Note: This article has been corrected to reflect that the date for lockup expiration is unknown.
Organovo Holdings (ONVO) was added to our speculative screen on February 28th 2012 at $1.65. We stated:
- ONVO Just completed a reverse merger with a company focused on the development of bio-printing technology for research and medical applications.
- Concurrent with its reverse merge, the company was able to raise $6.5 million.
- ONVO was beginning to attend investor conferences.
On June 25, 2012, we alerted our Premium members that we were taking a short position in ONVO shares.
Look Out Below
Since February 28, 2012 ONVO has skyrocketed, reaching a high of $10.90 on June 18, 2012. We see little fundamental reason to explain why the stock has made such an aggressive move. But we believe that shares could get destroyed once an S-1 filed on June 13, 2012 goes effective. This will allow investors who bought shares on the cheap at $1.00 per share in three private placements (see pg. 13 of the S-1) that took place in February and March of 2012 to begin liquidating their positions. As we will soon discuss, the amount of ONVO shares that could hit the market is massive compared to its current outstanding share count.
The Big Elephant in the room: Details in an S-1 filing could lead to a free fall in ONVO shares
The biggest reason to conclude that ONVO shares could implode is due to the fact that the company just filed an S-1 that, when it goes effective, could lead to massive shareholder selling.
Side Bar about the Offering Process
An S-1 or S-3 is filed to allow:
However, the SEC must review the filing(s) and designate them effective before shares can be sold related to the filing(s). Individuals that invest in private placement are often restricted from selling their shares until an S-1 is filed and goes effective. This restriction often ranges from 90 to 180 days.
ONVO's outstanding share count is around 44 million. Fifteen million Shares (most of which were part of the 2012 private placements) have been locked up (unable to be sold), but will be eligible for resale once the S-1 is effective. Furthermore, 16.7 million in-the-money warrants (with an exercise price of $1) could also be set free when the S-1 goes effective, leading to significant dilution. Shares outstanding would increase 61% to 60.4 million. This calculation does not even include 7.44 million shares:
- 896,256 shares of common stock issuable upon exercise of outstanding options, at a weighted average exercise price of $0.08 per share, which were issued under the company's 2008 Equity Incentive Plan prior to this offering; and
- 6,553,986 shares of common stock which remain available for grant and possible subsequent issuance under the company's 2012 Equity Incentive Plan.
In any event, a whopping 32 million shares will be eligible to hit the market soon. We don't know when the SEC will deem the S-1 effective, but the company has agreed to use its reasonable efforts to have the registration statement declared effective within 180 days of the S-1 (registration statement) filed on June 13, 2012. (see 8K/A, February 8, 2012, page 62, Registration Rights Agreement). Given the sharp run-up in ONVO shares, once the S-1 does go effective we are betting that the investors in the 2012 Private Placement will yell fire and rush to the exits as soon as they are able to sell per the terms of the private placement…
In connection with the Merger, each of the officers, directors and holders of 5% or more of our Common Stock and certain employees and affiliates of the Placement Agent have agreed to “lock-up” and not sell or otherwise transfer or hypothecate any of their shares for a term equal to the earlier of (i) twelve (12) months from the Closing Date of the Merger; or (ii) six (6) months following the effective date of the Registration Statement registering the shares of Common Stock included in the Units as well as the shares of Common Stock issuable upon exercise of the Investor Warrants and the Bridge Warrants.” (8K/A, February 8, 2012, page 9).
In this volatile market, wouldn't you seriously consider locking in a return of a $9.30 stock that you own with a cost basis of $1.00 and associated warrants also with a cost basis of $1.00? We do find it odd that the stock is pumping into the S-1 registration leading us to postulate that the market has not realized that ONVO has filed the S-1.
We believe that the market will change its tune on ONVO once it realizes that a massive amount of shares may need to find liquidity for 190 potential sellers listed in the S-1!
So, Why Have ONVO Shares Dramatically Risen?
We have noticed that companies that are able to raise capital in conjunction with their reverse merger transactions sometimes perform well in the near term, possibly due to a sense of legitimacy that investors may feel arises from "institutional backing." ONVO was able to raise total net proceeds of $11,593,065.91 in its February and March 2012 private placements.
Adding to ONVO's air of legitimacy, it claims to have:
- "Collaborative research agreements currently in effect with Pfizer (PFE) and United Therapeutics Corporation (UTHR)"
- Reported 2011 revenues of around $1 million.
ONVO's business description also has an appealing futuristic feel to it:
"…Organovo Holdings, Inc. develops NovoGen three-dimensional human tissue printing technology for creating tissue on demand for research and surgical applications. Its NovoGen 3D printing technology is a platform that works across various tissue and cell types. Organovo Holdings, Inc. serves physicians and researchers involved in the fields of cardiovascular medicine, medical research, and transplant medicine..."
In laymen's terms, ONVO's technology uses real human tissue in the application of research and surgical procedures.
Regardless of the "wow" factor present in ONVO's business description, we believe reasons exist to exercise extreme caution when considering ONVO shares as a near-term long investment option.
