A Free Kitten With Every Purchase, But It's An Ugly Kitten

| About: Alexza Pharmaceuticals, (ALXA)
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Grupo Ferrer tenders to purchase Alexza for $0.90, plus a CVR.

At current prices, the CVR is almost free.

There's a reasonable case for value in a merger arb.

The Offer

Alexza Pharmaceuticals (NASDAQ:ALXA) recently agreed to be acquired via a tender offer by privately-held Grupo Ferrer. The deal consists of $0.90 a share in cash and CVRs worth up to $35 million (roughly $1.05 a share). Alexza currently trades just above the cash portion of the deal at $0.90/$0.91 with some volume happening in the middle. This presents an opportunity to get the CVRs for close to free.

The Players

Alexza Pharmaceuticals is a micro-cap company focusing on drug-delivery through its Staccato inhaler technology. Staccato is currently used to deliver ADASUVE, approved in the US and EU for agitation associated with schizophrenia or bipolar I disorder in adults. Staccato is in a phase I trial in another indication and in pre-clinical studies in a third.

Grupo Ferrer is a privately-held Spanish pharmaceutical company. I am unable to find any revenue information for the company, but it appears to be a mid-sized firm, with distribution in 90 countries, and a few thousand employees.

Timing and Likelihood

The deal should close quickly, and I believe it has a high probability of completion. The tender period is only 20 days (the shortest legally possible), with the 14D-9 being filed on 5/9/16. Anti-trust issues seem unlikely, and should be satisfied in 15 days. The cash amount of the purchase is $20 million, an amount trivial to a company of Grupo Ferrer's size. Additionally, both sides are highly incented to make the deal happen. Alexza is close to running out of cash, and will otherwise have to raise capital at unattractive prices. Ferrer, meanwhile, has a strategic interest in Alexza's drug delivery technology, and is a 10% owner of Alexza's stock.


In any merger arbitrage, the risk is in the failure of the deal to close. Based on the factors above, I think this is unlikely. The downside in the event of a failed tender here, however, is larger than typical. Prior to the offer, ALXA had been trading in a range of $0.50 to 0.60, with a 12-month low of $0.22. The company burned $7.7 million of cash in the most recent quarter, ending with $4.5 million in available cash and $84.9 million in liabilities. I model the value of the company (and shares) at zero in the case where the tender is not completed.


For a small amount of deal premium (let's call it a penny at the time of this writing), shareholders get CVRs with a potential value much higher than that. The CVRs will not be listed and will not trade. They expire after 15 years. Note that the count of CVRs will be substantially higher than the current common share count at the acquisition due to dilution. RSUs (0.05 million), options (2.1 million), and warrants (5.6 million) increase the CVR count and the denominator in the CVR payout calculation.

The merger agreement gives the details of the CVR milestones and payments. Milestones are triggered by licensing payments related to the Staccato drug delivery technology, and base payments are as such:

CVR Milestone Schedule

Note that these base payouts are modified by various advisory fee deductions and adjusted payment calculations. Computation examples at the end of the merger agreement do little to clarify exactly what the actual payments might be in the event of the achievement of various milestones. They do, unfortunately, show cases where the milestone is reached, and yet the payment is zero due to the arcana of the computation. A great deal of the uncertainty here is due to the indeterminate nature of the fees and expense reimbursements eventually due to the Alexza's advisors on the deal.

The CVR payouts must also be adjusted for probabilities for success of reaching milestones. Considering the heretofore low utility of the technology and the relatively high hurdles for the licensing payments, I place long odds on success here.

Lastly, it's important to place a discount rate on the cash flows to be able to compare them to current prices. Applying these discounts, I get a CVR present value of $0.17 $0.05. Note: Astute reader Alpha Vulture caught an error in my spreadsheet.

ALXA PV Calculation

Small changes in my assumptions here give wildly different values, and frankly the assumptions aren't all that exact to begin with. Despite this, the exercise is useful for pointing to an order of magnitude of CVR value. A $0.17 $0.05 expected value of the CVR compares quite favorably with its net cost of $0.01.


In summary, the odds of the deal completing appear high, and the risks in the case of failure are also high. However, the expected payout is excellent relative to the net cost of the CVR.

After correction of my spreadsheet error, this trade looks attractive, but less so than I previously thought. I intend to tender my shares as originally planned. I apologize for the error.

Disclosure: I am/we are long ALXA.

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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