Biostage: Dilution Now A Factor

| About: Biostage, Inc. (BSTG)
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Biostage had positive study results announced last week.

The company announced dilution this week.

Dilution includes warrants.

One issue that always arises with early stage bio companies is the cash on hand vs. the cash needed to progress the pipeline to a point of approval. With hundreds of companies seeking capital in one form or another, things can at times get dicey. Biostage (NASDAQ:OTC:BSTG) announced today that the company is raising $5 million in an at-the-market direct offering.

The news of dilution follows a positive development in the company's program related to the esophagus. While any dilution is frustrating, this particular instance has more frustration than many investors, myself included, would have anticipated.

Biostage already has an ATM facility of sorts with Aspire. This facility allowed for the sale of registered shares of up to $15 million. The Aspire deal had certain covenants that did not allow Aspire to hedge. Such protections helped to protect and preserve share price while the company is at a critical juncture.

The deal announced today raises $5 million via 2.8 million shares being sold. While no one is a fan of dilution, this was in many ways an inevitable situation at some point between now and when the company can move toward FDA approval.

What is even more frustrating about the deal today are the warrants issued. Essentially there are now 1.4 million shares in warrants tied to a strike price of $1.76 per share. These warrants can be exercised at any point starting 6 months from now and expiring 5 years from now. In simple terms, warrants often create a bit of a ceiling on the stock. Let's assume that the stock price moves to $2.50 per share. A warrant holder can exercise his warrant at $1.76 and sell the stock at market prices of $2.50. It is very easy for warrants to add selling pressure to a stock. As time passes, that pressure rises. If the clock on the warrants is close to expiring, a hedge play could enter the equation as well.

Here are the essential terms of the offering:

  • In connection with the offering, the company will issue approximately 2.8 million registered shares of common stock at a purchase price of $1.7625 per share.
  • Concurrently in a private placement, for each share of common stock purchased by an investor, such investor will receive from the company an unregistered warrant to purchase one-half of a share of common stock.
  • The warrants have an exercise price of $1.7625 per share, will be exercisable six months from the date of issuance and will expire five years from the initial exercise date.

The reward side of the equation remains intact and remains speculative. If the company can get to a point of filing an IND with the FDA by the end of 2016 and obtain orphan status, then the pathway to approval gains a lot more traction. The concept seems to have been proven. What remains now is seeing success in human trials that delivers a medical solution with less risk than existing treatments.

Biostage has its critics. Those critics have valid points for the bear case thesis based on data, past pre-clinical studies and past failures. The bull side is betting on potential, the idea that the company has learned from failures and the idea that the current path (with apparently successful large animal studies) is the correct path.

The $5 million raised today, while a negative in many ways, does preserve the $15 million Aspire deal. Was management smart in taking the selected route vs. using the Aspire facility? Time will tell. In the short term, the deal announced today carries unanticipated baggage. The next several months will be critical for this company. If Biostage can get to an IND application with the FDA without further dilution, it would be positive. Stay Tuned!

Disclosure: I am/we are long BSTG.

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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