They’ve sold their soul to the pharma devil. This gives the enterprise value of their drug a value closer to $4.2 billion than their $1.5bb. The value of Synergy’s drug (which they own 100% of the rights to) is their market cap of $326 million. This makes the spread even larger between the two companies and takes the potential upside up to a 12x return on Synergy’s current stock price.
C) Synergy’s Phase II trials showed better safety than IRWD’s drug. Ironwood's drug has a potentially very negative side effect: diarrhea. According to a Merrill Lynch report written by their research analyst Rachel McMinn on October 6, about the Synergy drug: "The one specific detail noted is that none of the patients experienced diarrhea, a side effect noted with [the Ironwood drug]." She also notes, "the mechanism of action of the two drugs is identical." In other words, we have a potential $20bb market with two drugs that act the same, except one drug causes "Montezuma's revenge" (Ironwood) and the other doesn't (Synergy).
D) Morgan Joseph recently put out a report with a $15 target on Synergy. However, in the report they also noted the arbitrage and stated: “We would note that, if plecanatide were to be valued similar to linaclotide [Ironwood’s drug], the implied price per share of Synergy stock would approach $45, without considering Synergy’s pipeline.”
E) The Morgan Joseph report also noted the increased M&A in the area: They mention Shire (SHPGY) buying Movetis for $600m
So, we basically have a huge spread ($326mm for Synergy, $4.2 billion for Ironwood) that should close, a disease that needs to be treated, a $20 billion potential market size. However, there are several other recent catalysts:
A) Last week on July 18, Synergy filed a prospectus. A “Re-IPO”. Cowen, a respected bank, is basically taking them public on the NYSE/AMEX. Once the company goes from the pinks to the NYSE, every mutual fund in the world that missed out on IRWD can start buying them. This will have a significant effect on the stock. They did not release this news in a press release.
B) M&A activity is heating up. Irena Rivkind at Duncan Williams recently wrote a report on Salix Pharmaceuticals (SLXP). In the report she states:
M&A: Management indicated that it is actively looking at other opportunities and is willing to
consider larger transactions (can go as large as $2-2.5 billion). We also learned that the team has
an interest in chronic constipation/IBS-C products and we have identified two companies with
late stage assets in the space.
o Synergy Pharmaceuticals is developing Plecanatide, a GCC agonist (similar mechanism
as Linaclotide) that is entering a large registrational chronic constipation trial later in the
year following robust data in Phase 2. This product is believed to have similar efficacy to
Linaclotide, but with a lower incidence of diarrhea. Synergy has global rights to
Plecanatide and a composition of matter patent that expires in 2023. Both Salix and
Synergy management denied a potential transaction.
- Enormous arbitrage: $326mm for Synergy’s drug versus a potential $4.2bb enterprise value on Ironwood’s very similar drug. Ironwood is one phase ahead in trials but its drug also has the adverse side effect. The market is there. Synergy's drug is safe. I fully expect Synergy to eventually trade up to where Ironwood is but let's even say it trades to half that level. That would still put it at approximately a $25-30 stock price.
- The company, led by Cowen, is re-IPOing in order to get on the NYSE/AMEX. Moving from the pink sheets to the NYSE gives investors a chance to get in on the IPO without being a big institution.
- M&A is definitely heating up in biotech. The report from Duncan Williams is only one example. Shire buying Movetis for $600 million is another.
I’m long Synergy.
Disclosure: I am long SGYP.PK.