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  • CGEN: Putting The Secondary Offering In Perspective 1 comment
    Mar 1, 2014 8:56 PM | about stocks: CGEN, BMY, NVS

    Compugen shares traded down about 20% on Friday on the news that the company completed a 6 million share secondary offering at $10.50.

    Shareholder concern seems to center around two primary issues: first, the offering being priced well-below Thursday's $14.20 closing price; and second, the logic for selling stock now and "diluting" existing shareholders.

    On the issue of price it is important to keep in mind that while the transaction closed on Friday morning the investment bankers would have been securing investor commitments to participate in the offering the week prior. A simple look at CGEN price chart shows that the stock traded pretty consistently in the low-$11 range. The $10.50 offering price represents a normal discount to the then prevailing market price.

    Consider too that open-market investors are naturally hesitant to buy a stock after a 25% one week move, preferring to wait for a pull-back. Investors participating in this offering are no different. If the company went back to investors and unwisely insisted upon a higher price to reflect the most recent four days gain investors would have certainly balked.

    With respect to the "dilution" to current shareholders from this offering, the idea is silly. The concept of dilution is probably one of the most misunderstood by retail investors. To gauge whether the value of your holdings in Compugen were diluted by this offering it is not enough to only consider that the transaction resulted in a higher share count. Nor is it correct to assume the only benefit of the offering is the cash received.

    What Compugen does with the proceeds of this offering will determine whether this offering dilutes the value of your holdings or is anti-dilutive. And from our view this offering is potentially anti-dilutive to shareholder value in a substantial way.

    Investors need to consider that in drug development the value creation curve is parabolic. Pre-clinical drugs are extremely risky and are less valuable to Pharma. As drug candidates advance through a Pipeline they become less risky and their value increases exponentially. In this way Compugen's decision to raise funds so that it has the resources needed to develop their drug candidates internally rather than engage in pre-clinical licensing deals can be seen as anti-dilutive. A couple of data points can help clarify this point.

    In our Seeking Alpha article last week on Compugen we highlighted how the stock market was awarding tens of billions of market cap to BMY for its cancer immunotherapy assets, with its most promising drug in Phase III trials.

    Another data point to consider, two years ago Gilead Sciences (NASDAQ:GILD) acquired Pharmasset for $11 billion. Pharmasset's lead drug for Hepatitis C was in Phase II trials.

    Compare those valuations to the licensing deal Compugen signed with Bayer in August for two pre-clinical cancer immunology discoveries. For each one Compugen received $20 million upfront (including pre-clinical milestone payments), $250 million in potential clinical trial milestone payments and a high single-digit royalty on sales.

    The comparison does not suggest Compugen got a bad deal, it simply highlights how much additional value can be created for shareholders by developing drug candidates longer internally. And that is why this offering is potentially massively anti-dilutive as it enables the company to ride its discoveries up the parabolic value creation curve.

    Another dynamic of this offering that may have been overlooked by investors is the heightened value and appeal of Compugen as an acquisition candidate since the company has the resources to develop its discoveries longer without Pharma licenses.

    Two weeks ago Novartis bought CoStim Pharmaceuticals a "discovery stage" company, also with a focus on cancer immunotherapy. While the terms of the acquisition were not disclosed, Atlas Ventures, one of CoStim Pharmaceuticals venture capitalists said this about the transaction: "The syndicate we joined and co-led last year was designed to be strong enough to take these programs into the clinic ourselves, but Novartis pre-emptively moved forward with a discovery-stage deal. The credible "threat" of going longer alone as an early-stage company was an important component of the deal dialogue."

    Large Pharma companies are urgently trying to acquire assets in cancer immunotherapy via M&A and licensing agreements. To the extent any Pharma companies were planning to license Compugen's discoveries on similar terms as Bayer received in August this funding now also gives Compugen the credible threat of going longer alone.

    Disclosure: I am long CGEN.

    Stocks: CGEN, BMY, NVS
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    As a long term investor in Compugen, delighted to see the run up in the share price over the last 12 months, I am in full agreement with the above comments and quite content with the pricing of the shares at 10.50. The jump up and down in the share price in the last couple of weeks should be seen as a temporary blip... nothing more...
    2 Mar 2014, 07:53 AM Reply Like
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