Secondary equity offerings (& unfortunate shareholder dilution) are extremely common for development-stage medical companies, but the recent secondary offering by ECHO Therapeutics (ECTE) demonstrates almost unparalleled disregard for shareholder value. Remaining shareholders should make note of the company's gross negligence exhibited in the management of its finances. Even if you believe strongly in Echo's Symphony glucose monitoring system, you may want to exit your position solely based on the lack of financial leadership that has led to a 50% decline in shareholder value from June 6 to June 14.
It has been a horrific comedy of errors at Echo, and it's difficult to pinpoint the most glaring blunder - that the company had already just tapped equity markets in February 2013, the reverse stock split on June 6 (one week prior to the latest secondary offering), the obvious information leak regarding the offering, or that Echo decided to go through with the share issuance despite a 50% decline in shares.
Two share offerings within 4 months
To begin with, share offerings cost money. The due diligence, prospectus, underwriting and legal fees involved are especially expensive for a small company like Echo. Tapping equity markets on a regular basis is a poor use of resources. Yet despite the fact that Echo burnt through $5.8 million in the March quarter (operational cashflows), the company raised only $11.7 million from a share offering that closed on February 6 of this year. Such a small fundraising would be acceptable if Echo had visibility of a lower cash-burn rate, or if it anticipated material positive developments that would boost the share price prior to the next share issuance. Neither of these occurred. What management needed to do to support the share price was develop a definitive financing strategy whereby shareholders aren't worried about when the next secondary offering will be, or at what price.
Reverse Stock Split on June 6
On June 6, Echo issued a 1-for-10 reverse share split from a closing price of $0.57. While I agree that it was important for the company to regain compliance with the NASDAQ's $1.00 minimum share price regulation, doing this just prior to a secondary offering is one of the most short-sighted market developments I can recall. While in reality, a pie remains the same size no matter how many pieces you cut it into, this logic doesn't apply to equity markets and somebody at Echo should have known that. Reverse share splits almost always bring about downward pressure on a stock. Bringing this pressure upon shares of ECTE just prior to a share issuance was financially negligent. The day after the reverse share split the stock closed at $5.35, down from an adjusted pre-split price of $5.70.
Information Leak regarding Secondary Issuance
According to Echo's June 13th press release, a preliminary share issuance prospectus was filed with the SEC on June 7th. Between these 2 dates, the company's share price plummeted from $5.35 to $2.89. Those with inside information about the pending share issuance and Echo's precarious financial position punished shares lower on rapidly increasing volume, leaving other investors scratching their heads and calling their therapists. Those who were selling were very likely the same investors who were planning to participate in the secondary offering, therefore profiting from every tick lower in the share price.
| Date | Share Price | Volume |
| June 6 | 5.70 | 15 k |
| June 7 | 5.35 | 65 k |
| June 10 | 3.97 | 411 k |
| June 11 | 3.73 | 243 k |
| June 12 | 3.31 | 389 k |
| June 13 | 2.89 | 576 k |
Secondary Issuance at $2.70 / share
Finally, the street received word on June 13 of the secondary issuance at a price of $2.70. This price was 53% lower than the pre-split adjusted price of $5.70, almost 50% lower than when the preliminary prospectus was filed with the SEC, and 7% lower than the closing share price on June 13. That's correct - despite the fact that the share price had already been split in half, Echo priced the issuance below market value, further destroying shareholder value. The company was clearly at the mercy of new lenders, and was going to agree to any terms set by them.
The short story is that no company should be issuing shares 50% below where their stock was trading. If new funding was not desperately critical, and management had Echo shareholders best intentions in mind, they should have declined to issue shares at $2.70 because the market was pricing the company's business above $5.00. On the other case, if the company was facing a liquidity crunch and needed to raise funds at any cost, then the firm should have raised cash sooner, or arranged a larger secondary issuance in February. In both cases, what we clearly have is financial mismanagement.
Given all that has happened to a company whose shares were trading 100% higher last week, new shareholders who have entered near the issuance price of $2.70 might think they have fallen upon a grand bargain. But what we know for sure is that management does not appear to have shareholders' interests in mind, and that given the company's cash-burn rate another $11 million in funding won't last much longer than the last time. More than likely, Echo will be desperately placing another secondary issuance shortly down the road.
If that doesn't change your mind about holding this stock, perhaps you should go ask investors who participated in the February share offering at $7.50 how they are feeling these days. Sell and move on.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
