Seeking Alpha
Profile| Send Message|
( followers)  
Interesting article in Forbes recently talking about the special-purpose entities used by some small biotech companies to raise money. Exelixis (Nasdaq: EXEL) has been in partnership with Symphony Capital for almost a year, and I've written before about the fact that I like EXEL's innovative financing -- special purpose entities get everyone's arm hairs tingling these days, but this is very different from the infamous SPEs of Enron.

Exelixis is in an interesting position now, but it's also a somewhat perilous one financially: They do have plenty of cash on hand at the moment, but they also have a huge number of drugs in the pipeline that will require very expensive clinical trials. As each phase of FDA approval progresses, the next trials become dramatically more expensive -- early safety and efficicacy trials might be relatively inexpensive and include dozens or a few hundred patients, but a late phase III trial for final approval might have thousands of patients and take several years to complete.

That costs a huge amount of money, which is part of the reason that many small biotech companies partner their drugs with large pharmaceutical companies to help with costs, or end up themselves being bought out because a larger partner can do a better job of pushing their pipeline forward.

There are several ways to raise this money, of course -- you can borrow from the bank, or issue bonds if investors are at all interested, or you can offer more shares and dilute current shareholders. All of these are used with some frequency in biotech, but there are negatives associated with them -- for small companies that are not near profitability, it's hard to get favorable terms.

So EXEL, and some other companies recently, have gone to special purpose entities to raise money. Unlike Enron's special purpose entities which seem to have been intended simply to defraud and to hide debt, these SPEs are intended to raise money for targeted programs, in exchange for the rights to that drug, a piece of that drug's income, or other considerations.

In the case of Exelixis, they have partnered with Symphony Capital, a big private equity firm, to fund several of their ongoing drug programs. That means Symphony puts up a sum of money in a separate investment fund -- up to $80 million under their current agreement -- to pay for clinical trials on specific drugs. Symphony has effectively purchased the rights to these drugs (XL647, XL999 and XL784), but EXEL maintains the right to buy them back at attractive prices if they choose, and has agreements with Glaxo SmithKline to provide larger milestone payments to cover that repurchase of rights in the event of a successful trial.

The big thing that EXEL has done with these special purpose entities is reduce risk. Even for a company with such a large and deep pipeline, the failure of a drug in development is costly -- if the drugs that Symphony has purchased fail in trials, EXEL is not obligated to buy the rights back and will not have to repay that part of their financing.

Dr. Scangos, CEO of Exelixis, had a few quotes in a press release last summer that seem to sum up their thinking:

We have retained exclusive rights to the compounds, obtained attractive funding to enable aggressive, thoughtful clinical development, and have off-loaded the financial risk of compound failure ...

We have been remarkably productive over the past few years, and are on track to have eight compounds in clinical trials by the end of the year. We believe that conducting extensive Phase II trials is an important aspect of avoiding late-stage product failures. Obviously more extensive programs require significant financial investment, and this transaction is one example of how we intend to finance these programs while minimizing dilution to our investors.

With the massive warchests being built by private equity firms, I think we'll see more of this -- private equity and venture companies with good biomedical analysts will start looking at investing not in biotech companies themselves, but in specific drug programs to underwrite clinical trials. It seems a good deal for everyone involved, but it's an especially effective one for a company like Exelixis that has a market cap of less than a billion dollars but is trying to manage a deep pipeline of cancer drugs that's as large as or larger than many of those of larger biotechs and pharmas.

EXEL's stock has been performing pretty well recently, breaking out of an $8-10 range that it had traded in for several years. Since the pipeline is so large we're likely to hear relevant news about specific compounds with some frequency, any of which could move the stock if they're dramatically good or bad. I would like to add more to my EXEL position, and I'm not sure whether it makes sense to make a buy soon or to wait for a possible dip if one of their trials hits a snag, I'll let you know if I make up my mind.

EXEL 1-yr Chart


Aside: Did you know that Seeking Alpha now publishes a one-page recap of Jim Cramer's Mad Money TV show, Lightning Round, Radio program and Stop Trading?

Source: Exelixis' Special Purpose Entities A Far Cry From Enron (EXEL)