Orexigen (NASDAQ:OREX) investors are faced with some troubling times these days. The price of the stock is well below $1 per share, sales of its only product are much lower than needed, its U.S. partner has walked away, and a powerful entity has essentially waltzed in and taken effective control of the future of the company.
This past week management sealed a deal whereby Baupost and its partners provided $165 million in funding in exchange for convertible notes tied to 100 million shares due 2020 and warrants that tie to another 100 million shares due in 2026. The convertible notes price out at just $0.75 while the warrants are tied to a price of $1.50 per share. Baupost already controls 27 million shares of Orexigen.
For the time being, let's set aside the sales levels of Contrave and the fact that Orexigen must now bear the burdens of either landing a new partner in the United States, or funding a sales force on its own. The first critical thing that investors need to consider is NASDAQ listing requirements.
Orexigen has now been trading below $1 per share for 20 trading days. If the closing bid price of Orexigen does not reach $1 for 30 consecutive trading days, a de-listing process from Nasdaq starts. That 30 day window closes on April 8, 2016.
Essentially NASDAQ has listing rules and requirements. One of the rules is that an equity trade above $1. Orexigen is currently in violation of that rule, but NASDAQ allows "self correction" by giving a company an initial 30 days to get back into compliance prior to beginning a de-listing process.
Once the 30 days pass, and if the stock price has not breached the $1 level, a de-listing notice will be sent to the company in violation. This will generate an 8k filing with the SEC, notifying investors that the company is in violation of listing rules.
There are grace periods, guidelines, etc. that can all take place after an initial de-listing notice is sent. The typical strategy in solving the minimum price requirement is a reverse split. Companies do not usually have such provisions already approved by stockholders, thus it usually means that a proxy will be sent out requesting that shareholders approve of a reverse split.
For the benefit of less experienced readers I will describe what a reverse split means. Essentially it lowers the number of authorized shares, thus making each share more valuable. Let's assume for a moment that a company has 1 million shares at $0.50 each. The market cap of that company is $500,000. If a 1 for 10 reverse split were to happen, there would now be 100,000 shares that are worth $5.00 each. The market cap remains at $500,000. In this example you would be given 1 share of stock worth $5.00 for 10 shares of stock worth $0.50.
A reverse split is rarely viewed in a positive light. It is typically a strategy used by companies that are in some sort of distress. It does nothing to solve the underlying issue of why a stock dropped so low in the first place, and only serves to get meet the minimum price requirements.
Being in a de-listing process also impacts a company's ability to work financial deals, and actually narrows the pool of possible participants. Would you lend money to a company on the pink sheets? Perhaps, but only if you get a lot in return. This is what Baupost just did.
The Problem with Convertible Notes
Convertible debt is a double edged sword. It is a method to garner needed financing, but also sets up the remaining investors company to have some severe challenges ahead.
Baupost just got a promissory note of sorts for 100 million shares of Orexigen stock. Baupost and its group can convert the debt associated with the convertible notes at any time in lieu of cash payment on debt.
Bond players are savvy. Let me break this down. The converts that are due in 2020 are tied to about $75 million of the funds that Orexigen just received. Essentially Baupost paid $75 million at 0% interest. Orexigen now owes Baupost that money. Baupost can, instead of collecting money, convert the debt to shares at essentially any time.
What typically happens with convertibles is that the company receiving them shorts the underlying equity. Why would they do this? The reason is actually quite simple. It removes almost all risk from the deal. What differs with this Orexigen deal is that the underlying price is not at current prices, but rather $0.75 per share.
Let's boil this down:
- Baupost gives Orexigen $75 million for the right to convert that debt to 100 million shares
- Baupost can short 100 million shares at current market prices of $0.55 per share, receiving $55 million of its money back.
- If the stock goes up, Baupost's only risk is $0.20 per share. This is because even if the stock were to go to $1 per share, Baupost can convert at just $0.75 per share.
- Baupost can wait until the price gets above $0.75 per share and then short. In that case, Baupost has essentially no risk. If the stock goes up, Baupost can convert at $0.75 per share and return the shorted shares. If the stock goes down, Baupost gets a good return on the short position and could even wind up owning the company outright.
The bottom line on the convertibles is this. They place a ceiling of sorts on the stock because any investor knows that there are a massive number of shares available to a single party at $0.75 per share.
Think about it. If the stock went to $1 per share, and you had the right to get shares at $0.75 each, what would you do. The answer is simple. You would convert at $0.75 and then sell for $1. You would make a healthy profit.
The unknown factors here are the intent of Baupost and its partners. Are they in it for the typical short the convert's strategy, or do they see something that offers huge potential? Perhaps they are on the fence.
Essentially what Baupost did was double down on the 18% already owned at much higher prices and built in a strategy that they can now mitigate those losses and even make some money. It is even possible that this ownership group could even take over.
Retail investors need to look at these stark realities closely. Orexigen just took on $165 million in additional debt. That debt needs to be paid back. Baupost has the option to convert that debt into shares, which dilutes the market. Baupost has the option to go short if it desires, which can dilute the market in an artificial manner.
At this stage the Baupost ownership group is in the driver's seat of a pickup truck with seatbelts and airbags while the average investor is simply along for the ride in the truck-bed with no real protection. What happens to an investor in that truck bed if the driver decides to take a sharp right turn or a sharp left turn? Retail investors can only hope that Baupost drives straight and allows these passengers to benefit from the journey.
There are many other dynamics to consider. There are net operating losses that are an asset of sorts, but are impacted by changes in control. There is a possible sale of the company. There is the issue of what happens with Contrave. Will Teva's desire to make a generic come to fruition? Could Teva already be discussion various options with the Baupost group?
The bottom line is that Orexigen investors have a lot more to consider now than simply how the low sales of Contrave will impact the company. Orexigen remains a highly speculative stock that at this stage will be dominated by active traders playing the roller coaster ride that will transpire over the coming months. Certainly management will say all of the right things, but at this stage Baupost and its partners have all of the leverage. Stay Tuned!
Disclosure: I am/we are long OREX.
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.
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