Alcobra Is A Net-Net That Could Sell Itself

About: Arcturus Therapeutics Ltd. (ARCT)
by: Safety In Value

The company trades below Net Current Asset Value.

Activists have forced management's hand into a strategic process.

Israeli NOLs could help with a sale to another local biotech.

This article originally appeared in the Microcap Review.

Alcobra (ADHD) is a biotech company with a failed product. It has historically tried to develop a drug, but it failed its Phase III trial. The company has a significant cash balance, although it is burning cash for G&A as it has no revenue. This description more or less fits the vast majority of biotech net-nets: companies that have money but will most likely spend it on something that the market has already concluded was a failure.

If that was all there was to the story, I wouldn't be interested. But in this case, an activist has already gotten involved. You can see Brosh Capital's letter to the company here. But that isn't all that has happened. In fact, I would go so far as to say the activists have already won.

First, the CEO stepped down. After that, the company entered a cooperation agreement with the activists in exchange for a standstill. Finally, it announced a strategic alternatives process, a search for monetization or partnering of its drug development assets, and 65% reduction in staff (including the chief medical officer) which should reduce G&A go-forward, and provide comfort it isn't spending more on research.

I think by far the most likely outcome is that this is sold or liquidated. There have also been rumors in the Israeli press of a takeover by Regenera at a premium, but if that doesn't pan out, a liquidation would be a perfectly acceptable outcome for shareholders.

The company has delayed its annual meeting a number of times, most recently to October 19, 2017. The announcement of that delay had some interesting wording:

  • The parties also agreed that the Company's upcoming Annual General Meeting ("AGM") would be postponed until September 1, 2017, and, if needed, further postponed as long as Alcobra's strategic review process is ongoing and satisfactory to both parties.
  • The parties have agreed that the AGM will be postponed until October 19, 2017, based on continued progress on the strategic process.

In my opinion, they may be trying to have a transaction for shareholders to vote on at the annual meeting. Given the short timeline between now and the meeting, that has a potential to be a short timeline catalyst.

The company has $40.5 MM of current assets (almost all cash and marketable securities) after deducting all liabilities as of its most recent financials. It had significant one-time expenses in the last quarter, for employee terminations and other restructuring type items as well, so cash burn should come down considerably going forward.

The cash burn is obviously an important factor here. It had $2.1 MM of G&A in the last quarter, but $1.4 MM of that were one time charges related to the strategic review, severance, stock compensation, etc. Even assuming it doesn't save anything from the 65% reduction in staff on the G&A line gives $0.7 MM cash burn going forward per quarter. It also had $1.7 MM of R&D and pre-commercialization expenses. Given it announced its chief medical officer was leaving and it announced it was continuing drug development as late as the end of May (two-thirds through the quarter) it had significant costs in the quarter that aren't recurring. With no development, and 65% of staff including the chief medical officer gone I suspect a 50% reduction in those expenses is conservative, so I will estimate $0.85 MM of R&D and pre-commercialization expense going forward. That is a total of $1.55 MM, offset by interest income of $0.15 MM, for a total cash burn of $1.4 MM per quarter. If it takes them 2 quarters to complete a transaction, that suggests an NCAV of $37.7 MM.

The company has 27.562 MM shares outstanding. Given its terrible share price performance, almost all of the options are out of the money, so the diluted share count is approximately 27.9 MM shares. The strikes on these few options are so low that the cash on exercise is nominal. That leaves a net current asset value per share of $1.45, (or $1.35 after 2 quarters at my estimated burn rate) and the current price of $1.12 is a significant discount to that value, suggesting a reasonable margin of safety is present here.

It is worth noting that it appears NOLs could be used to cover any capital gains on the sale of its IP based on Israeli tax law. However, that same tax document indicates that NOLs are not transferable unless the business is being continued, so it isn't likely that value will be generated from an NOL shell strategy here given its Israeli incorporation.

The best outcome here would probably be an acquisition by an Israeli based drug company of some kind that could use the NOLs while credibly claiming to be continuing its drug development business, even if all it did was keep the patents warm. In that case, the value might be higher than the NCAV, which would be a nice surprise.

This article originally appeared on the Microcap Review, when the share price was $1.01 per share. The service focuses on undervalued microcap stocks, with monthly features on small arbitrage plays, net-nets, and dividend stocks. Subscribe now to lock in the current low rate of only $32/month, with an additional discount for annual subscriptions.

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Disclosure: I am/we are long ADHD. 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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