Arena (NASDAQ:ARNA) investors were treated to a bit of good news/bad news after the market closed today. The company filed a registration statement for up to $250 million worth of stock. The good news is that the company essentially has a way to access cash when and if needed. The bad news is that the access of cash will be dilutive to current holders when it is used.
If the full offering were to be made at today's stock price, the dilution would equate to 127.5 million shares. The current shares outstanding is 243,044,672. This would represent a fully diluted share count of 370.5 million. That equates to a potential dilution of a bit over 50%.
Arena stock traded down after hours on the news. The cash position of Arena Pharmaceuticals was one of the major overhangs on the stock. Many passionate longs wanted to believe that no dilution would be necessary, but it should now be crystal clear that not only should we expect dilution, the market may well begin to build it into the price of the stock.
To be very clear, dilution has not happened yet. What currently exists is the right of management to dilute at any time up to a value of $250 million. The scary part of that situation is that it may be necessary to see some dilution happen prior to seeing phase 2 results on pipeline drugs.
As usual, I try to present what I feel is realistic assessments. There are positives in this situation. As an example, this gives Arena the ability to not rush into partnership deals earlier than needed. If we assume that the company feels strongly that APD334 (now known as Etrasimod) will deliver good phase 2 data, then waiting until that data is presented could bring a far superior partnership deal as opposed to seeing a potential partner discount the risk because phase 2 data is not yet in hand.
The downside is that, in my opinion, some dilution will need to happen with the stock at lower than desired prices. Let's assume that the company wanted to raise $25 million. At today's stock price of $1.91, the number of shares that would be issued is 13.1 million. If the stock price were at $3, then the number of shares issued would be 8.3 million. That is a stark difference in the number of shares, but the same $25 million would be raised.
Another negative to shelf registrations is that they can actually make getting good news an event that causes anxiety. Let's assume that the company suddenly gets approval for Belviq in Mexico and Brazil on the same day. Let's assume that the stock rises 20% on the news. Novice investors would celebrate the big move and wait to see the stock rise again tomorrow. Savvy investors would grasp that the big swing up in price is the perfect time for the company to sell off a block of shares in an offering. In the after hours the company announces a dilution of 10 million shares and the stock moves downward to adjust for the dilution. That savvy investor sold just before close and locked in a profit.
All things considered, the positives and negatives associated with this registration could be argued to balance each other out. Bulls have very valid points, as do bears. In my opinion, $50 million in the coffers should be enough to get to some pipeline data readouts. If a dilution happens in that range, a level of shelf registration uncertainty would be removed.
A final note is that this shelf registration actually buys a bit of Eisai (OTCPK:ESALY) insurance. Eisai is Arena's marketing partner on Belviq and has essentially pulled the plug on expending marketing dollars except for what is minimally required under the contract. With enough cash in hand, Arena actually gains some leverage if the company and Eisai decide to part ways in the future. If that were to happen, some added clinical trial expense would fall onto Arena's shoulders, and the company would have the ability to absorb that while continuing programs on phase 2 pipeline drugs.
If Arena dips down lower again, it could enter the range of being a decent speculative buy. The pipeline does have very good potential. The race against the cash clock is mitigated, so there is new-found opportunity. Be cautious on any upward moves until it is certain that the company can get to phase 2 read-outs without needing to dip into the well. It has long been my opinion that Arena would not let the cash balance slip below $100 million. I still maintain that opinion. Stay Tuned!
P.S. - It is possible that the new CEO is already working on a private placement of some magnitude. An example of such a move can be seen with what competitor Orexigen (NASDAQ:OREX) did with Baupost. In my opinion a one time offering that can raise cash and avoid warrants would be a very bullish move. That being said, if a private placement were to happen in the next week or so, I see it as $50 million at $2.25 with warrants to buy an additional $25 million at a the same price point and exercisable within a year.
Disclosure: I am/we are long ARNA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have no position in Eisai or Orexigen