- With such a "great technology" and relationship with two behemoth pharma companies (PFE, UTHR), why did the company choose a reverse merger transaction to go public, rather than an IPO transaction?
- We consider the collaborative investment to be peanuts ($688,000 in 2011). While it is great that reputable firms have allotted funds toward ONVO, in the scheme of things this amount is such a small nut for these large companies.
- The majority of the 2011 reported revenues came from what we consider potentially non-operating sources (collaborations and grants). Pure product revenue was a mere $223 thousand.
- The meaningful commercialization of ONVO's technology from a revenue view point seems to be well into the future and would probably require a constant amount of funding.
- The stock is selling at a market cap of over $400 million compared to revenues of around $1 million.
Quotes from company filings amplify some of these issues:
- It does not appear that ONVO will generate meaningful sales and profitability in the foreseeable future:
"…As of March 31, 2012, we had devoted substantially all of our efforts to product development, raising capital and building infrastructure. We did not, as of that date, realize significant revenues from our planned principal operations. Accordingly, we are considered to be in the development stage…"
"…We have generated operating losses since we began operations, including $1,338,694, $3,964,610 and $1,329,130 for the year ended December 31, 2010 and 2011 and the three months ended March 31, 2012, respectively, and as of March 31, 2012, we had an accumulated operating loss of $43,772,138. We expect to incur substantial additional operating expenses over the next several years as our research, development, and commercial activities increase. The amount of future losses and when, if ever, we will achieve profitability are uncertain…"
"…We have a limited operating history and a history of operating losses, and expect to incur significant additional operating losses…"
"…In the United States and most foreign countries, we will be required to complete rigorous preclinical testing and extensive human clinical trials that demonstrate the safety and efficacy of a product in order to apply for regulatory approval to market the product…"
- Constant dilution seems like a certainty:
"…We need to secure additional financing to support our planned operation…"
Weak Auditor Raises our Red Flag
The most recent PCAOB Inspection of ONVO's auditor, Mayer Hoffman McCann, does not lift our confidence
"…The deficiencies identified in one of the audits reviewed included a deficiency of such significance that it appeared to the inspection team that the Firm, at the time it issued its audit report, had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements..."
It is easy to get excited about a company like ONVO that is attempting to make strides in medical research, but we think the valuation, given the facts, is insane.
A bullish ONVO Seeking Alpha article mentioned two comparables, Scolr Pharma Inc (DDD) and Stratasys, Inc. (SSYS). Both firms generate significant revenues, are profitable and are selling at market cap to sales ratios of 5. Both of these companies serve the three-dimensional (3D) printer market, so we are not sure why the author even used them as comparable to ONVO. Regardless, the author should realize that ONVO, a company with minimal revenues, is selling at a market cap to sales ratio of over 500, assuming all in-the-money warrants are exercised!
We believe a more appropriate comparable would be a direct competitor mentioned in ONVO's S-1 filing, Advanced BioHealing, Inc. Advanced BioHealing planned an initial public offering in May of 2011, but chose not to when Shire Plc agreed to buy the company a day before the biotechnology company was to go public. The company had planned to offer 13.4 million shares, priced from $14 to $16 and would have had 39.8 million shares outstanding, giving its shares a market-cap of around $600 million or a market-cap to sales ratio of 4. Advanced BioHealing achieved 2012 revenues of $140 million and was profitable on a non-GAAP basis. Investors can view the Advanced BioHealing May 16, 2011 prospectus here. Armed with this data, we can derive an approximate value of ONVO's shares of it were to IPO today:
- ONVO's 2011 revenues ~ $1 million
- ONVO's market-cap assuming all warrants are exercised: 60 million outstanding shares times current price per share of 9.1 = $546 million
- ONVO's market-cap to sales ratio >500
In making a casual observation, we believe it is ridiculous that the valuation ($546 million) of a company with virtually no revenues is on par with a top tier company with meaningful revenues that is profitable. But we will still give ONVO the benefit of the doubt.
Let's be foolishly optimistic and assume that ONVO will accomplish the unthinkable and generate $45 million in revenues in 2012, which matches the revenues Advanced Biohealing, inc. achieved after its first full year of product commercialization.
Let's also assume that investors are willing to pay four times our revenue 2012 assumptions. Doing this yields a valuation scenario of $3.0. ($40 million in sales times 4 divided by 60 million shares).
If you wanted to believe that ONVO is going to revolutionize its industry then let's get crazy and believe that investors will be willing to pay eight times sales, or $6.0.
Obviously, we believe these valuation scenarios are still unrealistic as might investors who, just 4 months ago, funded this company at much lower prices than today's current price. Our valuation assumptions don't even include dilution from very probable future equity financing.
In the end, we need to ask why ONVO didn't follow the route of a company like American BioHealing instead of performing an RTO transaction that, from an investing point of view, may destroy its capital structure.
Disclosure: I am short ONVO.
Additional disclosure: We are short a very small amount of ONVO shares; we are continuing to look for shares to short, but are having hard time finding shares